Last week, Tesla (TSLA 0.71%) shareholders approved a controversial new long-term incentive package for the electric-car maker's visionary CEO, Elon Musk. This plan sets cash compensation at zero but would grant Musk up to 20.3 million shares if Tesla meets a series of financial hurdles and increases its market cap to at least $650 billion, from roughly $50 billion today.
The value of these shares would be roughly $56 billion based on a Tesla market cap of $650 billion. In that scenario, Musk's total stake in Tesla (including shares he already owns) would be worth approximately $184 billion.
Elon Musk could receive more than $50 billion of stock if Tesla hits aggressive growth goals. Image source: Tesla.
Tesla has attracted criticism for the sheer size of Elon Musk's potential payday. However, the bigger problem is that the structure of the stock award could encourage Musk to indulge in risky "bet-the-company" moves to try to reach the maximum payout.
The experts say no
Tesla's CEO pay plan won shareholder approval even though both major proxy advisory firms (ISS and Glass Lewis) recommended voting against the proposal. In their criticism, ISS and Glass Lewis zeroed in on the sheer size of the potential award.
The present value of the stock award is $2.6 billion according to Tesla, and about $3.7 billion according to the proxy advisory firms, which used a different valuation methodology. "Even when annualized, Musk's pay opportunity would dwarf that of nearly every CEO at the largest and most profitable public companies," ISS noted (via Bloomberg).
ISS and Glass Lewis also highlighted that Musk could receive a substantial stock award even if Tesla doesn't hit all of its financial goals. For each $50 billion of stock market value that Tesla adds, Musk will receive another 1% of the company's outstanding shares, as long as Tesla has met either one of eight annual revenue targets -- which range from $20 billion to $175 billion -- or one of eight adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) targets, which range from $1.5 billion to $14 billion.
In theory, Musk could receive a substantial number of shares without hitting any of the EBITDA targets, as long as he drives revenue growth and creates enough hype to push the stock price up.
Elon Musk's pay package incentivizes taking big risks to drive growth. Image source: Tesla.
The bigger problem
While the amount of money that Musk could earn is ludicrous, it's probably fair to say that he's more important to his company's success than any other CEO in the world. If Tesla really does reach a market cap of $650 billion a decade from now, I doubt any shareholders will complain about how much Musk got paid.
Additionally, Musk has to hold the shares he exercises for at least five years. This reduces the likelihood that he would be able to achieve a big payday based on hype alone. Stock market hype wears off over time.
The more worrisome aspect of this stock award is that it incentivizes unhealthy risk-taking. Arguably, Tesla's main priorities for the next decade should be broadening its product lineup to cover all of the major market segments, expanding its Supercharger network, and implementing industry best practices for mass production.
Succeeding in these objectives would enable Tesla to significantly increase its output and turn sustainably profitable. However, it probably wouldn't provide a big enough jolt to achieve the milestones needed for Musk to earn most of his available stock awards.
As a result, Musk may be more likely to pursue high-risk, high-reward projects in an attempt to maintain Tesla's phenomenal growth rate. If these efforts fail, they could severely damage the company.
Musk already dreams big
Elon Musk appears to have a natural predisposition toward a "bet-the-company" philosophy. For example, during an earnings call last year, Musk announced that Tesla's next new vehicle, the Model Y, would be based on an all-new platform. This would have been a massive waste of money, compared to designing it for the existing Model 3 platform. Luckily, Musk realized that this plan made no sense before implementing it.
More recently, Musk and his lieutenants spent a surprising amount of time during Tesla's Q4 earnings call discussing plans to fully automate vehicle production.
Automation could have a substantial payoff in the form of lower production costs. However, other automakers have concluded that the production process is too complex to be suitable for automation. Given that Tesla hasn't even shown basic competence in vehicle manufacturing thus far -- let alone excellence or innovation -- investors could reasonably wonder whether this experiment will turn into an epic failure, further snarling production.
Elon Musk already has massive ambitions. That's part of what has made him so successful. But investors shouldn't assume that he is infallible. If the new compensation plan encourages him to make big bets outside of Tesla's core areas of competence, it could ultimately prove disastrous for Tesla.
