By Jessica Tasman-Jones
This article is brought to you by Agenda, an FT Specialist publication that focuses on corporate boards
A $735m settlement involving Tesla's board has highlighted the conflicts in non-executive directors setting their own pay, and forced the electric carmaker to tighten its governance.
The shareholder lawsuit, a so-called derivative claim because it is on behalf of the company, was filed by The Police and Fire Retirement System of the City of Detroit pension fund in 2020.
The plaintiff claimed Musk has “absolute control over Tesla with a completely subservient board” and that the defendants “unmoored from independent stockholder checks on their self-compensation… have granted themselves millions in excessive compensation and are poised to continue this unrelenting avarice into the indefinite future".
Reportedly one of the largest derivative settlements in history, cash, shares and unexercised options awarded to serving and former directors – including Elon Musk, his brother Kimbal, James Murdoch and Larry Ellison – since mid-June 2017 will be returned to the company.
Tesla has also made governance concessions as part of the settlement. This includes the company engaging with an independent compensation consultant for non-executive director pay every year, and publishing details on how director compensation is determined, including comparative data.
The non-executive director compensation package will go to unaffiliated shareholders for an annual binding vote, which will exclude the votes of the defendants and other directors.
The proposed settlement still has to be approved by the Chancery Court, but the numbers are high enough to suggest that it will go through with no more than minor adjustments, according to John Coffee, a professor at Columbia Law School and director of its Center on Corporate Governance.
“This was a far cry from an independent board and hence that may explain the need for an expensive settlement,” he says. The message is that companies whose board members are intricately enmeshed deserve more scrutiny than those with truly independent boards, he adds.
The settlement is “rare” in its provision that the defendants and directors cannot vote on the board’s compensation, says Jim Barrall, a senior fellow at UCLA School of Law and retired partner and former head of the executive compensation practice at Latham & Watkins.
“I know of no director compensation case or settlement that has contained such a provision,” he notes.
Director elections and career concerns are "quite strong safeguards against self-interested enrichment", says Tom Gosling, executive fellow at London Business School.
In the UK, premium-listed companies face a binding vote every three years on the non-executive director fees policy and an annual advisory vote on the remuneration report, he says.
Boards will often review market rates annually and make changes to director pay once every two or three years, says Matt Vnuk, partner at Compensation Advisory Partners (CAP). Directors do not “want to be a distraction" and it would be "unusual for them to want to be an outlier versus market data".
Directors are “less likely to get pushback" if they compensate themselves in line with other similarly sized companies, according to Kyle White, an associate at CAP.
The median director pay for the 100 largest US companies is roughly $325,000, which mostly includes equity, according to CAP data. Three-quarters have shareholder-approved limits in place and these are growing in prevalence among listed companies, says White.
In most cases non-exec pay in Europe is "far lower" than the US, says Gosling.
In the UK, for example, the corporate governance code says non-executive directors’ pay should not include “share options or other performance-related elements”. Fees are paid, with top-ups available for factors such as chairing committees. In 2022, the average base fee for UK non-exec directors was £72,051, according to Spencer Stuart.
Non-executive pay is typically "trivial" and doesn't rank highly among shareholder concerns compared with executive pay, says Rodion Skovoroda, head of the accounting and finance department at The Open University.
However, the integrity of the pay-setting process relies on the independence, experience and empowerment of the non-executive directors, he says.
While Tesla was not the first company to be sued over board pay, the size of the $735m proposed settlement could “renew board compensation as an area of focus for plaintiffs' lawyers", says Ron Mueller, a partner at law firm Gibson Dunn.
It will make companies "think twice" about what they pay directors, says Joshua Wurtzel, a partner at law firm Schlam Stone & Dolan. “Indeed, even when a company experiences significant growth and posts record-setting numbers, this settlement shows that the board of directors doesn’t have carte blanche to pay itself whatever it wants.”
This article is based on a story written for Agenda by Nick Muscavage.
