TSLA Settles for DSoP

Or, Director Say on Pay, to invent a new acronym.

It was easy to miss the case where Tesla, Inc. (TSLA) settled a massive shareholder derivative lawsuit alleging its BoD vastly overpaid itself for a few years. The parties, a City of Detroit employee pension fund and TSLA, announced the settlement in mid-July.

Or, if you saw it and took at least some satisfaction in an immense BoD comp clawback, you may have missed a few other corp gov reforms. Or, if you just skimmed news reports, you saw only "the board will change the way compensation is determined" or will make "corporate-governance changes to the way board-level compensation issues are reviewed".

That vastly understates the unprecedented and potentially radical reform in BoD comp and shareholder influence over a truly critical element of BoD-shareholder relations. Now, TSLA shareholders will now approve BoD comp.

The settlement has two principal components: the BoD will return a meaningful chunk of its comp for the past few years, and TSLA agrees to some possibly enormous changes in how it determines BoD comp. The latter changes may suffer from a big problem with enforcing the results of the shareholder vote on DSoP.

$735 Million Is a Lot of Money

The clawback itself astonished us. The TSLA BoD will return $735 million in cash, shares, and options it paid themselves from 2017-2020. Directors also will receive no comp for 2021-2023. Observers have called this one of the largest derivate suit settlement ever in Delaware.

The clawback terms and damage calculation is intricate, and according to a post in the Chancery Daily, has some curious and possibly controversial elements to it. We plan to review them in a subsequent missive. For now, we commend to everyone The Chancery Daily Substack, an invaluable resource to activists, companies, and their advisors with any interest in what happens in Delaware corporate law.

What Corporate Governance "Changes"?

For now, we have a greater interest in how the settlement might deal with the BoD comp process. What about those "governance changes"? Here we break new ground in how shareholders might hold a BoD accountable. TSLA must follow these new procedures for five years starting in 2023.

First, TSLA will formalize internal BoD comp processes. The BoD Comp Committee will oversee it, and hire an independent comp consultant (Sec. 2.10). The Comp Committee will recommend BoD comp to the BoD, who will review the Comp Committee work (Sec. 2.11).

This sounds vaguely weak, to those of us with experience with exec comp, Comp Committees, and comp consultants. While better than nothing, these changes alone don't impress us.

Next, TSLA will disclose all this to shareholders in the annual proxy statement (Sec. 2.13). It will describe the overall BoD comp philosophy, the decision process and role of the independent consultant in determining BoD comp, any peer groups used by the consultant, and the proposed comp for each director. This strikes us as somewhat better, seeing as shareholders almost always see only the philosophy stuff ("We recommend a mix of cash and equity...").

Finally, surprisingly, and hugely, shareholders will vote on what they see in the proxy statement (Sec. 2.12):

On an annual basis, Tesla shall submit the proposed annual compensation to be paid to Non-Employee Directors to an approval vote of the majority of Unaffiliated Tesla Stockholders present in person or represented by proxy and entitled to vote on such decision.

Even better, the BoD doesn't vote on its own comp! "Unaffiliated Tesla Stockholders" excludes all the defendants in the lawsuit and any other directors. Those defendants include CEO Elon Musk, BoD Chair Robyn Denholm, brother Kimbal Musk, Oracle CEO Larry Ellison, News Corp CEO James Murdoch, and the rest. Together they account for about 21% of TSLA common shares, almost all Elon Musk.

The voting standard to approve is a simple majority of the "unaffiliated" shareholders that attend the meeting, similar to current say-on-pay and shareholder proposals. Let's repeat that: director pay will depend on the approval of a majority of the votes of independent shareholders.

We cannot recall any US public company ever submitting BoD comp to a shareholder vote, or even disclosing that extent of detail to shareholders. This goes far beyond today's executive SoP vote. Allowing shareholders to accept or reject BoD comp gives us unprecedented influence over the BoD.

What Does "Approval" Mean?

We see a huge and potentially fatal gap in the settlement terms. The agreement is silent as to any enforcement mechanism. If the proposed BoD comp fails, the settlement does not set forth what happens next. In other words, based on the current settlement agreement, it seems the vote is at best advisory and non-binding, just like executive say-on-pay.

Suppose the DSoP item on the annual meeting agenda fails to win the requisite majority. Would TSLA not pay the BoD for the coming year? Does TSLA propose a different BoD comp plan that it thinks could win a majority and schedule a special shareholder meeting just to vote again?

Or, would TSLA consider the vote as "advisory" and pay directors anyway? It would then dare the plaintiff and other shareholders to return to court to challenge the payment. Musk has a habit of defying courts and judges, so this would not surprise us completely. His pending exec comp case before the same Vice Chancellor might prompt him to avoid this, though.

Shareholders Can Object to the Settlement

It seems the plaintiff wants to not only punish the BoD for its past acts, by denying it past comp. It also wants to assure it doesn't repeat these acts, at least for the five-year term of the settlement. Within the reality of how BoDs work today, it wants to promote BoD independence. We love that.

If so, it both addresses some glaring problems with BoD comp, and misses a critical element. TSLA shareholders should welcome the new process and disclosures. At the same time, shareholders must have some way to enforce the outcome of the DSoP vote.

We really want to see the parties revise the settlement to include a firm enforcement mechanism, one that turns this into mandatory DSoP. Even better, TSLA should enshrine this new process in its bylaws. Without it, it looks like the BoD could mostly ignore the shareholder vote without any serious consequence.

As it turns out, shareholders can object to the settlement. The hearing on the proposed settlement is scheduled for October 13, 2023, with objections filed no later than September 21. The objection process is a little detailed, so best to consult with Delaware counsel.

We own TSLA and will consider an objection. Please let us know if you'd like to discuss such an initiative.