Corporate board compensation was thrust into the spotlight this week when members of the Tesla board agreed to return $735 million in company shares and cash as part of a settlement of a lawsuit accusing board members of overpaying themselves with stock options from 2017 to 2020. The lawsuit, filed by the Police and Fire Retirement System of the City of Detroit, raises questions about what levels of compensation and incentives are appropriate to motivate corporate board members to simply do their job — create value for shareholders.
While the Tesla directors did not admit to any wrongdoing as part of the settlement, they have agreed to make significant changes to how the company compensates its board members. According to news reports, in addition to returning $458.6 million in stock and $276.6 million in cash from exercised options from 2021 through 2023, Tesla directors will not receive any compensation for 2021, 2022 and 2023, and the board has agreed to reevaluate and revise its formula for executive compensation going forward. The settlement also requires future executive compensation packages to be voted on by Tesla shareholders.
As the Tesla directors stated, they agreed to the settlement to “eliminate the uncertainty, risk, burden and expense of future litigation.” However, in many ways the settlement can be considered a win for Tesla shareholders. Shareholders will benefit from the return of $735 million to the company, the company saving millions in litigation costs from defending the lawsuit against the directors, and from the company preventing future lawsuits by making governance changes to its executive compensation plan.
The settlement provides corporate board members a reminder that they might consider reviewing their own executive compensation plans to determine whether they are at risk of litigation now or in the future. A few observations from the Tesla settlement:
• Board compensation far above industry norms will trigger shareholder litigation. By now, boards should understand that they are under much higher scrutiny than ever before, so granting themselves compensation far above their peers will almost always be challenged in court. While “pay for performance” is what boards should strive for, directors should also understand that there are limits to how much they can “ethically” benefit from navigating a company to success. Since board members’ personal losses are limited whether a company succeeds or fails, shareholders are now insisting that their personal gains also be limited on some level.
• Adopting aspects of compensation plans from peer companies may lower shareholder objections. There are plenty of solid compensation plans that have not triggered compensation lawsuits, so why not model your company’s compensation plan after those? Over the last five years, many lawsuits have been filed exposing the challenges associated with options awards, so most companies should be able to avoid problems that could trigger lawsuits. An independent review of the executive compensation plan could improve compensation for everyone.
• Spending company resources to fight a lawsuit to pay yourself sends the wrong message. The optics here scream conflict of interest. Such lawsuits are not in the best interest of shareholders, so it also smacks of a breach of fiduciary duty. Board members certainly have a right to fight these lawsuits, but is it right to fight them? (Probably not) The reputation of the board members involved could also be damaged if they choose to fight such a lawsuit.