Explainer: Bombshell decision vs Elon Musk’s pay: What happens next?

Elon Musk’s proposed $56-billion compensation plan is massive. Shareholders approved it back in 2018, based on hard-to-reach milestones. But in a bombshell 200-page decision in January 2024, a US judge struck it down for being “excessive”, among others.

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The original pay plan was approved by shareholders six years ago, two years before the best-seller Model Y was launched, and long before Tesla hit a $700-billion valuation.

Is the payment in cash?

No.

Musk does not get a salary from Tesla, as the compensation deal comes in the form of stock options – which was tied to company performance.

Here’s what you need to know:

Opposition to compensation plan

The compensation plan requires approval by Tesla shareholders on Thursday (June 13, 2024).

Thursday’s shareholder vote reflects an attempt at a redo after Delaware Judge Kathaleen McCormick’s ruling in January scrubbed the original 2018 pay plan for Musk approved then by the majority of shareholders.

Stock options, not cash

The payout plan for Musk would not be a direct cash sum. Instead, he would receive stock options that vest only if Tesla achieves ambitious market valuation goals over the next decade.

Since Musk did not take a salary, the shares were his incentive. Shareholders who support the payment plan said honouring the contract now for Tesla’s past performance is the right thing to do.

How much does the lawyer want?

The law firm that successfully argued against Musk’s pay package is now asking close to $6 billion in legal fees – also in the form of stock options. This translates to an hourly rate for the lawyer of around $288,888, according to court filings.

Why is Musk's pay package (back in 2018) controversial?

Massive size:

The size of the package, estimated at $56 billion, is unprecedented for a CEO.

Stock options, not performance-based:

The payout is tied to Tesla’s stock performance, with Musk receiving stock options that kick in only if the company reaches specific market valuation milestones.

Critics argue this doesn’t directly incentivise strong day-to-day performance from Musk, but rather focuses solely on stock price. They believe a CEO’s pay should be more well-rounded and consider broader company goals.

Lack of shareholder control:

Some proxy advisory firms, who advise shareholders on how to vote, believe the structure of the pay plan gives “too much” control to Musk. Since it’s tied to stock options, achieving the valuation goals would “significantly” enrich Musk, potentially at the expense of other shareholders”.

Focus on stock price over other priorities:

There’s also a concern that prioritising stock price growth above all else could lead to neglecting other company priorities – like employee well-being, safety standards, or environmental responsibility.

Investors who don’t solely focus on stock price gains might be wary of a pay plan that incentivises this. The controversy boils down to whether such a massive, stock-based compensation plan truly aligns with Tesla’s long-term interests and fairly rewards Musk's contributions.

How did Musk’s Tesla compensation grow so big?

Tesla’s accounting fair value for Elon’s compensation plan award was $2.3 billion in 2018 when it was issued. It grew to $56 billion, a value approved by a majority of shareholders based on milestones they have agreed upon back then (2018).

The size of the award grew in proportion to the value that Musk and Tesla created for the shareholders. Tesla debuted at the New York Stock Exchange in 2010 at $17. Its share price surged to a peak price of $2,000, becoming one of the highest priced shares on Wall Street. Tesla completed a 5-for-1 stock split back in August 2020.

Before the 3–for-1 stock split in August 2022, Tesla shares closed at $891.29, which meant that Tesla’s share price soared by a whopping 5,251 per cent till then.

It closed $170.66 (post 3-1 split) on Tuesday (June 11, 2024), down 31.30 per cent since January.

My position is that it’s not obvious that the vote will do what they (shareholders) think it is. It’s legally questionable whether or not it (fresh vote by shareholders on the compensation package) can undo the judge’s ruling. It’s gonna lead to a lot more litigation.

- Ann Lipton, a Tulane Law Associate professor

For perspective, GM and Ford each spent $4 billion on advertising in just one year: 2018. Until very recently, Tesla never paid for advertising (and even now, it’s nowhere near $4 billion per year).

Thus, Elon's pay package at $2.3 billion was less than the annual advertising budget of Ford and GM. Yet Tesla generated over $600 billion in value for Tesla shareholders.

What do investors and lawyers say?

