Tesla’s $26 billion problem? Musk’s 2018 pay package may swallow years of automaker profits

Tesla’s lavish $1 trillion executive compensation package for CEO Elon Musk has overshadowed a more pressing concern: Musk’s 2018 pay package (still pending in court) could eat into years of future profits for the electric vehicle maker.

The Delaware Supreme Court will soon decide whether to reverse a lower court decision that invalidated Musk’s previous record-breaking severance package. If Tesla’s appeal fails, it could trigger a $26 billion hit to profits over two years, factoring in today’s much higher stock price and the replacement stock compensation package it promised Musk.

By comparison, $26 billion would equal more than half of Tesla’s total net revenue since becoming profitable in 2019.

Even if Tesla prevails in court, profits could be squeezed over the next decade if Musk hits performance targets in his trillion-dollar pay packet, each target triggering billions of dollars in compensation and accounting expenses.

The outsized profit impact highlights the risks inherent in Musk’s oversized compensation. Even the largest public companies often show little concern about the profitability impacts of CEO pay. The richest packages are usually measured in hundreds of millions, not billions.

Musk’s exponential compensation creates unique profit uncertainties for Tesla at a time when earnings are already falling due to falling car sales, the elimination of electric car subsidies and rising costs of booming bets like humanoid robots.

Brian Dunn, director of the Institute for Wage Studies at Cornell University’s School of Industrial and Labor Relations, said stock compensation expenses won’t hurt cash flow and shareholders can treat it as “pure accounting.”

But he said large net income declines from CEO compensation signaled that Tesla’s board was not following “reasonable fiduciary practices.”

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

Tesla’s board has argued that Musk’s latest pay package does nothing for him unless the automaker hits “Mars milestones” that include high profit targets. If Tesla hits these high profit milestones, Musk’s compensation expenses will consume less of his earnings.

But the easiest targets in Musk’s package could still trigger payouts worth tens of billions of dollars without changing Tesla’s business or profits, Reuters reported. The maximum payout to Musk is $878 billion because $1 trillion will be shaved off its stock value when Tesla’s board approves the pay package in September.

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

Upcoming court decision

The biggest near-term risk lies in the next legal rollover of Musk’s 2018 compensation. Last year, a Delaware judge tossed out the package, ruling in a shareholder lawsuit that Musk’s pay negotiations were compromised by Tesla board members’ own excessive salaries and close personal ties to the CEO.

If the Delaware Supreme Court sides with Tesla, Musk will be able to keep his stock options in the 2018 package and the company will not pay any more accounting expenses. By the time he reaches this plan’s performance goals in 2022, the stock options granted to Musk were worth $56 billion. Today its value is 116 billion dollars.

If the judge’s initial ruling stands, Musk’s replacement package will give him far fewer shares. But they would cost Tesla’s bottom line much more than the $2.3 billion value of the 2018 pay package when it was first approved, because Tesla’s share price is now much higher.

The value of Musk’s replacement package would have to be determined based on the stock price the board approved in August, or $26 billion. Tesla would have to make the payment by August 2027, when Musk becomes eligible to receive the shares.

Dividing $26 billion into eight quarters would reduce profits by $3.25 billion per quarter; That’s more than Tesla’s net income in every quarter but four of the last 25 quarters dating back to 2019.

The company explained in a filing that an unsuccessful appeal could have “a material adverse effect on our business and reported earnings.” The board argued that not changing the 2018 package could cause Musk to leave Tesla.

Tesla doesn’t need to pay cash for stock; can only issue new shares. But corporate accounting experts said accounting rules require recording stock compensation as an expense because the company may have sold those shares on the open market.

‘It harms shareholders’

These types of stock transactions weaken the voting power of other shareholders who own fewer shares in the company as the total pool of shares increases, with most of those shares going to the CEO.

“You’re hurting shareholders, without a doubt,” said Schuyler Moore, an attorney who specializes in corporate finance and tax law at the Los Angeles firm Greenberg Glusker.

Typically, such a big hit to profits would cause investors to devalue a company as it “takes a loss,” he said. But financial fundamentals have traditionally mattered little to Tesla’s stock market value, which has been based almost entirely on Musk’s promises of products and services the company has yet to sell, including self-driving robotaxis and humanoid robots.

“Nobody seems to care about Tesla because this company is in a dream world,” Moore said.