Top Lessons From Tesla On Doing Executive Pay Right
Originally published at Forbes.com
The Tesla shareholder meeting has prompted plenty of headlines and broader discussions about CEO pay. Shareholders voted to reinstall CEO Elon Musk’s compensation package, which had been approved by them in 2018 and then voided by a Delaware Chancery judge after a shareholder lawsuit.
The actual Delaware ruling was not based on whether or not the payment amount was excessive or unfair. It stemmed from the judge’s view that the process for obtaining the original board and shareholder approval was “inadequate.”
With the benefit of hindsight, one could stipulate that the terms and goals set in 2018 were based on very aggressive targets. Because the actual increases in Tesla’s valuation were so above what was deemed even remotely possible in 2018, the resulting compensation numbers were without precedent. Tesla is essentially a unicorn.
But since the Delaware ruling was about process, it is useful to ask these three questions:
What is good director and shareholder oversight these days?
How has that standard for duty of care changed over the last 30 years?
Is the investing public now better represented?
I began serving as a director of public companies three decades ago. Over that period, with more than half a dozen separate companies (many of which are household names), I have seen over 200 annual cycles of board review and approval of compensation programs, and the related shareholder disclosure and votes. I understand, having written a book about the search for and hiring of CEOs while also leading dozens of these undertakings, how the shaping of compensation programs and features occurs in the hiring process.
The truth is this: It’s a very different world today than it was 30 years ago. It is more transparent and more aligned with shareholder interest, providing for more meaningful shareholder input and oversight.
And so, let’s talk about the major obligations of boards of directors and compensation committees in fulfilling their duty of care to represent ownership in the compensation-setting process. The board’s checklist of priorities is straightforward:
Attract and retain the caliber of leadership talent that will work best to make the company successful in ways that rewards shareholders appropriately
Recognize and understand the competitive market for leadership talent and find the right balance to recruit and retain effective leaders, without overpaying compared to competitors for that kind of talent
Increasingly design the features of executive compensations programs so that only better outcomes in shareholder value terms generate higher levels of incentives
Provide full, understandable disclosure of the features and results of compensation programs to investors, maintaining an active program of sharing perspectives and receiving investor input
Boardroom discussions should include succession planning, the nature of the market for the company’s critical skill positions, and data on competitive compensation and the structure of competitive plans. There is no question that, looking back on the 1990s, there were cases of boards that were either too passive or too “grateful,” and program approvals were driven more by the desires of company management. Such cases did not pass the four-part checklist.
Over time, institutional shareholders and active investors forced changes to have companies better represent them. The Securities and Exchange Commission (SEC), in addition to “governance consultants” like Institutional Shareholder Services (ISS), contributed to shaping a set of practices that reflect a new balance.
The SEC made useful changes to disclosure regulations to make compensation and the structure of incentive programs more transparent. This has allowed shareholders and their various representatives to better judge the degree of corporate alignment. Increased transparency has led to more trust in the dialogue between those shareholders and management, since the data is ”on the table” to be discussed with specificity.
The likes of the SEC and ISS have been helpful in creating clarity about when, and how often, shareholders must be given not just disclosure, but also the opportunity to vote their degree of approval or consent. Executive search firms, executive compensation consultants, and accountancies have also geared up so that competitive practices are available as input to the balancing process.
One last observation: The rise in the average level of executive compensation is not principally driven by weak or inadequate oversight or transparency.
Our economic context is not the same today. In 1994, the total market capitalization of the top 20 U.S. listed firms was just over $1 trillion. In 2024, each of the top five firms by market capitalization exceeds the total for all 20 in 1994. This year, the total market cap of the top 20 firms is more than $16 trillion—14 times as much as 30 years ago. Since CEO compensation is directly correlated to size, you would naturally expect compensation to have grown in a similar way. News headlines tend to miss that point.
America’s largest companies are now knowledge firms, not product companies. The top seven market cap firms are all technology companies that didn’t exist four decades ago. Talent, including the CEO, is their key asset and competitive weapon.
Furthermore, we now have a leadership class—especially in the high-growth tech sector—embodied by the owner (the founder-manager). What shows as current compensation is often mixed in with the payoff for those who are successful after 10 to 15 years of investment, risk-taking, and product success. Musk, for one, became Tesla chairman 20 years ago.
I take no sides in the Musk case because it is not over. Although Tesla shareholders approved (again) the program they approved in 2018, the same Delaware Chancery judge will now decide whether or not to accept the new shareholder vote as curing process flaws. This is no guarantee.
As the case moves along, we should all remember that there are many, many determinants of CEO pay. However, over the last three decades, we have come a long way in allowing market forces to operate as they should, creating a balance of various interests. And that is worth celebrating.