The Elon Musk Compensation Ruling: What Does It Mean for Boards of Directors?

Elon Musk, the polarizing CEO of Tesla, made the news after a Delaware judge threw out a compensation package approved by Tesla’s board of directors. The pay package was worth a staggering $56 billion.

The judge, Chancellor Kathaleen McCormick of Delaware’s Court of Chancery, ruled against Musk’s unusually high compensation package for two reasons: (1) the board of directors failed to prove that that level of compensation was fair, and (2) there was no evidence that the board tried to negotiate with Musk — its members simply approved the payment.

No matter what you think of the ruling, it does raise an interesting ethical conundrum: does this decision undermine the authority of boards of directors? Or is it an appropriate way to ensure that boards of directors don’t disregard the best interests of the company in favor of high CEO compensation? Here’s a closer look.

What Happened?

The situation began when Tesla’s board of directors approved a record-breaking compensation package for Musk. Despite Tesla’s recent dips in performance and disappointing projected growth for 2024, the agreed-upon $56 billion pay package was the largest one in history (at least when it comes to publicly traded companies).

A compensation package of that value is certain to raise some eyebrows. One shareholder took action on that skepticism — he filed a lawsuit arguing that Tesla was violating its fiduciary duty to shareholders by offering such a massive compensation package to the company’s CEO.

On January 30, 2024, McCormick issued a ruling. The ruling is 200 pages in total, but its essence can be summed up with a quote: “Put simply, neither the Compensation Committee nor the Board acted in the best interests of the Company when negotiating Musk’s compensation plan. In fact, there is barely any evidence of negotiations at all. Rather than negotiate against Musk with the mindset of a third party, the Compensation Committee worked alongside him, almost as an advisory body.”

McCormick ruled that the plaintiff provided enough evidence to prove that Musk was in control of Tesla. She also noted that Musk’s significant ties to Tesla board members (even those members who aren’t in his family) were a primary reason that the board approved the compensation package. It’s a perfect illustration of cronyism at work.

It’s important to note that while this is a major ruling, the issue may not be completely closed. Musk has the opportunity to appeal the ruling. He also said that Tesla shareholders will immediately hold a vote to leave Delaware and re-incorporate the company in Texas.

Why Does It Matter?

So what does a high-profile ruling concerning one of the wealthiest people on the planet have to do with your business? The Tesla compensation debacle serves as a reminder of the role of a board of directors.

In an ideal system, a company’s board of directors and its CEO are part of a system of checks and balances. When a CEO makes a decision, it must first be approved by the board of directors. 

In a healthy system, the board scrutinizes the decision, ensuring it serves the company’s and its shareholders’ best interests. That way, if the CEO tries to make a decision that’s detrimental to the company — like giving himself an absurdly high compensation package — the board can deny that request and negotiate a package that’s more in line with the needs of the company and shareholders.

However, in the case of Elon Musk’s compensation package, Tesla’s board of directors did something that’s become a growing problem in the world of business. Partly because Musk has close ties to many board members, the board approved his compensation package with little to no scrutiny or negotiation.

In Musk’s case, the board’s approval was little more than a formality. This is exactly the kind of situation that the board/CEO relationship is meant to prevent.

Are Court Rulings the Answer?

As you may have guessed, the business community is divided on the ruling. 

Most people can see that at least in this instance, Tesla’s board of directors is not implementing the checks on the company CEO as it should. And because many board members are connected to Musk (familially or otherwise), there’s a very real risk of conflicts of interest clouding judgment.

Those who disagree with the ruling aren’t arguing that Tesla’s board of directors is ideal. Instead, they’re focused on whether the courts should be able to decide what constitutes a fair compensation package. 

Musk’s agreed-upon compensation was unprecedented, but it was also overwhelmingly approved by company shareholders. A full 73% of shareholders (excluding his family members) voted to approve it. When Musk’s family members are included, that number is 80%.

Critics of the ruling have noted that ultimately, CEO pay is an investment. When a judge invalidates a shareholder vote on pay, the court system is effectively saying that the investors in a company are incapable of making sound business decisions.

But what if those business decisions are heavily influenced by connections between shareholders and the CEO? A company’s board of directors is tasked with protecting the best interests of the company and not kowtowing to the CEO’s every demand. However, there isn’t currently a clear-cut way to hold board members accountable when they neglect that duty. 

Will court rulings be the answer? That remains to be seen.

The Tesla Ruling and You

Most businesses don’t have to worry about whether multibillion-dollar compensation packages are reasonable or not. However, they should be concerned with how effectively the board of directors is performing its duties. 

As seen with the Tesla debacle, boards with many members tied to the CEO can quickly run into major conflicts of interest. The best way to avoid situations like these is to make sure your company’s board of directors is diverse. When you make a point of including people with varied business focuses and ways of thinking, you increase your chances of establishing an impartial board whose main concern is the company’s well-being.