Musk Comp Overturned: Is Shareholder Democracy At Risk?

We always hope that our judiciary branch is balanced and doesn’t decide to legislate from the bench. We really want our courts to implement the law, not make the law. The recent decision out the Delaware Court of Chancery gives me pause.

In the recent court case a class action suit was brought on behalf of shareholders claiming that TeslaTSLA -3.4% CEO, Elon Musk, was awarded too large a compensation package. The allegation said the board was not independent. There were allegations of too close a collegial set of relationships with other areas where board members were investing in other businesses together. This is nothing new in Silicon Valley. In fact, this is quite standard. The most important and critical fact is that 80% of the shareholders ratified Musk’s comp package. Further, his comp package is 100% performance driven – compensation is only earned where the company’s performance hits financial thresholds that rewards all shareholders.

When the comp package was given the market cap of Tesla was $57.44B. Current market cap is $596.47 B. The case was brought 3 years ago when the market cap was $1.061 T. Clearly shareholders benefited. The shareholders approved the compensation package. The compensation was earned based on performance achieved. There is alignment of interest. It looks like an example of judicial overreach based on a judge’s perception of what is “fair” based on personal views as opposed to the law.

It is easy to extrapolate how concerning this could become if we have courts deciding in hindsight that 80% of the shareholders should be disregarded and the judges’ personal view should override a majority of the shareholders. This is a very worrisome precedent. This overturns the notion of shareholder democracy.

One of the most important roles of the board is leadership, continuity/succession.

Musk is a successful leader. Look at the external metrics of growth, market share, introduction of new innovative products. This has resulted in a high performing stock and increasing market cap, benefiting shareholders.

Additionally, there is something unique and especially valuable when you have a founder who is a new category creator. For example, Steve Jobs is the category creator of the smartphone with elegant and intuitive customer experience.

Mark Zuckerberg is unique in creating the category of social media.

Bill Gates is unique in creating the category of office suite software.

There is a difference between compensation, equity ownership, and often innovative governance provisions, such as some controls of the board with super majority voting, and other unusual governance provisions that are emerging in some of the most influential companies coming out of Silicon Valley. These unusual governance provisions, while still not the majority practice, are becoming more common, specifically for the highest performing tech companies.

Shareholders understand they are giving up some of their rights when they vote in favor at the annual shareholders meeting. They have made the informed decision that they value the high growth, high risk and innovation that these hyper performing companies add to their portfolio.

I question the comparison looking at the compensation structure of a large cap or a low growth value automotive company like General MotorsGM -2.8%, contrasted with very high growth innovative company like Tesla. Extraordinary innovative founders understand the outsized results they create for shareholders. Some founders are special and not at all the same as “professional CEO” managers.

Compensation committees look at peer companies through multiple lenses. You look at peer companies in terms of their overall revenue size, industry/direct competitor, adjacent industry companies. You look if the company is a value or a growth company, where your company’s talent will be recruited from, among many other factors.

It is critical that the shareholders have their say.

80% of Tesla shareholders voted in favor of Musk’s 2018 compensation package.

This ruling, if allowed to stand, creates a slippery slope that a judge can decide to overrule and opine on what is an “appropriate” compensation. The role of the judiciary is to see if the governance process followed the rules.

Governance process: There was a compensation consultant that the compensation committee used in constructing the 2018 compensation plan. The plan is based on performance that was quantifiably measurable. The biggest institutional shareholders along with retail shareholders voted 80% approving the plan.

This judge clearly is offended by the quantum of Mr. Musk’s compensation. “The board never asked the $55.8 billion question: Was the plan even necessary for Tesla to retain Musk and achieve its goals?” the judge wrote. She’s offended by the absolute dollars. She is not evaluating the fact that the compensation is based on performance with threshold of very specific quantitative performance metrics that only paid out when the threshold was met. While very high relative to the market, the award was all predicated on objective, pre-set performance criteria that were disclosed to all shareholders. Tesla’s revenue for the twelve months ending September 30, 2023 was $95.924B, a 28.13% increase year-over-year (as opposed to 24.6B in 2018.) There are very few companies with this scale revenue still growing at almost 30%.

This is a performance compensation package aligned with the interest of the shareholders. We will harm our innovation culture that rewards breakthrough new category creating companies if we have activist judges deciding CEO pay and nullifying the shareholders and the board.

Just as the board has to respect its role that it does not manage the operation of a company. So too judges have to stay in their swim lane and make decisions based on the legal rules of the governance that speak to the importance of process. The compensation committee has a duty of care to get outside information, look at market practice and apply them to the specifics of the individual corporate situation. Then the board discusses and deliberates, reaching a business judgement they believe is in the interest of the shareholders.

Shareholders need to be able to have the opportunity to diversify their portfolio.

Shareholders need to be able to have broad asset allocation choices for their portfolios. Shareholders need asset classes that are high risk, high growth and high volatility, along with offsetting it with other asset classes such as value stocks that are cash generating, dividend payers, fixed-income, large cap, small cap, mid cap, etc. By overruling the shareholders Chancellor McCormick is implicitly saying that investors are not competent enough to do adequate diligence and make sound business investment decisions, and that she knows better.

My view is that the Delaware chancery justice will be overturned on appeal. The key argument comes down to the transparency to the shareholders. 80% of the shareholders voted in favor. They were rewarded alongside CEO Musk with an 800% (8x) return of their investment.

It is a sad day for the US business community when we have activist judges second guessing shareholders and boards.

Ultimately, the question for shareholders, as when looking at any CEO in retrospect is whether the shareholders feel they got their money’s worth.

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