Was Elon Musk Overpaid?

Two executive compensation experts on the Tornetta v. Musk decision and its potential impact on how the chief executive is paid.

The Delaware Court of Chancery's late-January 2024 finding in the shareholder derivative action Tornetta v. Musk may be one of most impactful decisions in the annals of executive compensation, with the Court voiding the Tesla board's proposed compensation package, which had the potential to net Musk a $55.8 billion or more, depending on Tesla's future stock performance. Chancellor Kathaleen McCormick's post-trial opinion on the case, which extensively cites and quotes an amicus brief written by Directors & Boards executive editor-at-large Charles Elson, opens with the question “Was the richest person in the world overpaid?” and then makes an extensive argument as to why that answer would be “Yes.” To get another perspective on the question, as well as to get additional insights on the case's impact on executive compensation planning, the importance of shareholder alignment and more, we spoke with Don Delves, managing director, practice leader, executive compensation, North America, for WTW; and Margaret Engel, founding partner of Compensation Advisory Partners.

Directors & Boards: How do you think the Delaware Chancery Court's finding in Tornetta vs. Musk is going to change executive compensation planning going forward?

Don Delves on executive compensation
Don Delves

Donald Delves: Probably not significantly. There are always a small handful of companies that pay their top executives far more than the vast majority of companies. While most boards may take a passing interest in these headline-making pay packages, they tend to return quickly to the realities of competitive pay and performance for their own company and industry. However, there are important distinctions in this case that may be instructive to boards.

Margaret Engel on executive compensation
Margaret Engel

Margaret Engel: We don't expect huge changes in compensation plans going forward, because other compensation plans don't rise to the magnitude of Tesla's 2018 grant to Musk. What we do foresee is that public company boards, and compensation committees overseeing founder compensation, will pay more attention to the decision-making process.

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Based on review of the Court's opinion, the circumstances surrounding Tesla's 2018 grant to Elon Musk were unique. The quantum of the grant was immense since the grant date fair value (i.e., the non-cash expense booked by Tesla to account for the grant) totaled $2.2 billion. That's billions with a B, not millions with an M! The grant provided the opportunity for Musk to receive 12% of Tesla's outstanding shares if the performance hurdles were met. The award of a 12% grant to one person is also enormous compared to typical practice.

In fairness, the performance hurdles, particularly the requirement that Tesla's market cap increase by $50 billion for each 1% tranche to vest, as well as the requirements to meet certain revenue and profit hurdles, were viewed as extraordinary at the time. It's also relevant that the grant reportedly was approved by 73% of shareholders, given the perceived difficulty associated with the performance hurdles.

The 2018 grant coined a new phrase in executive compensation — the “moonshot” award — because of the perceived difficulty. Quite a few companies, particularly founder-led tech companies, copied the approach. But to our knowledge, none of these companies made equity grants that were remotely close to the size of the 2018 grant made by Tesla.

The Tesla board had exposure because the testimony indicated that there were significant personal and business relationships between board members and Musk, which created the appearance that the board lacked independence. The Court also concluded that the process did not include an arm's-length negotiation between the board and Musk. Instead, the Court believes that Musk dictated his own terms, which is a real governance issue if true.

DB: Is it proper or necessary to provide incentives — and stock incentives in particular — to a CEO who already owns substantial stock in the company?

DD: This is a fairly common question, particularly for boards of private, family and founder-owned or -led companies. The general practice is to separate an individual's non-compensation ownership interest from the pay decisions for that person. Pay levels should be determined based on performance and the competitive market for each person's position, regardless of their non-compensation ownership interest, or whether they are a founder, family member or investor. This helps maintain the integrity of the company's pay structure and governance process.

However, compensation-related ownership is sometimes taken into consideration in making pay decisions. This refers to stock, options or other vehicles held by an executive as part of their compensation package from current and prior years.

ME: We believe it is both proper and necessary to provide incentives, particularly stock incentives, to CEOs, even to those with substantial ownership stakes. In fact, it's routine for public companies to compensate CEOs in this way. In many cases, a founder brings unique talents that contribute to the success of the business over time.

