By Michael Homans
The stunning news earlier this month that a Delaware Court of Chancery judge rescinded Elon Musk’s whopping $56 billion compensation package because it failed an “entire fairness review” offers warning signs for other corporations and their directors about when exorbitant executive pay may be problematic.
First, the court noted that Musk was a “controller” of Tesla, as its founder and CEO, exercising “enormous influence” over the company’s directors. The complaint had noted that the grant of the performance-based compensation plan at an amount that exceeded the annual budget of many developing nations was approved by a board in which the majority of directors were conflicted and controlled by Musk and lacked independence from him, making it a “conflicted-controller transaction.” As such, decisions as to his compensation were subject to the “entire fairness review,” the most onerous standard applied to challenges to executive compensation.
Second, the court found that Musk exercised control over the compensation grant at issue. Notably, Musk proposed the pay plan himself and there were no adversarial negotiations about its size or terms. As such, it was not an “arm’s-length transaction.”
Third, the record showed that the proxy approved by shareholders (1) failed to disclose the compensation committee’s potential conflicts with respect to Musk and (2) omitted material information about the process.
Against this record, the Court applied the entire fairness review, which required the Tesla defendants to prove that the $56 billion grant was “entirely fair.” For many of the reasons noted above, the Court found that the defendants failed to prove that the grant was the product of fair dealing or that it needed to be so large.
Given that Musk’s pay package was “the largest potential compensation opportunity ever observed in public markets by multiple orders of magnitude,” according to the judge, perhaps other corporate boards will not face the level of scrutiny applied here. That said, the Musk decision highlights important standards and issues as to fairness, control, conflict, arm’s-length negotiations, and full disclosure to shareholders that should govern every executive compensation decision.
Michael Homans is an employment lawyer and litigator based in Philadelphia and Wayne, Pennsylvania. He can be reached at mhomans@homanspeck.com or (215) 419-7477.