Lucian Bebchuk and Robert Jackson argue that the Tesla board’s prediction that restoring Musk’s old pay package would require no new compensation charge to Tesla’s financial statement seems not to have been based on any independent accounting advice. This could carry substantial risks for Tesla stockholders.

You can read here the first, second, third, and fourth parts of this series of articles on Tesla’s corporate governance.

This week, Tesla’s stockholders will vote on a board proposal to restore Elon Musk’s 2018 massive options grant that a Delaware court invalidated in January. A key reason the board cited for preferring to restore Musk’s 2018 pay package rather than negotiate a new one is that the former would not involve any new accounting charge. However, the prediction that restoration would require no accounting charge is contestable, and it seems that the board’s claim that no new charge would be required is not based on any independent accounting advice. Therefore, stockholders voting this week should take into account that restoration of the old grant may well result in a massive account charge that could equal or exceed $25 billion.

Tesla’s accounting conjecture

Tesla’s proxy statement for the coming vote told shareholders the following about the accounting consequences of a new compensation package:

The Special Committee also concluded that … a new compensation plan … likely result[s] in a very large, incremental accounting charge for compensation expense. For illustrative purposes, the Company’s accounting team informed the Special Committee that a new grant of 300 million fully vested options — functionally equivalent to what Mr. Musk had before the [grant was invalidated]— would potentially result in an accounting charge in excess of $25 billion.

By contrast, reinstating Musk’s invalidated package, the proxy statement stated, “would avoid any new compensation expense.” Furthermore, in a subsection entitled “Seeking Ratification Now Potentially Avoids Other Costs,” the proxy statement provided as a reason for preferring reinstating the old package that a new plan “would likely result in a very large, incremental accounting charge for compensation expense.”

Note that the financial consequences of reinstating the invalidated grant are the same as those of a new compensation package that consists of the same securities as those provided by the old award. So why should the account consequences be so different? In a recent Forbes article, Shivaram Rajgopal, a chaired accounting professor at Columbia Business School, concludes that Tesla’s claim that reinstating the old package would result in no new compensation expense is “implausible” and “an unreasonable interpretation of both the accounting guidance and the economics of the ratified award.” Indeed, Rajgopal subsequently stated to the Wall Street Journal that the required new accounting charge would likely be between $25 billion and $51 billion. This raises the question: what is the basis for Tesla board’s confident prediction that restoring the 2018 grant would “avoid any new compensation expense”?

What did the board know?

Accounting is a specialized profession, and determination of accounting consequences requires substantial accounting expertise that the sole member of the Board’s special committee that decided to recommend restoration of the old award did not seem to have. And it seems that the special committee (or the board) did not get any independent advice as to the accounting consequences of restoring the old award: the proxy statement makes no mention of any such advice. Indeed, it seems that the board did not even obtain confirmation of its accounting prediction from the company’s external auditor, as the proxy statement is silent on that subject, too.

Reviewing Tesla’s proxy statement, the only information we found on the basis for the special committee’s claim that no new compensation expense will be needed if Musk’s old package is restored is that the special committee received from Tesla “[t]he Company’s position on any potential materially adverse tax, accounting, contractual, regulatory, or securities effects from” the proposals shareholders will vote on this week. It seems that the “position” of the company is that no such charge would be necessary, but a company position is different from a confident professional prediction as to what external auditors would require. In any event, Tesla cannot serve as a provider of independent accounting advice. The special committee hired a number of independent advisors, as good corporate practices require, but surprisingly chose not to hire any independent advisor with respect to this critical accounting claim.

In a statement last week to the Wall Street Journal,Tesla’s board chair, Robyn Denholm, rejected Rajgopal’s analysis and claimed that “[t]he notion that a new accounting charge would be required with ratification misunderstands what ratification is. 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.” This statement is notable for what it does not include: Denholm does not refer to any independent accounting advice received by the special committee or the board that could serve as a basis for Denholm’s belief. Instead, she merely asserts that her belief is what “the reality is.” (Denholm does appear to have worked previously as an accountant, though her advice can hardly qualify as independent.)

Notably, Tesla’s proxy statement for this week’s vote does not even warn stockholders that there is any uncertainty with respect to the prediction that restoring Musk’s old award would not require any new accounting charge. The statement does caution stockholders that, contrary to Tesla’s position, the courts might conclude that this week’s vote is legally invalid or that the sole member of the special committee lacked independence. By contrast, the proxy statement does not display any such caution with respect to the prediction that reinstating Musk’s invalidated award would not involve any new compensation expenses. Indeed, the proxy does not acknowledge any risk that reinstating the old award would require a new accounting charge in the many billions of dollars.

Why this matters

For two reasons, the accounting issue identified above is important for assessing the choice Tesla’s stockholders face this week. First, when weighing how to vote, stockholders should recognize that there is a risk, and in the view of  Rajgopal a substantial risk, that restoring Musk’s invalidated award would require an accounting charge of about $25 billion. Thus, voting stockholders should recognize the risk that restoring the old award does not have accounting advantage cited by the Board.

Second, the Delaware court found that the process leading to the board’s 2018 support for the award was skewed in Musk’s favor by factors such as the directors’ “controlled mindset” and lack of independence. Might the process leading to the board’s 2024 support for this week’s vote be similarly deficient or even more so? The board’s failure to get any independent accounting advice on the expected accounting consequences of restoring the old award could well be relevant for stockholder assessment of this important question.

Authors’ Disclosure: Lucian Bebchuk is a professor of law, economics, and finance, and director of the corporate governance program, at Harvard Law School. 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.