The Dark Stain on Tesla's Directors

Tesla's Board is attempting to award Musk compensation that is obscenely unfair, using a proxy statement prepared with a flawed process and containing egregiously inadequate disclosures.

The gambits to “ratify” the compensation package awarded to Elon Musk in 2018 (the 2018 Grant) and to reincorporate Tesla in Texas now being attempted by Tesla’s Board of Directors are the most shameful acts of corporate governance I have ever witnessed. They combine a terribly unfair price with a hideously flawed process and immensely misleading disclosures.

In criticizing these gambits, I am far from alone. Tesla’s largest individual shareholder has publicly announced he will vote against the ratification proposal. Eight of Tesla’s largest shareholders have filed as proxy materials a letter setting forth in great detail their objections to both ratification and reincorporation. Scholars such as Professor Ann Lipton and Professor Charles Elson have castigated the Board both for the proposals and the process by which the Board arrived at them.

Most recently, the proxy advisory firm of Glass Lewis has urged shareholders to reject both proposals, pointing to the “excessive size” of the compensation and the “additional risk” to shareholders of moving to Texas.

(generated by Microsoft Designer AI)

In this post, I owe much of the analysis to a brilliant corporate attorney who lives and works in Silicon Valley, and who has served as a board member for several prominent technology companies. He understandably prefers to remain anonymous. However, the anonymity does not detract from the analysis. The numbers are the numbers, and the facts are the facts.

I. The Elephants in the Room

We will examine the price, process, and disclosure analyses in that order. In considering each of them, we cannot ignore the two enormous elephants in the room, neither of which is ever mentioned, never mind addressed, by the Board in the proxy statement.

A. Musk’s Threat to Deprive Tesla of Its Business Opportunities

First is the corporate opportunity elephant. Musk has quite publicly stated that unless he is given at least a 25% ownership share of Tesla (he now owns 11.8% when excluding the rescinded options), he will cease developing artificial intelligence (AI) and robotics technologies at Tesla, and instead to move them “outside Tesla,” presumably to one or more companies in which he owns a much larger interest.

Tesla has long boasted about its AI and robotics technologies; indeed, it continues to do so in the proxy statement. Musk has acknowledged what he regards as their vital importance to Tesla. Here was Musk only a month ago on the Q1 earnings call:

As I've said before, I think Optimus will be more valuable than everything else combined. Because if you've got a sentient humanoid robots that is able to navigate reality and do tasks at request, there is no meaningful limit to the size of the economy. So, that's what's going to happen. And I think Tesla is best positioned of any humanoid robot maker to be able to reach volume production with efficient inference on the robot itself.

Musk made clear that the “inference” efficiency arises from Tesla’s AI capabilities:

I mean, this, perhaps, is a point that is worth emphasizing Tesla's AI inference efficiency is vastly better than any other company.

Is it clear enough that Musk’s vision for Tesla depends on AI and robotics? In case it’s not, try this statement on for size:

Like really, we should be thought of as an AI or robotics company.

For Musk to take these Tesla technologies elsewhere, or otherwise to hamper Tesla’s further development and exploitation of them, would be a brazen and immense breach of his fiduciary duty.¹

For Musk even to threaten to do so makes the entire shareholder vote coerced. He is announcing that, unless shareholders buckle under in the face of his threat, he will violate the well-established corporate opportunity doctrine. If one needed any further evidence that the Tesla Board is entirely controlled by Musk, willing do his bidding at every turn, and determined never to take a single action to police his misdeeds, the Board’s complete failure to address Musk’s lawless threat is that evidence.

B. The Inevitable *Next* Compensation Package

Even restoring the 2018 Grant will not get Musk close to the 25% voting control he is demanding. As jaberwock has explained in an astute analysis, assuming the rescinded options were restored, then upon their exercise, Musk would need to sell more than half of the 304 million shares he receives in order to pay the strike price and taxes. At today’s share price, that would bring Musk’s percentage ownership in Tesla only to about 17%.

Obviously, what Musk is demanding is not just restoration of the rescinded options, but in addition an entirely new compensation package that would increase his ownership share to 25%. Yet the proxy statement fails to address this demand, stating only that Tesla’s Compensation Committee has “not taken any steps to prepare or negotiate a new, forward-looking compensation plan.”

II. Price

In the April 17 proxy statement, Tesla’s Board takes the position the 2018 Grant is compensation for Musk’s employment  from 2018 to 2023. The Tesla proxy statement claims that absent this grant, Musk was not compensated in this period.   

Here are some basic undisputed metrics, commonly used in the financial world, regarding the 2018 Grant.

