Was World's Richest Person Overpaid? Delaware Court Says Yes, Tosses Out Elon Musk's $56b 'Unprecedented' Tesla Pay Package

In a challenge to billionaire Elon Musk's Tesla pay package of approx. $56bn, a Delaware court on Tuesday ruled in favor of plaintiff-shareholder(s) who pleaded that it was excessive.

The judge, Kathaleen McCormick of Delaware's Court of Chancery, held that the compensation plan was subject to review under the "entire fairness standard" and the burden to prove that it was fair was on the defendants (Musk and Tesla). However, the defendants failed to meet the burden.

"The plan is the largest potential compensation opportunity ever observed in public markets by multiple orders of magnitude—250 times larger than the contemporaneous median peer compensation plan and over 33 times larger than the plan's closest comparison, which was Musk's prior compensation plan" noted the judge.

Succinctly put, Tesla's pay package to Musk granted stock option awards, allowing him to purchase the company's stocks at heavily discounted prices if the company hit certain market capitalization and operational milestones.

The plaintiff-shareholder challenged this plan, alleging that it was a conflicted-controller transaction, inasmuch as it was dictated by Musk, and Tesla directors breached their fiduciary duties by awarding Musk a performance-based equity-compensation plan. It was contended that the Board should have looked for another CEO, or required Musk to work full-time at Tesla instead of allowing him to focus on other projects. The plaintiff also claimed that the plan was approved by shareholders who were given misleading disclosures in a proxy statement.

The defendants, on the other hand, averred that the compensation plan was fairly negotiated and Musk was not a controlling shareholder. During the compensation trial, Tesla directors argued that the company was paying to ensure that one of the "world's most dynamic entrepreneurs" continued to "dedicate his attention" to the electric-vehicle maker.

Arriving at the decision, the court observed that features characterizing Musk's relationship with Tesla and its directors gave him "enormous influence over Tesla". To list two of these features, as outlined in the judge's opinion, Musk had an equity stake of 21.9 percent (when Tesla approved his compensation plan) and he held some of the most influential corporate positions (CEO, Chair and Founder).

To the extent Musk dominated the process that led to board approval of his compensation plan, the judge found that he controlled Tesla.

It was considered that under Delaware law, a defendant can shift the burden of proof under the entire fairness standard, where the transaction was approved by a fully informed vote of the majority of the minority stockholders. But in Musk's case, though Tesla conditioned the compensation plan on a majority-of-the-minority vote, it failed to prove that the vote was fully informed.

During the analysis, the court focused on two issues ie process and price. On the first aspect, it concluded that the process leading to approval of Musk's compensation plan was deeply flawed, as Musk had thick ties with directors negotiating on behalf of Tesla and dictated the timing of the process.

"Given the collection of people tasked with negotiating on Tesla's behalf, it is unsurprising that there was no meaningful negotiation over any of the terms of the plan...consistent with this specific-to-Musk approach, the committee avoided using objective benchmarking data that would have revealed the unprecedented nature of the compensation plan".

On the price aspect, the judge was of the view that the "unprecedented compensation plan" was not necessary to retain Musk's leadership of Tesla.

"Swept up by the rhetoric of “all upside,” or perhaps starry eyed by Musk's superstar appeal, the board never asked the $55.8 billion question: Was the plan even necessary for Tesla to retain Musk and achieve its goals?"

The court also said that though Tesla insisted that the compensation plan worked, in that it delivered to stockholders all that was promised, no effort was made to prove causation.

In closing, the plaintiff was directed to work with Musk's legal team on an order implementing the decision. The decision is open to appeal before the Delaware Supreme Court.

Unquestionably bold, the ruling comes at a time when Tesla is looking at another round of compensation negotiations with Musk, who is aiming at about 25 percent voting stake in Tesla before fulfilling artificial intelligence and robotics goals.