Musk Losing His $56 Billion CEO Package Might be a Step in Ending Broader Abuses of Management Pay
Musk's Telsa was a cartoonish version of corrupt corporate governance - but the decision highlights the broader problems of extreme CEO enrichment
On January 30th, the Delaware Chancery Court ruled that Elon Musk’s $56 billion compensation package approved in 2018 was subject to “equitable rescission,” or in plain language, it was terminated.
Since that pay deal was based on negotiations with a corporate board Musk controlled, the court ruled that the shareholder vote approving it was invalid and the shareholders suing Musk had the right to their money back.
This is no small thing. As the Delaware Chancellor Kathaleen McCormick admitted, this “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.”
But kill it she did. And the decision came from the most important overseer of corporate governance in the nation, so it could be a step in changing a whole range of corrupt CEO giveaways which, as outlined below, have arguably been a major driver of increasing economic inequality in the nation.
For those less familiar with the Delaware Chancery Court, the reason it is the most important venue for lawsuits over corporate decision-making is that two-thirds of public companies in the S&P 500, including Tesla, are incorporated in Delaware so are subject to Delaware corporate law and the decisions of the Chancery Court.
It was McCormick who forced Musk to fork over the $44 billion for Tesla in 2022 after he tried to renege on the deal. So Musk has been bitten twice by this Chancellor — something he has already been whining about on Twitter.
Elon’s Crony Board of Directors at Tesla
The Chancellor found that Musk “controlled Tesla,” a critical legal step in finding that the process awarding him the outrageous compensation was invalid. It wasn’t just that he owned 21.9% of the company, but his positions as CEO, Chair of the Board, and Founder allowed him to completely dominate the process of selecting the directors on the corporate board that in turn would set his pay.
If the package had been approved by an independent board of directors, the court made it clear they almost certainly would have approved the compensation, however outrageously high it was. Delaware is the preferred place to incorporate corporations because the courts tend to approve whatever shareholders want. It is only when shareholder interests and management interests collide that the Chancery Court generally intervenes.
And that collision was evident here given the complete dominance of Musk cronies on the Tesla board:
One was his brother Kimbal Musk
Two had 15- and 20-year relationships with Musk, including one vacationing with Musk regularly
One was not just his hand-picked General Counsel but also his personal divorce attorney (almost a caricature of a corporate flunkie)
One was James Murdoch, Fox CEO and a personal friend of Musk, with whom he regularly took family vacations.
Two had no personal relationships with Musk but had been recruited by the others and heavily depended on the extravagant compensation they received as board members for their income and wealth.
Only one board member was deemed by the Chancellor as having “no compromising personal or business ties to Musk.”
And the compensation negotiation, such as it was, had a complete “absence of any evidence of adversarial negotiations.” Musk made the original proposal for what his compensation should be and the board suggested no substantive changes. At trial, the board members admitted they didn’t see it as adversarial; “we were not on different sides of things.” As the Chancellor wrote, “The testimony from the key witnesses is perhaps as close to an admission of a controlled mindset as a stockholder-plaintiff will ever get.”
The board just reported that it was a good deal for shareholders and urged them to approve it, but failed to inform the shareholders that the board members had “potential conflicts and omitted material information concerning the process.” Independent proxy advisors, ISS and Glass Lewis, recommended voting against the package, but shareholders spurred by the board’s recommendation supported it with 73% of shares voted.
One reason the Chancellor noted the stock options in the package seemed like a ludicrous offer was that their justification was supposed to give Musk an incentive to do well as CEO- but since he already owned more than 20% of the company, he already had that incentive. This is one reason McCormick argued similarly situated CEOs like Mark Zuckerberg, Bill Gates, and Jeff Bezos were not offered similar deals by their boards.
Musk’s Deal Not So Different from Other Inflated CEO Compensation
Even if Musk’s deal was extreme, many CEOs have been offered ever-escalating excess compensation. An Economic Policy Institute report found that CEOs have gone from making 20 to 30 times as much as the typical worker back in the 1970s to making 200 to 300 times as much each year. As CEO salaries have risen, so have other top managers’ pay. And with private sector management pay skyrocketing, even the pay of non-profit executives at universities, foundations, and private charities has often jumped to $1 million a year- and even multiples of that amount.
As EPI details, even with the pandemic, CEO pay continued to skyrocket: “While millions lost jobs in the first year of the pandemic and suffered real wage declines due to inflation in the second year, CEOs’ realized compensation jumped 30.3% between 2019 and 2021.”
The reasons for these extreme pay hikes are variations on the crony board of directors that Musk had. While corporate boards are supposed to hold CEOs accountable:
As a practical matter, directors are generally more responsive to top management (including CEOs), who often play a large role in selecting members of the board. Furthermore, once a director is on the board, the incentive structure goes strongly against raising serious questions about CEO pay. Being on a corporate board pays very well, typically well over $100,000 a year, and often several hundred thousand dollars a year, for very part-time work [where] the amount of work involved was typically in the range of 150 hours a year. The key to any one director keeping their job is keeping their other directors happy. This probably means not asking questions about the feasibility of drastic cuts to the board’s hand-chosen CEO’s pay.
The upshot is that the gross excesses of CEO and top managers’ salaries are major drivers of overall economic inequality. Thomas Piketty in his blockbuster Capital in the Twentieth Century argued that rising economic inequality in the U.S. was increasingly less about shareholders winning out over labor for their share of firm revenue, but of top managers disproportionately increasing their pay. Upper echelons of large firms captured an estimated 60 percent of the total increase of US national income” from 1977–2007. That means when we talk about the 1% or really the top 0.1%, the vast majority of the wealth is not going to passive shareholders but to these superstar CEOs and their top lieutenants. Like EPI and many others, Piketty stressed the lack of strong corporate governance as helping to drive this result.
EPI has a broad list of recommendations to restrain excess CEO pay, including higher corporate tax rates for firms that have higher ratios of CEO-to-worker compensation, comparing it to the way baseball team payrolls are internally taxed when salaries exceed a cap. Changing corporate governance rules to tighten shareholder power over compensation is another big recommendation, but making that work requires strong enforcement.
The Securities and Exchange Commission has some leverage on firms, but ultimately, under current corporate law, the biggest change could come if the recent Musk decision is upheld by the Delaware Supreme Court and broadened in future cases to start voiding a lot more CEO packages unless truly independent boards are established.
That won’t solve all the problems of economic inequality in our system but it could begin to rein in the incredible inequality between workers and their bosses that we increasingly take for granted.