Forget Musk's latest pay package, his last one could wipe out years of Tesla profits

Tesla's gaudy $1 trillion executive-compensation package for CEO Elon Musk has obscured a more pressing concern: Musk's 2018 pay package still tied up in court could eat up years' worth of the electric vehicle maker's future profits. The Delaware Supreme Court will soon decide whether to reverse a lower-court ruling invalidating Musk's previous record-breaking compensation package. If Tesla’s appeal fails, it could trigger a $26 billion hit to profits over two years to account for the replacement stock-compensation package it has promised Musk – at today’s much higher stock price.

For comparison, $26 billion would equal more than half of Tesla’s total net income since becoming profitable in 2019. Even if Tesla prevails in court, its profits could be squeezed over the next decade if Musk hits performance goals in his trillion-dollar pay package, with each goal triggering billions in payouts and accounting expenses.

The outsized profit impact highlights the inherent risks of Musk’s super-sized compensation. Even the largest public companies typically have little concern about bottom-line impacts from CEO pay. The richest packages are typically measured in hundreds of millions – not billions.

Musk’s exponentially bigger compensation creates unique profit uncertainties for Tesla at a time when earnings are already declining because of falling car sales, disappearing electric-car subsidies and spiking costs of moonshot bets like humanoid robots.

Stock-compensation expenses will not hurt cash flow, and shareholders may brush it off as “just accounting," said Brian Dunn, director of the Institute for Compensation Studies at Cornell University’s School of Industrial and Labor Relations.

But huge net-income declines caused by CEO-compensation, he said, signal that Tesla’s board is not following “reasonable fiduciary practices.”

“They’re backdooring a massive transfer of wealth from the shareholders to the single largest shareholder,” he said.

Tesla’s board has argued that Musk’s newest pay package gives him nothing unless the automaker achieves “Mars-shot milestones” that include lofty profit goals. If Tesla were to hit those higher profit milestones, then Musk’s compensation expenses would consume less of its earnings. But the easiest goals in Musk’s package could still trigger payouts of tens of billions of dollars without transforming Tesla’s business or its profits, Reuters has reported. The maximum payout to Musk is $878 billion because $1 trillion in stock would be reduced by the value of the shares at the time Tesla’s board approved the pay package in September.

Tesla’s board and Musk did not respond to Reuters’ requests for comment.

The largest near-term risk lies in the next legal turn over Musk’s 2018 compensation. A Delaware judge last year tossed the package, ruling in a shareholder lawsuit that Musk's pay negotiations were compromised by Tesla board members’ own excessive pay and close personal ties to the CEO.

If the Delaware Supreme Court sides with Tesla, Musk would be able to keep the stock options in the 2018 package and the company would incur no further accounting expenses. By the time he achieved that plan’s performance goals in 2022, the stock options granted to Musk were worth $56 billion. Today, they’re worth $116 billion.

If the judge's original ruling stands, Musk’s replacement package gives him far fewer shares. But they would cost Tesla’s balance sheet far more than the $2.3 billion value of the 2018 pay package when it was originally approved, because Tesla's share price is much higher now. Musk’s replacement package would have to be valued at the stock price in August when the board granted it, or $26 billion. Tesla would have to book the charge by August 2027, when Musk would be eligible to collect the shares. Dividing the $26 billion over eight quarters would reduce profit by $3.25 billion each quarter – more than Tesla’s net income for every quarter except four of the last 25 dating back to 2019.

The company disclosed in a filing that a failed appeal could cause “a material adverse impact on our business and reported earnings.” The board has argued that failing to replace the 2018 package could cause Musk to leave Tesla.

Tesla does not have to pay cash for the stock – it can just issue new shares. But accounting rules require booking stock-compensation as an expense because the company could have sold those shares on the open market, corporate accounting experts said.

Such stock transactions dilute the voting power of other shareholders, who have less of a stake in the company because the total pool of shares has increased, with more of those shares going to the CEO. “Without question, you are hurting the shareholders,” said Schuyler Moore, an attorney specializing in corporate financing and tax law at Los Angeles firm Greenberg Glusker. Typically, he said, such a huge hit to profits would cause investors to devalue a company because it was “running at a loss.” But financial fundamentals have traditionally mattered little to Tesla’s stock-market value, which is based almost entirely on Musk’s promises of products and services the company does not yet sell, including self-driving robotaxis and humanoid robots. In the case of Tesla, Moore said, “nobody seems to care, because this company is in fantasy-land.”