The $25 Billion Threat: Were Tesla's Directors Lying, Or Are They That Reckless?

The Board threatened to drive Tesla's share price to single digits unless the shareholders approved the "ratification." Are they idiots, or just liars?

I. Introduction

This Friday, August 2, the Chancellor presiding over Tornetta v. Musk¹ will hear arguments on whether the June 13 shareholder vote had the legal effect of erasing her January 30, 2024 ruling that rescinded the Tesla Board’s 2018 grant of stock options to Elon Musk (the 2018 Grant).

We² have already written extensively about the flawed proxy process leading up to the shareholder vote, and have detailed the salient arguments in the legal briefs filed by both the Plaintiff and Defendants.

This post focuses on Plaintiff’s argument that the shareholder vote was coerced (and hence ineffective) by the threat from Tesla’s Board that if the shareholders voted against ratification, then the Board would award Musk a replacement package that would cost Tesla at least $25 billion.³

We think that threat was an outrageous breach of fiduciary duty by Tesla’s directors, and we believe it was obviously coercive and consequently poisoned the entire proxy process and vote. In this post, we explain why.

(Musk & his director muppets, as interpreted by Microsoft Designer AI)

II. What the Proxy Statement Said

In the proxy statement, Tesla’s Board strongly implied that if the 2018 Grant were not restored, then the Board likely would make him a new grant that would come with a $25 billion price tag for Tesla.

Here is the language from the proxy statement:

Seeking Ratification Now Potentially Avoids Other Costs.   The Special Committee also noted that if the 2018 CEO Performance Award is not ratified, then Tesla may need to negotiate a replacement compensation plan with Mr. Musk in order to motivate him to devote his time and energy to Tesla. Negotiating a new plan would likely take substantial time in light of the criticisms in Tornetta of the process that led to the 2018 CEO Performance Award. And any new plan would, of course, require Mr. Musk to agree to the terms and amount. Although the Special Committee expressly and consciously did not negotiate (or renegotiate) with Mr. Musk about his compensation, it expects from its interview with him that, for Mr. Musk to agree to it, any new plan would need to be of a similar magnitude to the 2018 CEO Performance Award.

. . . [A new compensation plan] would likely result in a very large, incremental accounting charge for compensation expense. For illustrative purposes, the Company’s accounting team informed the Special Committee that a new grant of 300 million fully vested options — functionally equivalent to what Mr. Musk had before the Tornetta Opinion — would potentially result in an accounting charge in excess of $25 billion, depending on certain timing and valuation factors.

III. Why the $25 Billion Figure?

Let’s begin with what is defensible in that language from the proxy statement. A stock options package awarded today that would be equivalent to what Musk would have received under the 2018 Grant would indeed result in a compensation expense on Tesla’s income statement of approximately $25 billion. That’s because Tesla would have to award Musk “in-the-money” options, allowing him to buy Tesla stock that is trading (at the time we are publishing this post) for about $220 at a strike price of only $23.33. An outright grant of stock would come with the same astronomical price tag.

When the 2018 Grant was made, Tesla’s share price was much lower. That fact, combined with some highly aggressive assumptions by Tesla’s compensation consultants, allowed Tesla to beat down the compensation expense to only $2.6 billion. But even the most creative and aggressive efforts today would be unable to get the expense figure below $25 billion.

All of this underscores, of course, that stock-based compensation (whether by direct grants of stock or by stock options) is a real expense. While stock-based compensation is not a cash expense, it imposes a real cost on all the other shareholders by diluting their holdings.

IV. Why the Board’s Threat Is Outrageous

There are several reasons why the threat of a $25 billion compensation expense is outrageous. Let’s take them one by one.

A. Why would Tesla need to negotiate any replacement package?

The Special Committee said Tesla may “need” to negotiate a replacement package with Musk “in order to motivate him to devote his time and energy to Tesla.”

Why would there be any such need when Musk’s existing equity ownership already gives him ample motivation to achieve increases in Tesla’s operating metrics and market capitalization? The Chancellor made exactly that point in her January 30 ruling. And yet, astonishingly, neither the Tesla Board nor the Special Committee wanted to ask that question.

B. Who cares whether Musk ‘agrees’ to any new package?

Let’s look again at this language from the proxy statement:

[The Special Committee] expects from its interview with him that, for Mr. Musk to agree to it, any new plan would need to be of a similar magnitude to the 2018 CEO Performance Award.

The Special Committee’s “interview” with Musk is one of the great mysteries of the proxy materials. The shareholders are not informed when it happened. They are not informed who requested it, or for what reason. They are not informed who was present. They are not informed what questions were asked or what responses were given.

