Lucian Bebchuk and Robert Jackson discuss how Tesla is failing to bolster director independence despite a highly critical court opinion.
You can read here the first and second parts of their series of articles on Tesla’s corporate governance.
As Tesla prepares for next week’s stockholder meeting, all eyes are on the board’s proposals to reincorporate in Texas and reinstate Elon Musk’s massive stock option grant, which a Delaware judge invalidated in January. Insufficient attention, however, is being paid to the board’s failure to use the coming meeting to bolster board director independence and thereby address a serious problem stressed by the court decisions.
Directors that are independent from public-company executives provide a valuable benefit to investors, enabling the board to oversee and effectively compensate such executives in ways that would serve shareholder value. That’s especially true at a company like Tesla, which has a “superstar CEO” with a significant stake. At such a company, the Delaware courts have explained, an “indisputably independent” director is needed to “neutralize” the CEO’s sway. However highly one values Musk and his talents, making the most of those gifts for public stockholders requires that directors who bargain with him over his pay be fully independent.
In 2018 Musk requested, and Tesla’s board granted him, with stockholder approval, options to potentially acquire some 10% of Tesla’s stock. After a trial, Delaware’s chancellor concluded that all the directors on the board’s compensation committee lacked independence from Musk in light of the array of long personal and business relationships they had with Musk. Among other things, Musk and the “lead” director negotiating Musk’s pay, the Chancellor said, “spent the night at each other’s homes,” “vacationed together with their [] families,” and “spent Christmas together.” These close ties made Tesla’s directors the “opposite” of the “staunchly independent” board members needed to bargain with a powerful CEO.
Even the board’s chair, Robyn Denholm, lacked independence, the court concluded. The Tesla stock she received produced hundreds of millions of dollars for her, a majority of her overall wealth. Therefore, citing her testimony that her Tesla compensation was “life-changing,” the court determined that she could not be independent from Musk.
And since Tesla’s board “repeatedly” told investors in 2018 that the directors negotiating Musk’s pay were independent, the chancellor concluded, the stockholder vote on the award had been uninformed and thus “meaningless.” Indeed, the court explained, it was “false” for Tesla to “describe key [directors] as independent.”
In light of the importance of director independence and the court’s disconcerting conclusions, Tesla’s board should have accorded high priority to bolstering its independence in the aftermath of the court’s opinion. Given that the board made various key decisions between the court’s ruling and the issuance of the proxy statement for the coming meeting, one might have hoped to see on the board’s slate at least one candidate that could be viewed as “indisputably independent.” Surely there are highly qualified individuals that can meet that standard and would be willing to serve on Tesla’s board.
But at next week’s meeting, no such new candidate is on the slate for stockholders to elect. On the slate are only two candidates that are existing directors: Kimbal Musk, the CEO’s brother, and James Murdoch, the former CEO of 21st Century Fox who, the court noted, “took family vacations together” with Musk. The court described its finding that these directors could not be independent from Musk a “clear[] call.”
To be sure, Tesla’s proxy statement for next week’s meeting describes the board’s view that, contrary to the court’s conclusions, all of the directors other than Musk’s brother are independent. The proxy statement attaches the court’s ruling as an appendix for stockholders who wish to review it, but the statement does not substantively engage with the court’s analysis. In particular, the statement offers no specifics as to why the Tesla board drew from the same facts conclusions regarding independence that are so different from those of Delaware’s chancellor.
The lack of independent directors has hobbled the Tesla board’s capacity for decision-making—even regarding next week’s meeting. To make certain decisions that were clearly independent of Musk, Tesla’s board assembled a special committee with two members. Before the committee made any decisions, however, one of its two members stepped down because of his “personal relationship with Elon Musk, as well as a potential business transaction […] with him” that could lead to “unfair attacks based on perceived conflicts of interest.”
This director’s departure left just one board member on the special committee, which decided to press forward with next week’s votes. But that director, like the chair of Tesla’s board, has received “a meaningful portion of her net worth” from her Tesla compensation. The compensation for her other public-company roles seems to pale in comparison to her earnings at Tesla. Thus, based on the court’s reasoning about the effects of receiving life-changing compensation, there is reason to worry about her independence.
Notably, after the other director’s departure from the special committee, the committee’s sole remaining member discussed with the board chairperson “the possibility of accelerating the in-process search for new independent directors, and adding any new director(s) to the Committee.” However, it was decided that the committee’s work would not wait until such new director(s) could be added. Thus, it seems that, since there was no addition of a new director, then there was no current director on the board that could have been added to the special committee who could be viewed as “indisputably independent” and thus not create the risk of a “perceived conflict of interest.”
It is unusual for the board of a large public company to be unable to staff a special committee with more than one director who is indisputably independent from its CEO. That is all the more alarming in the case of a company that was the subject of a landmark judicial opinion placing a spotlight on problems arising from the lack of independence.
That decision found that key Tesla directors acted with a “controlled mindset” and “approach[ed] negotiations seeming less intent on negotiating [with Musk] and more interested in achieving the result that [he] wanted.” Such a finding could have, and should have, served as a wake-up call for Tesla’s leaders. Unfortunately, Tesla’s board seems to have chosen to ignore this call.
Authors’ Disclosures: Lucian Bebchuk is a professor of law, economics, and finance, and director of the corporate governance program, at Harvard Law School; and Robert Jackson is a professor of law at NYU School of Law who served as a Commissioner of the U.S. Securities and Exchange Commission from 2018 to 2020. They have 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 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.
