By Hyunjoo Jin and Tom Hals
(Reuters) -After a Delaware court threw out Elon Musk's $56 billion pay package on Tuesday, the Tesla (NASDAQ:TSLA) chief executive and a board seen as captive to him must find a way to negotiate a replacement contract. It will not be easy.
The ruling is spurring on investors who for years have raised concerns about Tesla board independence. This could be a turning point for Musk, who recently said he was uncomfortable transforming Tesla into an artificial intelligence leader if his control did not rise with a new pay package.
"This throws Tesla into a complete sort of tailspin from an executive perspective," said Tesla shareholder Ross Gerber, who said the court decision essentially required new independent board members who would provide CEO oversight. "Then it gets real messy because Elon - it's either his way or the highway," said Gerber, who last year publicly considered a board run as an independent.
Musk has not said what he will do, though an appeal is almost certain. Tesla shares fell 2.2% on Wednesday.
First, Musk will have to give back what he got if the ruling stands. He has satisfied the 2018 contract terms and received 12 tranches of options worth about $51 billion.
However, the options grant "sits unexercised and undisturbed," the court ruling said, so giving up his earnings may not be complicated.
Deciding what to replace the package with will be a difficult process, since it is unclear who will bargain on Tesla's side. The judge who threw out the package called it an "unfathomable sum" that was unfair to shareholders and questioned the board's independence.
Equilar estimated in 2022 that Musk's package was around six times larger than the combined pay of the 200 highest-paid executives in 2021. Musk was the world's second-richest person, worth $184 billion on Wednesday, Forbes calculated.
TEARS OF ADMIRATION
Delaware Judge Kathaleen McCormick (NYSE:MKC) said many current board directors labeled as independent by Tesla, including James Murdoch, Chair Robyn Denholm and Ira Ehrenpreis, showed a lack of independence in the pay decision.
The judge's ruling described a board with little control over its chaotic CEO. After a settlement with the U.S. securities regulator required Musk to get approval from a Tesla lawyer for some tweets, Denholm described the Musk tweet process as "self-regulating."
The chair said sales of $280 million in stock received for her director service were "life-changing," and the judge described the board members and executives as advisors to Musk. The compensation setting process was "me negotiating against myself," Musk testified.
"They're going to have to refresh the board," said Charles Elson, director of the University of Delaware's corporate governance center. "I mean, he may not like it, but it's going to be very hard to run this company as it did."
Musk could decide to leave, a possibility raised by JP Morgan (NYSE:JPM), but Elson said that would torpedo the value of the 13% stake Musk holds, independent of the pay package. Even before Tesla has announced this year's annual meeting, several shareholders already are promoting resolutions to give investors more control by moving to annual director elections and eliminating a supermajority voting requirement.
McCormick questioned if any pay for Musk was necessary, given his fortune swelled along with Tesla's success, through his stake in the company.
"There are many examples of visionaries with large pre-existing equity holdings foregoing compensation entirely: Zuckerberg, Bezos, Gates, and others so familiar to the world that no first names are required," McCormick wrote.
Musk brings a strong record into any negotiations.
Tesla's stock market value was $53 billion when Musk's package was approved in 2018. It was a money-losing enterprise, struggling to accelerate production of its Model 3 sedan. That was when Musk famously described Tesla as being in "production hell."
By 2021, now profitable, having weathered the pandemic and launched the Model Y small SUV, Tesla's market value reached $1.2 trillion. That became the world's second best selling car or SUV last year, Car and Driver estimated.
Tesla's valuation has fallen to around $600 billion, but that is still more than 10 times what it was when the process began, and the company remains worth more than most auto industry veterans, combined.