The sum total of what the shareholders learn about that interview is that Musk indicated that for him to agree to any new compensation plan, the plan would have to be of a “similar magnitude” to the 2018 Grant.

Okay, well, if Musk won’t agree to anything less, then why isn’t that his problem? The Tesla Board does not have to offer him anything at all. By reason of his stock ownership, he already has a massive incentive to see Tesla succeed. Tesla is the source of all his liquidity. To buy Twitter, he sold Tesla shares. His income is (tax free) derived from margin loans supported by the pledge of Tesla stock.

Musk simply cannot afford to leave Tesla. Given these facts, any independent board of directors, operating with these irrefutable facts, would simply tell the CEO that he has it backwards: the company doesn’t need him nearly as much as he needs it.

C. If Musk is now threatening to leave, where is the disclosure?

Musk made emphatically clear during his 2022 trial testimony that he was not threatening to leave Tesla if the 2018 Grant wasn’t approved. From the January 30 Post-Trial Opinion (footnotes omitted):

In other words, Musk had every intention of remaining “significant[ly] involved” in some leadership role at Tesla, even though he did not envision himself being “CEO forever.” Musk repeated this assertion at trial, stating unequivocally that he would have remained at Tesla even if stockholders had rejected a new compensation plan because he was “heavily invested in Tesla, both financially and emotionally, and viewed Tesla as part of his family.” Trial witnesses similarly testified that they never heard Musk say he had any plans to quit Tesla. And even though Musk did not intend to stay CEO forever, he had no immediate plans to resign from that position. Corroborating that fact is lack of any succession plans during the relevant period.

Was there some new threat that Musk will leave Tesla, even though the economic reality is that he cannot afford to do so? The proxy statement gives absolutely no indication that is the case.

If Musk were actually threatening to leave Tesla if the ratification vote failed, or if a replacement package were not approved, then the absence of any mention of that threat in the proxy materials is, to say the least, a massively material omission in violation of the securities laws.

D. If Musk is threatening to leave, then that amounts to wrongful manipulation.

If Musk is indeed threatening to leave Tesla (and Defendants’ briefing strongly suggests as much, even though the proxy materials do not mention it),⁴ then such a threat would create even bigger problems for Musk. In connection with the April 2022 trial in Tornetta, Plaintiff argued that Musk was guilty of manipulative conduct, and pointed to Musk’s May 2018 statement that he would not remain CEO forever. The Chancellor was not convinced. Again, from the Post-Trial Opinion (footnotes omitted):

Plaintiff argues that this statement was intended to pressure the Board. That is not a far-fetched theory, but it is not supported by the record. The more likely explanation is that Musk was considering stepping down from CEO to become Chief Products Officer. Another likely explanation is that Musk lacks a filter, so his public statement easily could have been a momentary thought that immediately found expression. In all events, he clarified his intentions at the time and at trial: Musk is committed, Tesla forever.

In other words, if the story from the Special Committee or the Tesla Board is that it was proper to threaten a hugely costly replacement package if the ratification vote failed because without ratification Musk would leave Tesla, then that amounts to saying Musk was improperly manipulating the vote.

Again, this problem is all the more serious because the proxy filings contain absolutely no disclosure that Musk is threatening to leave Tesla. You cannot cure the omission of a material fact from the proxy statement by disclosing it in after-the-fact legal briefing.

V. What Will the Board Do If They Lose?

As we have written, we see several compelling reasons to believe the Chancellor will find the June 13 ratification vote legally ineffective to undo her recission of the 2018 Grant. So, then what?

The Board threatened to saddle Tesla with a massive compensation expense if the ratification vote failed. If that vote turns out to have been legally ineffective, then it is the equivalent of a vote failure. Will the Board go ahead and award a replacement package, costing Tesla at least $25 billion?

OF COURSE IT WILL NOT!!!

Why not? Several reasons. Let’s consider.

A. Tesla would risk exclusion from the S&P 500.

Slapping a $25 billion compensation expense onto Tesla’s books would wipe out its profit in 2024. Based on the Q2 results, Tesla’s annual profit right now works out to $5.9 billion. So, a $25 billion compensation expense would insure that Tesla has a massive loss (approximately $19 billion) this year.

Well, you might say, many shareholders will overlook a one-time hit to profits. Perhaps that would be true if such a one-time hit would not place Tesla in peril of exclusion from the S&P 500. But such peril would exist. S&P eligibility requires (among other things) positive GAAP income for the trailing four quarters as well as in the current quarter. Companies admitted to the S&P 500 which later fail to meet the eligibility criteria can be excluded, and are then not permitted to apply for re-admission for another year.⁵

A great deal of Tesla stock is held in S&P 500 index funds. Were the institutions managing those funds required to sell Tesla stock because of exclusion from the index, the downward pressure on the share price would be ferocious. (Recall that Tesla’s astonishing price rise in 2020 occurred in anticipation of its inclusion in the index, with the consequent buying pressure.)