A. Current Value of the Options

The current value of the options from the 2018 Grant is easily calculated:

• Number of shares under the option: 303,960,630

• Exercise price. $23.33 per share

• Current price (closing price on May 24): $179.24

Thus, the in-the-money value of the 2018 Grant is currently $47.4 billion.

B. Comparison of Current Value with Tesla Financial Metrics

Now, let’s ask: how does $47.4 billion compare to Tesla’s:

1. total net income to date,

2. forecast earnings as forecast over the next six years,

3. book value,

4. historical unlevered cash flow, and

5. forecast unlevered cash flow

1. Total Net Income to Date

Tesla went public in June of 2010. Let’s be generous and ignore the loss in that partial year. Tesla’s total net profits from 2011 through 2023 were $27.45 billion. Let’s add to that the $1.13 billion of earnings in the first quarter of this year.

Rounding up, we arrive at a grand total of $28.58 billion in profits to date.

In other words, the current value of the 2018 Grant is 166% of Tesla’s profits to date.

2. Forecasted Earnings for the Next Seven Years     

Ok, that’s historical earnings. How about forecasted earnings?

Almost all Wall Street analysts make forecasts of Tesla’s expected earnings over the years to come. Who, among these analysts, is the most visible, well-known, and closely followed? Why, that would be Adam Jonas at Morgan Stanley, of course. Let’s look at the most recent Jonas forecast of Tesla earnings through 2030, the last year for which Morgan Stanley makes estimates.

Mr. Jonas forecasts Tesla net income of $2.3 billion this year² growing to $7.7 billion in 2030. Based on his estimates from 2024 to 2030, Jonas expects Tesla to earn an aggregate of $62 billion in that seven-year period. Notably, the vast majority of those projected earnings are in the “out years” (the last three years of the period).

Thus, the award that Tesla’s Board is asking shareholders to “ratify” equals 76% of total expected Tesla earnings in the next seven years. 

3. Book Value

Tesla’s total shareholders’ equity at the end of the most recent quarter was $64.3 billion.

So, in attempting to revive the defective 2018 Grant, Tesla’s Board is attempting to award Musk a value that is equal to 74% of the company’s total book value as of the most recent quarter.

4. Historical Unlevered Free Cash Flow

Tesla’s unlevered free cash flow from 2018 (the year of the 2018 Grant) to the present was $16.4 billion.

Thus, the current value of the 2018 Grant is 289% of the unlevered cash flow since the time of that grant. In other words, the Board is attempting to award Musk almost three times the unlevered free cash flow over that period.

5. Forecasted Unlevered Free Cash Flow

What if we compare the current value of the 2018 Grant to the forecasted unlevered free cash flow for the next seven years?

Again, we’ll refer to the forecast of Adam Jonas at Morgan Stanley. Mr. Jonas sees $21.4 billion of free cash flow over his seven-year horizon.

Thus, the current value of the forecasted unlevered free cash flow is 221% of the current value of the 2018 Grant. In other words, more than double what the Board is attempting to award Musk.

III. Process

If either the ratification or reincorporation gambits is approved by the shareholders, further litigation is inevitable. That litigation will take place in Delaware’s Court of Chancery, and the governing law will include two important cases: Kahn v. MF Worldwide Corp. (often referred to as MFW) and In re Match Group, Inc. Derivative Litigation. Under those cases, Tesla will need to show, among other things, that (1) the process followed by the Board was proper, and (2) the compensation package was approved by a properly functioning independent committee.

Here are some factors that, we believe, will make it impossible for Tesla to make such a showing.

Musk Controlled the Process from the Start

There is ample evidence Musk controlled the entire process starting only minutes after the Tornetta ruling was handed down. Without awaiting any Board meeting or decision, Musk took to his social media site to attack the Court, to announce unilaterally that Tesla would immediately consider moving to Texas, and to post an on-line vote at which has faithful horde of X followers could choose Texas over Delaware. Thus, the Board’s process was tainted from the start because its decision was pro-ordained by the Controller. The demanded result had already been communicated to the supine directors. The Board tried to unring this bell with the endless contortions described in the proxy statement, but the effort is ineffective as the Board took no consequential curative steps.

An Unseemly Rush

Initially, at a time when the Special Committee’s mission was to consider only reincorporation, the Board appointed two members to that committee, Joe Gebbia and Kathleen Wilson-Thompson. When the mission was expanded to include ratification, Gebbia bailed immediately. He evidently was unwilling to vouch for a prior flawed decision by substituting a new post hoc decision. Now all alone on the Special Committee, Wilson-Thompson asked the Board to find one or more new independent directors to join here. The Board instead decided to push forward, despite no apparent reason for doing so. This decision likely was motivated by Musk’s impatience to secure a shareholder vote before the Chancellor could make a final ruling in the case (the issue of legal fees remains to be decided), and undermines the integrity of the process.

