In a surprising turn of events, a Delaware judge has recently invalidated Elon Musk's astounding $56 billion compensation package at Tesla. The judge deemed the exorbitant sum determined by the company's board as unjust to shareholders, referring to it as an "unfathomable sum." This decision raises important questions about the fairness and alignment of interests between managerial decisions and shareholder value.

For quick background on the story, listen click on the link below to listen to NPR's story.

Elon Musk's compensation journey at Tesla has been nothing short of extraordinary. In a bold move, Musk decided to forgo an annual salary,  and instead tied his entire compensation to the future performance of the company. Under a unique 10-year agreement, Musk would earn new stock in Tesla based on the achievement of 12 ambitious milestones aimed at driving the company's value, market capitalization, revenue, and EBITDA growth. This meant that if the milestones were not met, Musk would earn no income.

The magnitude of this compensation package was unprecedented, but it garnered significant support from Tesla shareholders in 2018, with a 73% approval rate. Critics voiced concerns about Tesla's ability to compete and thrive amid growing competition in the electric car market. However, Musk defied expectations by successfully meeting all 12 targets, resulting in the options now being valued at an impressive $56 billion. This remarkable feat has sparked discussions around the balance of risk and reward, and the alignment of interests between managers and shareholders.

From a risk management perspective, this is all about agency costs, the costs associated with managing the relationship between agent and principal.  One of the primary ways to align manager and shareholder interests is through Incentive compensation. Linking managers’ compensation to corporate performance encourages decisions that increase shareholder value.​

​McCormick, the Delaware judge, expressed concerns about the level of influence Elon Musk holds over Tesla's boardroom. She believes that the superstar status of a CEO can lead even independent directors to be overly deferential to the CEO's decisions, creating a 'distortion field' that hampers board oversight. Essentially, this interferes with the checks and balances meant to hold the CEO accountable.

Going back to the original proposal, Musk is not taking a salary and his only compensation is based on the performance of the company.  This is the ultimate example of risk management and incentive alignment costs.  Without such an arrangement, there would not be an incentive to grow the company so quickly and to the scale that Musk achieved. The Board of Directors, and ultimately the shareholders, agreed and benefited from the arrangement.  Whether one agrees with the amount of his compensation, the judge's decision ultimately impacts the relationship between managers and shareholders and the idea of value maximization being a primary goal of corporate governance. 

After the court's decision, Elon Musk conducted a poll among his followers, seeking their opinion on whether Tesla should relocate from Delaware to Texas. The majority of his followers responded affirmatively, expressing support for the move. In response, Musk promptly announced that Tesla would initiate a shareholder vote to determine the final decision on the matter.