B. Shareholder sentiment is changing.

Since the June 13 shareholder meeting, Tesla has reported its second straight quarter of shrinking profits. Its forward price/earnings ratio is now about 120 — an utterly fantastical number for an auto manufacturer, where the industry average is closer to five or six. And but for regulatory credits, which are in political peril, the P/E ratio would be even higher.

On the earnings call, Musk again underlined that Tesla should not be thought of as an automobile manufacturer, but rather as a company invested in automated driving, artificial intelligence, and robotics. On the same call, though, he admitted that the “robotaxi” reveal (now delayed to October 10) will be all for show. There will be no working robotaxi in 2024. Maybe it will happen, he said, in late 2025.

Or, if you take it from people knowledgeable about autonomous driving, maybe never. Indeed, most likely never. Tesla is nowhere close to achieving autonomous driving, and it is highly doubtful that its “vision only” approach can ever work.⁶

At present, Tesla’s net revenues from the combination of robotaxis, artificial intelligence, and robotics add up to exactly zero. That is likely to be the net revenues figure from those sources for years to come. All while its EV deliveries, EV revenues, EV margins, and EV profits continue to shrink.

By the time the Chancellor rules on ratification, we will be several months down the road. By the time the inevitable appeal to the Delaware Supreme Court is resolved, we will be at least another year down the road.

By then, the Elon Musk magic may well be a thing of the past. Many of the market capitalization and adjusted EBITDA milestones Tesla achieved that led to options awards under the 2018 Grant may well have melted away. Many of the serious litigation risks to which Musk has, for years, exposed himself and Tesla may well have matured into dangerous threats to the company’s survival.

C. The directors would be sued.

Any replacement package would lead, inevitably, to more shareholder derivative litigation. Such litigation would be decided by a Texas court under Texas law. Texas corporate law is, to put it kindly, far less developed than Delaware corporate law.

Consequently, there would be much litigation uncertainty associated with any attempted replacement package. Moreover, if the newly created (but not yet existing) Texas Business Courts with their appointed judges are ultimately found in violation of the Texas Constitution (which requires that judges be elected), then brave indeed will be a corporate director who decides to have his fate decided by 12 residents of Travis County.

VI. The Directors Were Lying in the Proxy Statement

I’ll go out on a limb and say it: the Tesla directors were bluffing about a replacement compensation package that would cost Tesla $25 billion. In other words, they were lying. They never intended to really do it. There was no Board meeting where a decision was taken to grant Musk a replacement package if ratification failed. There was no Board vote. There are no Board resolutions.

It was all made up. It was all for show. It was all to coerce the shareholder vote.

And when those directors and Musk lose at the Court of Chancery, and then lose again at the Delaware Supreme Court, the Board won’t dare try to replace the 2018 Grant with a new package giving Musk anything close to 304 million shares. Indeed, the big question will be why Musk deserved the 2018 Grant to start with when so many of the milestones have already melted away.

1. Readers not already familiar with the background of Tornetta v. Musk, or wanting a refresher on some points, can find a summary in Part II of this Substack post.

2. In reviewing the proxy materials and ratification briefing, I have had extensive assistance from an insightful and successful Silicon Valley corporate attorney. Because he has served on the boards of several prominent tech companies, he understandably wishes to remain anonymous.

3. There is also the coercion inherent in Musk’s threat to appropriate Tesla’s artificial intelligence and robotics opportunities to another (private) entity in which he owns a much greater share. We have already written about that at length, and may have even more to say about it in a later post, especially given how absurd the Defendants’ arguments are on that point.

4. From the individual Defendants’ reply brief: “Stockholders understood the central importance of Musk’s motivation to continue his work at Tesla and the risk of his potential departure. The Court’s opinion drew analogies to corporate founders Zuckerberg, Bezos, and Gates (Tornetta, 310 A.3d at 537), two of whom stepped back mid-career to pursue other passions. Cf. Frantz Mfg. v. EAC Indus., 501 A.2d 401, 408 (Del. 1985) (“Directors are . . . free to resign.”). Tesla’s investors would have known the risk that Musk would follow that path, and the importance of keeping him motivated.”

5. You can find more detail on S&P index inclusion at this link.

6. Moreover, the business model for a Tesla robotaxi business is murky indeed. But, that problem is likely to remain purely hypothetical.