About six years ago, Jim Chanos, the investor known as a Tesla "short", explained why he was shorting (betting that stock price would go down) Tesla -- executive departures; stock has made no progress in years; earnings estimates falling, incinerating capital; production problems; Tesla has nothing unique; and the competition is coming.

After more than a 10x rise in Tesla's share price, Chanos had to shut down his short fund, and his followers saw their short positions incinerated.

Cathie Wood, of ARK Invest, said it’s time to honour Musk’s compensation plan: “I’d argue that no other executive is as aligned with shareholders as Elon Musk who committed with no salary, no bonus, no stock comp for 10 years, unless he created tremendous value for Tesla shareholders.”

I’d argue that no other executive is as aligned with shareholders as Elon Musk who committed with no salary, no bonus, no stock comp for 10 years, unless he created tremendous value for Tesla shareholders.

- Cathy Wood, ARK Invest

Venture capitalist Naval Ravikant, describing the invalidation of Musk's pay package as "politically motivated", has threatened to sell all Tesla holdings if Musk's pay plan is rejected, but says he'll buy more if approved.

On the other hand, Ann Lipton, a Tulane Law Associate professor, told CNBC recently: “My position is that it’s not obvious that the vote will do what they (shareholders) think it is. It’s legally questionable whether or not it (fresh vote by shareholders on the compensation package) can undo the judge’s ruling. It’s gonna lead to a lot more litigation.”

“If a mutually-agreed contract can be rejected by a judge years later, how would business work in the future? Similarly, can we undo vote result for president after the election day?” asked another shareholder.

Moreover, they cited that it is legally questionable how the shareholder with 9 shares can bring a case to court and a judge can overrule the majority of shareholders in the first place.

“The court ruled in favour of breaching contract and not paying people for their hard work, based on something that can’t even be proven. In a way, the court is ruling in favour of personal bias over data and against Tesla’s investors wishes.”

“This boggles my mind. It's a ton of money, true. But he was promised that amount. No one complained when their shares skyrocketed 700 per cent. Especially with the majority voting in favour when they thought Musk is not going to get much.”

What happens if the compensation plan is not approved?

If Musk's compensation plan isn't approved by Tesla shareholders, the outcome could unfold in a few ways:

Renegotiation:

Tesla's board might go back to the drawing board, develop a new compensation plan addressing shareholder concerns and adhering to the court's previous ruling. This could involve reducing the overall size of the package, changing the structure of the stock options, or increasing board oversight during the creation process.

Performance-based pay:

The board could shift to a more traditional performance-based pay structure that ties Musk's compensation directly to achieving specific company goals, not just stock price. This could incentivize broader success for Tesla beyond just short-term market gains.

Lawsuit impact:

The outcome of the shareholder vote could influence the ongoing lawsuit regarding legal fees for the lawyers who challenged the original plan. If shareholders reject the revised plan, it might strengthen the argument that the initial proposal was truly excessive.

Still, there are more things to consider:

Musk's Influence:

Even if the plan fails, Musk still holds significant influence as CEO and a major shareholder. His future compensation would likely remain a hot-button issue.

Update on shareholders’ vote

On Thursday, Sawyer Merritt, an X-verified EV industry tracker, wrote: “Tesla shareholders have officially re-approved Elon Musk's 2018 compensation package, and approved Tesla's reincorporation to Texas, according to @elonmusk”.

Signal to other CEOs:

Rejection of the plan could send a message to other companies and CEOs that such large, stock-option-based pay packages might not be readily approved by shareholders.

Overall, a failed vote would force Tesla to re-evaluate Musk's compensation and potentially set a precedent for CEO pay in similar situations.

And then?

If companies like Tesla will not get the passionate, innovative and sleeping-rough-during-production-hell kind of leadership that it currently has with Musk, his focus and the company's rate of innovation may be affected, or slow down.

Better-led EV makers would easily kill Tesla with a faster rate of innovations and more compelling products. The global new energy and self-driving contest is already shifting east-ward, a trend pregnant with long-term geopolitical implications.

With US tech leadership being disincentivised at the corporate level, or reversed through the courts, any edge that its remaining innovative sectors enjoy could be blown to smithereens.