The Special Committee Missed the Most Important Interview

In the entire process, Musk submitted to only one Board-requested interview, which occurred on April 10. Clearly, given the elephants in the room detailed earlier, that interview was of crucial importance. Despite the interview’s importance, Wilson-Thompson, the sole member of the Special Committee, did not attend. That is (another) astonishing failure of process.

The Special Committee Deliberately Declined to Take Important Actions

The Special Committee expressly determined not to hire a compensation advisor or otherwise seek outside advice on the appropriateness of ratifying the 2018 Grant, and expressly declined to determine whether the grant was fair.

The Board & Special Committee Considered No Alternatives

At the core of any important Board decision is deliberation on alternatives. Every action must be considered in the context of “Compared to What?” And yet, one can search the proxy statement in vain for any deliberation or discussion of alternatives to the 2018 Grant.

No One Asked: ‘Why Is any Grant Necessary?’

A major reason Chancellor McCormick found that the 2018 Grant was not fair was because the Tesla Board never asked this question: “Why, given his 21.9% ownership in Tesla, and the enormous incentives for growth and profitability inherent in such ownership, is it even necessary to award Musk more stock?” After all, in other companies where the founder owns a large equity interest (for instance, Microsoft’s Bill Gates, Meta Platform’s Mark Zuckerberg, Amazon’s Jeff Bezos), the interests of those managers is regarded as already sufficiently aligned with those of the minority shareholders, so no additional compensation is required.

Again, one will search the lengthy proxy statement in vain for evidence of any attempt by either the Board or the Special Committee to consider whether the 2018 Grant was necessary in the first instance.

IV. Disclosure

If the shareholders vote to ratify the 2018 Grant, and the inevitable litigation erupts, then under the MFW and Match Group cases cited earlier, Tesla also will need to show (in addition to proper process) that the shareholder vote was an “informed” vote. For the vote to be informed:

• the proxy statement must not include any statements that are false or misleading, and

• the proxy may not omit to state any material fact necessary when the absence of that fact would make the statements that are made false or misleading.

Tesla will be unable to make such a showing because the proxy statement is rife with material omissions:

No Discussion of Musk’s Threats Regarding AI & Robotics

The proxy statement makes no mention of the first elephant in the room: Musk’s threat to stop developing robotics and AI technologies at Tesla (and, indeed, it never mentions that Musk has poached Tesla engineering talent for his own AI start-up, or that he just raised $6 billion for that start-up). Even worse, the proxy materials omit this information while at the same time boasting of “our progress in artificial intelligence via full self-driving and Optimus.” If the Board failed to discuss these issues with Musk, then that failure is a colossal breach of fiduciary duty. If the Board did discuss these issues with Musk, then the omission of the details of those discussions from the proxy statement makes the proxy materially misleading.

No Discussion of Musk’s Demand for 25% Ownership

The proxy statement makes no mention of the second elephant in the room: Musk’s demand for a 25% ownership share, which cannot be achieved without a further compensation package in addition to a restored 2018 Grant.

No Discussion of the Ongoing Criminal Investigations

The proxy statement fails to discuss, or even mention, the criminal investigations of both Musk and Tesla now underway at the Department of Justice. Those investigations are highly material to Tesla; Board Chair Robyn Denholm herself, in the cover letter that introduces the proxy statement, cites Tesla’s “tremendous strides in our quest for FSD.” Later, the proxy statement describes one of the key motivations for the 2018 grant of stock options as incentivizing Musk to cause Tesla to “[a]dvance autonomous technology to create a fully-self driving future.” In this regard, recall Musk’s statement at the April earnings call:

If somebody doesn't believe Tesla is going to solve autonomy, I think they should not be an investor in the company.

No Discussion of What Musk Will Do In the Event of a ‘No’ Vote

The proxy statement makes no mention of whether the Board had any discussions with Musk about the consequences of a “no” vote, either for ratification or reincorporation, on his focus on the company and his tenure. Again, if the Board conducted no such discussions, then that failure is an abject failure of process and dereliction of duty. And if such discussions did occur, then the omission of what was said makes the proxy materially misleading.

