If Tesla wins shareholder support for reviving Elon Musk’s 2018 pay package at its annual meeting this week, it raises a $25 billion question: Will the company’s profit take a big hit?
Tesla says no. The electric-car manufacturer already booked the cost of the original award, so it argues that reinstating the same pay package shouldn’t add any expense. Others say that approach doesn’t reflect the facts: A court found the original award was adopted improperly, and any reinstatement amounts to giving Musk the stock options anew — a far costlier proposition given the run-up in Tesla’s shares.
The price tag on any re-evaluation of the award could surpass $25 billion, at least on paper. That amount is 10 times what Tesla originally reported and more than the company’s last two years of pretax profits combined, said Shivaram Rajgopal, a Columbia University accounting professor who studies executive pay.
“Tesla will have to book that number as compensation expense,” Rajgopal said.
How the accounting plays out might depend on a little-tested corner of Delaware corporate law, and on how Delaware courts view a shareholder vote to reapprove the package: Is it a fix going forward, or a do-over that reaches back in time?
Tesla’s eventual accounting for Musk’s pay package — and the potential for a significant one-time, noncash charge — is another factor for shareholders to consider as they prepare to vote on the proposal this week.
Across nearly 200 pages of securities disclosures on the vote, Tesla argues a yes vote would be beneficial to the company. Tesla says voting with the board would let the company avoid $25 billion or more in compensation expense from adopting a new pay package of similar size.
“The notion that a new accounting charge would be required with ratification misunderstands what ratification is,” Robyn Denholm, Tesla’s board chair and the head of its audit committee, said in a statement. “The company has already taken the expense for these options, and the reality is that ratification saves stockholders from a new charge for a new compensation plan.”
The pay package at issue, dating to 2018, gave Musk the opportunity to receive options on about 303 million shares (adjusted for subsequent stock splits) if Tesla’s market value and measures of sales and profit hit a series of targets over the following decade.
At the time, Tesla valued the options at $2.3 billion — to this day the richest pay package reported for a CEO of a U.S. publicly traded company, according to compensation-data firm Equilar. Baked into that figure were projections of how likely Tesla was to meet the targets, and when.
By last year — after leading the electric-vehicle boom — the company had hit all the marks. The options had vested, becoming fully Musk’s property, with the underlying stock valued multiple times the initial figure.
At about $23 a share to exercise the options, converting them into stock, Musk could have received more than $50 billion before taxes in shares earlier this year. He exercised none, and today they would net closer to $47 billion, after a retreat in Tesla’s share price.
In January, Chancellor Kathaleen McCormick of Delaware’s Chancery Court threw out the pay package in a lawsuit brought by a shareholder.
She found the board was insufficiently independent and Tesla failed to adequately disclose important details of the pay package to shareholders.
Tesla has promised an appeal. In late April, it also asked shareholders to vote to reapprove the pay package at its June 13 annual meeting. Doing so, the company said in securities filings, would ensure Musk keeps the options and doesn’t go unpaid for six years of success at the company.
Rajgopal says reapproving the award won’t leave things as they seemed to be previously by unwinding the court’s ruling.
Rather, Tesla would likely have to book the cost of issuing the options to Musk as if they were new, offset by the $2.3 billion in compensation expense booked since 2018, or as a modification of the original.
Either would carry a hefty accounting cost. Paying an executive with vested, in-the-money stock options — ones that would generate a gain if exercised immediately — incurs compensation expense at or near the “intrinsic” value of the award: what the recipient could realize by exercising immediately.
That expense is particularly big when the cost to exercise the options is well below the current share price, as it is for Musk. He must hold the resulting shares for at least five years, but the figure likely lies between $25 billion and the options’ value when the judge invalidated them, or about $51 billion, Rajgopal estimates.
Some experts say such an accounting charge could be necessary, but might depend on the interplay between accounting and Delaware law.
If Delaware courts treat majority support from Tesla’s shareholders as fixing the company’s disclosure problems going forward — but leaving the January court decision intact — Tesla likely would have to book billions in new compensation expense for reinstating the old options, said Mary Ellen Carter, a Boston College accounting professor.
“If you take those 300 million shares and you grant them with the original strike price of $23 and the stock is now worth $175 — that valuation blows up into crazy, ridiculous amounts,” Carter said.
If, instead, the court reverses its previous decision, finding that shareholder reapproval cures the original flaws retroactively, it might amount to turning back the clock and avoiding an accounting hit, she said. “I think it’s a legal question as to what the yes vote could mean.”
The company says two elements of Delaware corporate law give it avenues to retroactively fix problems with the 2018 shareholder vote by holding a new ballot, while also leaving the door open to other, unspecified routes.
There is no precedent under those provisions for resolving something so significant with a shareholder vote, said Eric Talley, a Columbia University law professor who specializes in corporate governance and finance.
One provision Tesla cites was adopted to fix technical errors, though nothing in the language restricts it to that use, said Talley, who holds Tesla shares and plans to attend the annual meeting online to cast his votes. “It’s certainly not what the section was intended to do.”
The other element of Delaware corporate law likely depends on persuading the courts that the board deserves a second chance, even though it was responsible for the failures in the first vote, Talley said. That argument is tough but not impossible.
“They’ve got a fighting chance,” Talley said of Tesla’s overall approach. “It’s a kind of a thread-the-needle strategy.”
Stock analysts and investors routinely ignore one-off adjustments of financial results, even big ones, when assessing a company’s underlying health and prospects.
“The accounting for stock compensation is all about: What were these things worth when they were granted?” said David Zion, a longtime accounting and tax analyst who heads Zion Research Group. “As an investor what I care about is: What are these people actually paid? The accounting here I don’t think changes the economics.”