Tesla’s splashy $1 trillion executive compensation package for CEO Elon Musk has overshadowed a more pressing concern: Musk’s 2018 pay package, which is still in litigation, could eat up years of the electric vehicle maker’s future profits.
The Delaware Supreme Court will soon decide whether to overturn a lower court ruling that invalidated Musk’s previous record compensation package. If Tesla’s appeal fails, it could result in a $26 billion profit loss over two years to cover the new stock compensation package it promised Musk, given the current much higher stock price.
By comparison, $26 billion would be equal to more than half of Tesla’s total net income since it began turning a profit in 2019.
Even if Tesla wins in court, its profits could be squeezed over the next decade if Musk hits the performance targets of his trillion-dollar pay package, as each target carries billions in payments and accounting expenses.
The outsize hit to profits highlights the risks inherent in Musk’s exorbitant compensation. Even the largest public companies tend to care little about the impact of their CEO compensation on their results. Higher pay packages are typically measured in hundreds of millions, not billions.
Musk’s exponentially higher compensation creates unique uncertainties for Tesla’s earnings at a time when profits are already declining due to falling auto sales, the disappearance of subsidies for electric cars and the skyrocketing costs of ambitious projects such as humanoid robots.
Spending on stock-based compensation won’t affect cash flow, and shareholders might downplay it as “just accounting,” said Brian Dunn, director of the Institute for Compensation Studies at Cornell University’s School of Industrial and Labor Relations.
But, he says, the huge drops in net income caused by CEO compensation indicate that Tesla’s board of directors is not following “reasonable fiduciary practices.”
“They are carrying out a massive transfer of wealth from shareholders to the largest individual shareholder through the back door,” he said.
Tesla’s board has argued that Musk’s new pay package does nothing for him unless the company hits crucial milestones, such as very ambitious profit targets. If Tesla achieved those goals, Musk’s compensation expenses would consume a smaller proportion of his profits.
However, even the simplest targets in Musk’s incentive package could generate payments of tens of billions of dollars without transforming Tesla’s business or profits, Reuters reported. The maximum payout to Musk is $878 billion, as the $1 trillion in stock would be reduced by the value of the shares at the time Tesla’s board of directors approved the compensation package in September.
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The biggest short-term risk lies in the upcoming legal twist surrounding Musk’s compensation in 2018.
Neither Tesla’s board nor Musk responded to Reuters requests for comment.
The biggest near-term risk lies in the next legal twist surrounding Musk’s compensation in 2018. Last year, a Delaware judge struck down the package, ruling in a shareholder lawsuit that Musk’s pay negotiations were compromised by the excessive salaries of Tesla board members and his close personal ties to the CEO.
If the Delaware Supreme Court rules in favor of Tesla, Musk would be able to keep the stock options from the 2018 package and the company would not incur any further accounting expenses. By the time he met that plan’s performance targets in 2022, the stock options granted to Musk were worth $56 billion. Today, its value amounts to 116 billion dollars.
If the judge’s original ruling stands, Musk’s new compensation package gives him far fewer shares. However, these actions would cost Tesla’s balance sheet far more than the $2.3 billion compensation package in 2018, when it was originally approved, because Tesla’s stock price is so much higher now.
Musk’s compensation package would have to be valued at the stock price in August, when the board approved it, or at $26 billion. Tesla would have to account for the charge by August 2027, when Musk could receive the shares.
Splitting the $26 billion over eight quarters would reduce profits by $3.25 billion each quarter, more than Tesla’s net income in all but four of the last 25 quarters since 2019.
The company disclosed in a court filing that a failed appeal could have a significant adverse impact on the business and reported earnings. The board has argued that failing to replace the 2018 package could lead to Musk’s departure from Tesla.
Tesla doesn’t have to pay cash for shares; you can simply issue new shares. However, accounting standards require that stock compensation be recorded as an expense because the company could have sold those shares on the open market, corporate accounting experts said.
These types of stock transactions dilute the voting power of other shareholders, who have a smaller stake in the company because the total number of shares has increased, and a greater proportion of those shares go to the CEO.
“They are certainly hurting shareholders,” said Schuyler Moore, a corporate finance and tax law attorney at the Los Angeles law firm Greenberg Glusker.
Normally, he explained, such a drastic hit to profits would cause investors to devalue a company because “it was operating at a loss.” However, financial fundamentals have traditionally had little bearing on Tesla’s stock value, which is based almost exclusively on Musk’s promises about products and services the company does not yet sell, including autonomous robotaxis and humanoid robots.
In the case of Tesla, Moore said, “no one seems to care, because this company lives in a fantasy world.”
With information from Reuters
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