No Disclosure of Wilson-Thompson’s Other Compensation or Wealth

The proxy statement fails to provide information that is crucial to determining whether Wilson-Thompson, the sole member of the “independent” Special Committee that recommended ratification and reincorporation, is in fact truly independent from Musk. To be clear, the proxy does disclose that, thanks to stock and/or options grants, Wilson-Thompson has realized $62 million from sales of Tesla shares; that she owns an additional 771,255 shares (which as we write this equates to a value of more than $138 million); and that such wealth is “a meaningful portion of her net worth.” However, the proxy does not reveal how that windfall compares to her non-Tesla-related compensation or wealth.

This omission is particularly glaring given Chancellor McCormick’s determination that Robyn Denholm was not independent in large part because Denholm’s wealth derived from Tesla was, by her own admission, “life-changing,” and dwarfed her compensation from other sources.

No Disclosure of Wilson-Thompson’s Plan to Sell 280k Shares

The proxy statement likewise fails to disclose that, just one day after the Tesla Board first met (on February 4) to discuss the Tornetta ruling, Wilson-Thompson adopted a Rule 10b5-1 trading plan to sell 280,000 of those 771,255 shares. Five days later, she accepted appointment to the Special Committee, and several weeks later, as that committee’s sole member, she cast the vote to ratify the 2018 Grant. The existing plan to sell 280,000 shares surely is a fact germane to assessing Wilson-Thompson’s independence.

No Disclosure of Why Gebbia Stepped Aside

The proxy statement states that Joe Gebbia (the only Tesla director who has not been enriched by munificent stock grants, and consequently the only truly independent director) withdrew from the Special Committee on March 6 (thereby leaving only Wilson-Thompson). Why?

Mr. Gebbia explained that he was stepping down from the Special Committee out of an abundance of caution because of the potential for unfair attacks based on perceived conflicts of interest.

The Tesla Board made clear that it saw no conflict of interest for Gebbia. So, what were those perceived conflicts of interest? Why did Gebbia have such perceived conflicts of interest, but not Wilson-Thompson? The proxy is silent.

No Explanation of Why the Board Was in Such a Rush

After Gebbia stepped down, Wilson-Thompson requested that new independent directors be appointed and added to the Special Committee. This would seem to have been an excellent idea given the serious independence concerns. Yet, the Board declined to do so. Instead of any real explanation for the Board’s rejection of the request, we get this argle-bargle:

The Special Committee reported that the timing of the ongoing director search ultimately did not fit with the Special Committee’s work, and the Special Committee determined there was no reason to delay its work based on the possibility that additional directors would be added to the Board at some point in the future.

In other words, Wilson-Thompson was told there was no time to add an independent board member; evidently, the push for a quick shareholder vote was too important. The proxy statement offers no details about why the other directors felt it was so important to rush things along. (Was it because Musk wanted to be sure the shareholder vote occurred before the Chancery Court hearing on legal fees, which was by then scheduled for July 8?)

No Disclosure about the Elon Musk Interview

The proxy statement reveals that on April 10, Tesla legal counsel interviewed Elon Musk, presumably about the Tornetta ruling and the proposals for the June 13 shareholder meeting. Obviously, there was much to discuss, including the elephants in the room mentioned earlier.

Yet the proxy statement offers absolutely no information about that interview. Not the length of the interview, not the topics, not what Musk said about his intentions regarding AI and robotics. Not about whether he intended to stay at Tesla, not about whether he would make any time commitments in his role as CEO. Not a single detail. Given the crucial nature of such questions, the lack of detailed information about what was said during the April 10 interview (indeed, the lack of any information at all) is a material omission.

V. Conclusion

When one compares what the Tesla Board wants to bestow on Musk with Tesla’s historical earnings, or with any of the other financial metrics, only one conclusion is possible: the compensation Musk seeks is obscene and unfair. This is especially the case given that, today, Tesla’s market cap, revenues, and EBITDA are shrinking rather than growing.

The Board might as well just say that Musk should receive 80% of Tesla’s earnings. Even that would be more fair to the shareholders.

And, when one considers the appalling flaws in both process and disclosures, it is evident that, if ever the April 17 proxy statement is placed under a microscope in legal proceedings, the imprint of Musk’s influence and control will be seen throughout, and the Board’s process and disclosures will fail the applicable legal tests.³

1. It appears the theft has already begun. Musk reportedly has poached engineering talent from Tesla for the benefit of his x.AI start-up, for which he just concluded a $6 billion capital raise.

2. Quite a dramatic drop from the $15 billion last year & the $12.6 billion in 2022. It’s worth noting that, several times in the past several months, Jonas has revised his EPS forecasts downward.

3. This post assumes a shareholder vote to ratify the 2018 Grant would be legally effective. There are numerous reasons why it almost certainly would not be, independent of the price, process, and disclosure deficiencies detailed here. For some of those reasons, see the bullet points in this earlier post.