Lucian Bebchuk argues that, in response to the Delaware court decision invalidating the 2018 pay grant to Elon Musk, the Tesla board did not react with contrition and an attempt to improve its governance, but rather followed an approach of dismissal and defiance.
You can read here the first, second, and third parts of this series of articles on Tesla’s corporate governance.
In January, a Delaware court invalidated after a long trial a massive option grant that Tesla’s board awarded CEO Elon Musk in 2018. The New York Times described the court’s decision as casting “a harsh light on the behavior of … Tesla’s board of directors.” Tesla’s board, however, did not react to the decision with contrition and an attempt to improve its governance. Instead, it seems to be following an approach of dismissal and defiance.
To begin, a well-governed board should take seriously a critical court decision and address with high priority the problems identified by the decision. But Tesla’s board chose not to. For example, as discussed in an earlier post I co-authored with Rob Jackson, because the court concluded that various Tesla directors displayed a lack of independence when approving the 2018 option grant, the board should have addressed this concern by adding candidate(s) that are “indisputably independent” (a term used by the court) for election in the annual meeting taking place this week. However, no such director was added to the slate for the upcoming annual meeting.
Similarly, as discussed in detail in another post co-authored with Jackson, the court explained that, in negotiating the terms of Musk’s award, the board failed to include (or even attempt to discuss with Musk) a contractual commitment that would limit the amount of time and effort that Musk would spend on endeavors outside Tesla. Given that the board cited a desire to get Musk’s time and attention as a major objective, one would have expected the board going forward to seek such a commitment before providing Musk with a large compensation award. However, the board elected not to negotiate for a new pay package with terms that would not be structurally defective. Instead, the board is seeking stockholder support for a proposal to ratify and thus reinstate the invalidated grant exactly as it was, without even trying to obtain from Musk a time-and-attention commitment as a condition for bringing such a proposal to a vote.
Most disconcerting might well be how the Tesla board has been misdescribing the court’s decision in its efforts to obtain stockholder votes for the ratification proposal. In seeking such support, the board has been criticizing the court’s opinion in ways that could be viewed as unfair, dismissive, and disrespectful.
First, consider an interview that Tesla’s chair Robyn Denholm gave to the Financial Times in advance of the upcoming vote. After the FT noted that “the court ruled that Tesla’s board had failed to act in shareholders’ interests… and Denholm as having a ‘lackadaisical approach to her oversight obligations,’” the FT then indicated that Denholm “dismissed“ those findings. Furthermore, the FT quoted Denholm as labeling the findings “absolute BS” and “crap.” Such labeling is not what one would have expected from a public-company chair discussing a court decision criticizing her behavior.
Second, Tesla’s proxy statement and subsequent proxy materials have unfairly portrayed the Delaware court decision as attempting to suppress the will of stockholders. In particular, Tesla stated that “[the Board] is troubled…by the Delaware Court’s…willingness to make decisions contrary to the will of our stockholders,” and asserted that the court “second-guessed [stockholders’] decision.” Relatedly, given the portrayal of the court decision as trying to overrule the will of stockholders, Tesla described the board’s ratification initiative as an attempt to protect stockholder democracy. In particular, Tesla stated that “[c]orporate democracy and stockholder rights are at the heart of Tesla’s values;” that “[w]e are asking you to make your voice heard;” and that ratification “will restore Tesla’s stockholder democracy.”
These characterizations of the court’s decision are quite unwarranted and unfair. The court’s decision did not seek to overrule or suppress the stockholders’ will. Rather, it concluded that, because the disclosures to the voting stockholders were seriously deficient, the 2018 vote’s outcome was not a meaningful expression of the stockholders’ will.
Whereas the court decision did not overrule a meaningful expression of the stockholders’ will, it did invalidate the board’s decision because it was skewed by Musk’s influence and was inconsistent with fiduciary duties. Such invalidation does not undermine stockholder democracy but rather supports it, for stockholder democracy works best when proposals are bought to vote by directors acting faithfully in stockholder interests.
Third, Tesla has blamed the court for creating a situation in which Musk has not yet been paid for his work in certain years. “Because the Delaware Court second-guessed your decision,” Tesla stated, “Elon has not been paid for any of his work for Tesla for the past six years that has helped to generate significant growth and stockholder value.” But such blaming of the court ignores the board’s responsibility for the current state of affairs. Had the board negotiated a pay package and made disclosures with respect to it in accordance with its obligations, the pay package (which would have been better designed) would have been validated.
Fourth, Tesla stated that a ratification vote would ensure that “no fair-minded person can claim stockholders do not have all facts necessary for an informed decision.” This statement should be viewed as reflecting a problematic position on the legitimate role of the courts. For it is possible, indeed plausible, that a Delaware court might be asked to assess whether the disclosures provided to stockholders prior to the 2024 ratification vote were deficient, as the disclosures provided to stockholders voting in 2018 were. The board’s statement implies that, if the judge reviewing the ratification decision would conclude that the 2024 disclosures were deficient, the judge could not be a “fair-minded person.”
Fifth, and importantly, Tesla’s proxy statement puts forward a strong and sweeping rejection of the court opinion while avoiding any detailed explanation of the specific reasons for the rejection. Tesla stated that “[w]e do not agree with what the Delaware Court decided, and we do not think that what the Delaware Court said is how corporate law should or does work,”and that “[t]he Company and the Board believe that the [court decision] ignored material evidence presented at trial and that the Delaware Court made errors of fact and incorrect conclusions of law.” But Tesla chooses not to elaborate to stockholders or others what specifically were the errors of fact and incorrect conclusions of law and why specifically what the court said is not how corporate law works.
Relatedly, Tesla’s proxy materials put forward various statements that are contrary to the court’s conclusions. For example, notwithstanding the court’s contrary conclusions, Tesla states in its proxy materials that all directors other than Musk’s brother are independent of Musk, and that the 2018 process was adequate. Tesla seems to believe that putting forward statements that are contrary to the court’s conclusions can be justified by attaching the court opinion as an appendix to the proxy statement to make the court’s contrary conclusions easily accessible to stockholders. But what is problematic is that the board elected not to explain in detail why it drew from the same facts conclusions that are opposite to those of the court. A board taking the court decision seriously should substantively engage with it, and the board’s doing so would facilitate stockholders’ ability to make an informed choice.
The protection that corporate law accords to public company shareholders is substantially dependent on effective judicial oversight of corporate decisions that are challenged by investors. For this system to work well, it is important that corporate boards take court decisions seriously and respectfully, drawing lessons from them to address identified deficiencies, and not react to such decisions dismissively and defiantly. Unfortunately, Tesla’s board seems to be taking the wrong approach.
Author’s Disclosure: Lucian Bebchuk is a professor of law, economics, and finance, and director of the corporate governance program, at Harvard Law School. He has served as independent experts on behalf of the plaintiff in the Delaware litigation regarding Musk’s pay package. The post is part of a series of academic posts, some of which have been co-authored with Robert Jackson, on Tesla’s governance.
Articles represent the opinions of their writers, not necessarily those of the University of Chicago, the Booth School of Business, or its faculty.
