20230913 elon musk
Elon Musk, chief executive officer of Tesla. Image Credit: Bloomberg

Questions abound after a Delaware judge struck down Elon Musk's pay package, ruling that the biggest payout ever granted to a corporate executive was unfair and should be voided.

What does this mean for Tesla Inc., which issued the award, and for Musk, who has already been pushing for even more compensation? How might it impact shareholders? And what happens next?

What's certain is that this adds another chapter to the strange and winding saga of Musk. It's another instance of the centibillionaire clashing with the legal boundaries that publicly traded companies must contend with.

What's the deal with this pay package anyway?

It was unique both in size and scope "- a big chunk of stock options split into 12 pieces. The payout of the options was contingent on three sets of increasingly steep targets to grow Tesla's market value, revenue and adjusted earnings excluding certain expenses. Each time Tesla exceeded a market value goal and one of the other two goals, Musk would receive one piece of the award.

When the package was proposed in early 2018, the goals seemed like moonshots. The top threshold in each category required Tesla to grow by more than 11-fold. But the payoff was equally staggering: each tranche of options corresponded to 1% of Tesla's outstanding shares. If fully earned, it would yield Musk a roughly $50 billion payoff.

At the time, critics said the package was way too big. But Tesla called shareholders to a special vote, and two-thirds of them approved it. Tesla then made unprecedented progress scaling up its EV business, becoming one of the world's most valuable companies. By the end of 2022, Tesla met enough of the goals for Musk to receive the entire award.

Why did Tesla's board want to pay Musk so much?

When it was granted, the board said it meant to "motivate and incentivize" Musk, who was worth $21.5 billion and beset by questions about whether he was devoting enough time to Tesla. Some speculated he might depart the company, or hire a CEO to replace him.

But another factor played a big role: control. Tesla continually issues new shares to give employees in the form of stock awards. As more Tesla shares flood into the world, everyone's stakes shrink on a relative basis "- including Musk's. In finance speak, this is called dilution.

The 2018 award would help Musk boost his stake. Just this month, before the Delaware ruling, he said on X it might be time for yet another massive award to ensure "the right amount of voting influence."

"If I have 25%, it means I am influential but can be overridden if twice as many shareholders vote against me vs for me," Musk wrote. He currently has roughly a 20% stake in the company when including the options from the 2018 award.

Has Musk exercised any of the options? If not, why hasn't he?

No. The terms of the award entitles Musk to exercise them whenever he wants to, though he's barred from selling any of those shares for the next five years. (He's allowed to sell enough shares to cover his tax liability and the exercise costs.)

The lawsuit challenging the award was filed in June 2018, only months after it was proposed and approved. Had Musk exercised options, unwinding those transactions in the event that the court ruled against Tesla likely would have been difficult, and perhaps costly.

What happens to the options now?

It depends on Tesla's next move. If the company appeals the ruling, the options likely will stay put until that process concludes. If the company accepts the ruling, the options likely will be unwound at some point. Options are just a financial instrument, and there's no cash or shares changing hands until they're exercised. So they effectively would just disappear.

Why was this pay package challenged? Can't boards pay CEOs however much they want?

Not necessarily. Directors who sit on boards of directors represent shareholders. They are obligated to put shareholders' interests ahead of their own. One of their most important jobs is to hire, fire and serve as a check on the CEO. This can be tricky in situations where the CEO also is a big shareholder, is famous or holds large personal sway with people in the boardroom.

The plaintiff in the Delaware case is a Tesla shareholder who says the board failed to exercise independence from Musk when it created the 2018 pay package. In her ruling, the judge said the process that led to Musk's plan was "deeply flawed" and that he had "extensive ties" with the people involved.

But didn't a majority of shareholders approve this pay package?

Yes. Tesla's board held a shareholder vote about the award even though it didn't have to. Around 73% of votes cast at the meeting were in favor of the award. But the judge said in her ruling that the court has the authority to remedy corporate transactions regardless of whether or not a vote is legally mandated.

Can the board just give him another pay package?

It could. But it's in a thorny position now and under a lot of scrutiny. The judge pointed out several weaknesses with the people who were involved with formulating Musk's 2018 pay. Several of the directors have known Musk for a long time "- some of the directors vacationed with Musk and his brother was also on the board.

The judge said Tesla employees who were part of that group were beholden to Musk, and that this led to a lack of independent thinking. So while Tesla has shuffled its committee of directors that set executive pay, chances are the board might meet opposition even if it granted Musk a smaller pay package.

What does this mean for Musk's $205 billion fortune?

Nothing for the moment. Tesla is likely to appeal the ruling, which will start the process over again. Until the company announces next steps, the options "- valued at about $51 billion "- will remain part of Musk's fortune and underpin his position atop the Bloomberg Billionaires Index.

What does this mean for Tesla shareholders?

The drama could be an overhang for Tesla's already-slumping share price. The ruling may also have longer-term implications: Musk floated the idea of trying to move the company's state of incorporation to Texas from Delaware. It could spur the board to appoint new directors.

But Tesla has done really well since the award was granted. So what's the big deal?

It has, but that's not the point. The judge concluded that Tesla failed to prove that the grant was solely or directly responsible for Musk's efforts, and that those efforts in turn were solely or directly responsible for Tesla's growth.