In a free market, a founder has the option to either lead or step back from a business by hiring professional management to run the company. The latter comes at a cost, so most boards determine the market value of executive oversight and pay the founder commensurately with that standard. The mix of cash versus stock often varies, however. Some founders prefer to receive packages heavily weighted toward stock. Others prefer an overweight on cash. In either case, the total value of the package normally can be justified by market practice.

In addition, regular grants of stock as part of a compensation package create alignment with shareholders who invest in the stock at different points in time. In other words, the pay packages are designed to provide rewards for the continued success of a business over time.

DB: In general, how much is too much to pay a CEO?

DD: Boards and their compensation committees make this assessment every year as part of their ongoing governance process. The actual question is “What is the right amount to pay our CEO and how should the pay package be structured?” Boards make this assessment by following tried-and-true processes of making extensive comparisons to what peers and other companies pay for running companies of similar size and scope, and in similar industries. Comparisons are also made based on relative performance. Compensation is generally considered to be fair if it falls within the range of competitive practice, and relative pay levels reflect relative performance levels over time. The general view is that there is a fair market for CEO talent and an abundance of data on competitive pay and performance.

ME: $2.2 billion appears to be an upper limit! On a serious note, boards normally benchmark compensation to determine the going rate for executive pay packages and then apply judgment to position an individual's pay against that range and factor in company performance. Apparently, this did not happen at Tesla.

DB: How important is it for an executive compensation plan to be aligned with shareholder concerns?

DD: It's extremely important. One could argue that the number one objective of an executive compensation plan is to align the interests of management with those of the owners — and to motivate the management team to pursue those interests. This typically involves incentives that reward stock performance, achievement of strategic objectives and hitting or exceeding goals for specific value drivers. The board and compensation committee monitors and evaluates how this connection is established and how well it operates over time.

Note, however, that the amount of compensation offered and delivered is also part of shareholder alignment. The board and compensation committee must determine whether the relative amount of pay is reasonable and fair to shareholders. This is typically achieved by reference to competitive market practices, as was discussed previously.

ME: It's critical to create alignment between executive compensation and shareholder interests. Public company boards and compensation committees test that relationship all the time. They will look at the magnitude of pay relative to results to ensure alignment, so that pay reflects long-term company performance and shareholder value creation.

DB: What lessons can boards take away from this case about good (and bad) governance?

DD: While there are certainly lessons here about board independence or lack thereof, we'll keep our comments focused on compensation. The lessons here are fairly straightforward and reinforce standard good compensation governance practices:

  • Use the abundance of excellent, objective data available to you on competitive pay levels, practices, payouts, share usage, incentive structures, etc.
  • Stay within the range of competitive practice and try to match relative pay to relative performance over time.
  • Make sure that pay and incentive design are well aligned with the interests of shareholders over time.
  • Although pay design and pay levels are related, they are distinct elements that must be considered separately as well as together. Questions to be addressed include:
    • Is our pay program designed properly and aligned with shareholder interests?
    • Is the level/amount of the package reasonable and competitive?
    • Will the resulting payouts reflect relative performance over time?

ME: A major lesson from the Court's decision is the importance of process, and how a lack of process or a failure in process can lead to unintended consequences. We expect the Court's decision to rescind the 2018 grant to be appealed, so we don't believe we have heard the end of this matter, but lapses in governance are difficult to defend. By lapses, I'm referring to the perceived lack of independence of certain directors and the lack of a true arm's-length negotiation between the board and Musk. The enormous size of the 2018 grant also contributed to the Court's decision that Tesla failed to meet the “entire fairness” standard that it applied. But, at its core, this matter was a governance issue. The consequences to Musk are enormous, since cancellation of the 2018 grants means that he would lose $56 billion in realizable value, plus any upside on the stock options.

Musk photo by Frederic Legrand – COMEO / Shutterstock.com; photo illustration by MLR Media

About the Author(s)

Bill Hayes

Bill Hayes is editor in chief of Directors & Boards.


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