Delaware Chancellor Kathaleen McCormick held again last week that the pay package that Tesla’s board of directors awarded to Elon Musk in 2018 suffers from “fatal flaws,” and it was therefore rejected. This was the second time Judge McCormick reached this same result, and she issued her new ruling despite the fact that, after she tossed out Musk’s compensation plan back in January, the Tesla shareholders then voted overwhelmingly in June (by more than 70%) to approve the full stock award that the company’s board had granted to Musk. There is little doubt that Musk is a unique figure, and it is also significant that Tesla is a public company, but looking under the hood of the Musk/Tesla compensation battle provides some valuable lessons for non-public companies and their majority owners.
Some would say that with Musk at the steering wheel, Tesla is driving the “diva model” of company leadership. Whether one agrees with Judge McCormick’s rulings or thinks she overstepped her authority (Musk has made his position clear by pledging to move Tesla to Texas), her decisions highlight what constitutes good corporate governance, which applies to both public and private companies. As discussed below, committing to board independence, focusing on leadership that recognizes teamwork and building a strong company culture is an approach that will benefit companies of all sizes.
1. Appoint and Foster an Independent Board
The importance of independent board oversight cannot be overstated. No majority owner of a private company needs to cede control over the business to an independent board, as this is not required for effective company governance. But majority owners and their companies do benefit when their boards are not populated solely by their family members and close friends. Specifically, owners will obtain an invaluable perspective and hard-earned insights from board members who have a track record working in the industry, have served on other boards, and do not shy away from offering their views about the company’s plans and operations.
It is not hard to understand why Judge McCormick questioned the independence of the Tesla Board members. Musk’s brother, Kimbal Musk, is one of five Tesla Board members with close ties to Musk, which include financial relationships with his other businesses like SpaceX, the rocket company. The court’s opinion from January set forth these concerns.
The process leading to the approval of Musk’s compensation plan was deeply flawed. Musk had extensive ties with the persons tasked with negotiating on Tesla’s behalf. He had a 15-year relationship with the compensation committee chair, Ira Ehrenpreis. The other compensation committee member placed on the working group, Antonio Gracias, had business relationships with Musk dating back over 20 years, as well as the sort of personal relationship that had him vacationing with Musk’s family on a regular basis. The working group included management members who were beholden to Musk, such as General Counsel Todd Maron, who was Musk’s former divorce attorney and whose admiration for Musk moved him to tears during his deposition. In fact, Maron was a primary go-between Musk and the committee, and it is unclear on whose side Maron viewed himself.
For the majority owners of private companies, securing a board that is truly independent avoids these types of conflicts over decisions regarding the executive’s compensation. Just as importantly, an owner who receives input from an independent board is positioned to accomplish the company’s goals more quickly, while also steering past avoidable mistakes.
2. Share the Wealth with Others
The second point goes beyond fairness. Given the staggering appreciation in the value of Tesla’s stock during Musk’s tenure, there are strong arguments to justify his unprecedented pay package. But a different question is whether any company leader should receive compensation that is drastically higher than all other executive team members, who also contributed to the company’s success. By analogy, consider the lead singer/songwriter in a rock band who writes all the band’s songs and therefore receives royalties that provide him with compensation vastly greater than all other band members. The lead singer/songwriter can certainly justify his outsized compensation, but if he declines to figure out how to share royalties or other income streams more equitably, he will likely find himself becoming a solo artist on his next tour.
Turning back to business leaders, even when a CEO is vital to the company there are other stakeholders in the company, who also play a meaningful role in helping the business achieve success. If the compensation of the other executive team members is dwarfed by the CEO’s pay package, they are likely to look for other places where they feel more valued. It also goes beyond the amount of the compensation because a CEO who takes all the credit and fails to recognize the contributions of others will not maintain a long-lasting team. Finally on this point, a CEO who receives an extremely high level of compensation will become a target much more quickly. The patience of the board and shareholders will run out much sooner when the high-paid CEO fails to consistently deliver extraordinary results.
3. Develop a Culture of Collaboration, Not Conflict
The third point relates to creating a successful company culture. In Musk’s case, Tesla’s board has largely given him free rein to run the company as he deems best as CEO, but he has had contentious relationships for many years with other officers, employees and stakeholders. It should be noted that this type of leadership conflict may not derail the company, and Tesla continues to perform well in the public market (in 2024, its stock began trading below $250 but is now closing in on its record high of almost $410 reached in 2021).
Notwithstanding Tesla’s notable success, most majority owners would prefer to govern their companies through collaboration rather than conflict, which requires focusing on collective efforts that celebrate teamwork. At a granular level, teamwork requires the owner to facilitate open lines of communication, to conduct decision-making through consensus and to maintain transparency throughout the process. This multi-faceted process may slow down the time for making key decisions as it requires more input and deliberation. When the members of the executive team have meaningful roles, however, and they are permitted to participate in the decision-making process, that will create strong buy-in. A collaborative company culture will sustain the company during good times, as well as through challenges, and the majority owner will not have to go it alone. Instead, the company’s success will be shared by the entire team.
Conclusion
The stock award granted to Musk at Tesla is so extraordinary, the legal conflict it has led to in Delaware has generated ample headlines. In more simple terms, however, the underlying dispute in the Musk case raises broad questions about how companies can be run effectively, including private companies controlled by founders. Although the diva model has worked well for Musk as a singular talent at Tesla, this approach may not provide majority owners in private companies with the best opportunity for success. Instead, majority owners may want to consider: (i) establishing a board that provides them with the benefits of independent judgment and input, (ii) creating a compensation structure designed to allocate financial rewards more broadly for all executives and (iii) fostering a culture of collaboration so that the company’s success is truly a product of teamwork.
Musk may well prevail in Delaware and finally receive his enormous stock award from Tesla after years of litigation. Whether private company majority owners would prefer to avoid this drawn-out legal conflict with their shareholders is worth considering, as well.