In the years leading up to the slowdown in the IPO markets in late 2021, it had become increasingly common for high-growth technology companies to grant large equity incentive awards to their founders and/or CEOs in the lead-up to a public listing or, in some cases, after the company went public. These awards, which are often referred to as “special value creation,” “mega,” or “moonshot” grants, were frequently tied to achieving aggressive stock price milestone targets, with the rationale that the market price–based performance condition aligns incentives between the company visionary and the company’s stockholders around driving exceptional increases in stockholder value, with the executive realizing value only if the company’s stockholders benefit from substantial value creation.
Tesla granted a “moonshot” award to Elon Musk, its founder, chair, CEO, and “Technoking,” in January 2018. Musk’s award represented the largest equity award ever granted to a public company executive, anticipated to have an approximate value of $55.8 billion if the applicable performance criteria were achieved (which would have resulted in, among other things, an increase in Tesla’s market capitalization by $600 billion) and covering up to 12% of the total outstanding shares. The award was subject to 12 equal performance-based vesting tranches, each requiring an increase of the company’s market capitalization by $50 billion and the satisfaction of certain revenue or EBITDA targets.
In June 2018, a stockholder sued the board and Musk for, among other things, breaches of fiduciary duty, unjust enrichment, and waste. The case went to trial in November 2022, and, in January 2024, the Delaware Court of Chancery ordered the grant rescinded in full after finding that the grant of the moonshot award was tainted by improper approval processes and had not been shown to be entirely fair to minority stockholders. We expect Tesla will appeal the decision to the Delaware Supreme Court, which could overrule or modify the decision (or aspects of it).
In a 201-page Post-Trial Opinion, delivered over a year following trial, Chancellor Kathaleen St. J. McCormick sided with the plaintiff in a derivative suit against Tesla (as the nominal defendant) and several current and former members of its board of directors. In doing so, Chancellor McCormick found that awarding the moonshot grant to Musk was a “conflicted-controlled transaction” as a result of:
In describing Musk’s “Superstar CEO” status, the court noted his “unusually expansive managerial authority,” including that he:
Further, the court underlined that, following settlement with the U.S. Securities and Exchange Commission, he continued to make determinations on what was appropriate to tweet regarding Tesla with “desultory [board] enforcement” of the agreed supervision structure.
The court also found that the majority of the board, including the compensation committee, was not truly “independent” of Musk. In support of that finding, it devoted significant portions of the opinion to discussing Musk’s close relationships with his board members, which included his brother and several longstanding business associates and personal friends. Notably, a few of the board members were sufficiently close to Musk to have repeatedly vacationed with his family and others had earned what they characterized as “life-changing” or “dynastic” wealth from their investments in Musk’s companies and/or engagement as members of Tesla’s board.
The court also noted Musk’s significant control over the review and approval process for the moonshot award. The opinion concluded that Musk proposed the initial set of terms and all meaningful changes thereto; there was no adversarial negotiation over the size, performance criteria, or other aspects of the award; and he controlled when discussions and approvals of the award occurred (with meetings largely being scheduled or postponed on a highly rushed basis and with agendas and other items for consideration being changed or shared at the last minute). In one example of that control, the court noted that one of the biggest purported concerns the board expressed when considering the grant was their desire to keep Musk engaged in Tesla despite his significant time commitments at his other companies (including SpaceX, The Boring Company, Neuralink, and later, Twitter (now known as X)), and that the grant could have addressed this issue by requiring continued employment as CEO as a requirement for vesting, but that no one proposed that to Musk.
Collectively, the court found that the foregoing factors resulted in Musk having at least transaction-specific control of Tesla. As a result, the defendants bore the burden of proving that granting the moonshot award was entirely fair to Tesla stockholders, which is the highest standard of judicial review applicable under Delaware corporate law. In determining whether a transaction is entirely fair, Delaware law looks to whether there was both “fair dealing” (fair process) and a “fair price” (financial fairness). However, the final analysis of whether a transaction was fair is based on a holistic examination, rather than looking at bifurcated factors. Following the trial, the court found that Tesla was not able to meet this evidentiary standard and successfully establish that there was fair dealing or a fair price with respect to the moonshot grant.
Tesla’s counsel argued that, because the moonshot award had been granted subject to approval by a “majority of the minority [stock]holders,” the burden of proof should shift back to the plaintiffs. However, the court held that the stockholder consent was insufficiently informed and therefore did not shift the evidentiary burden because the disclosure materials did not apprise stockholders of all material information related to the transaction, including:
In the entire fairness analysis, the court noted that Tesla did not undertake any benchmarking analysis with respect to the award—nor did it appear to consider either a lesser award or that Musk’s pre-existing stock ownership may have provided sufficient incentive for him to continue to grow the value of the company. Additionally, the court suggested that the board could have pushed for a commitment that Musk would remain Tesla’s CEO during the entire vesting period of the award (Musk’s prior award contained this requirement, but the new moonshot award instead required that he continue as either CEO or executive chairman and chief product officer during vesting). In addressing Tesla’s arguments that the performance milestones were sufficiently calibrated to warrant the moonshot grant, the court noted the criteria were achieved relatively quickly and that Tesla’s own internal projections indicated that several milestones were 70% likely to be achieved shortly after the grant was approved.
The court noted that the defendants maintained that the plan is an exceptional deal from a financial fairness perspective compared to compensation plans in portfolio companies backed by venture capital and private equity funds. However, the court stated that the defendants did not explain why anyone would compare a public company’s compensation plan with a private equity or venture capital compensation plan. It may seem obvious to practitioners and compensation advisors that public companies compete for executive talent with private companies (whether backed by private equity, venture capital, or otherwise), but the court did not make that connection—despite previously noting in its opinion that Tesla was competing with private companies SpaceX, The Boring Company, Neuralink, and, eventually, Twitter (now known as X) for Musk’s time and attention. Instead, the court said the defendants appeared to come up with the argument at trial, stating that they offered no theoretical justification for comparing the grant to venture capital or private equity compensation structures when Tesla is not backed by venture capital or private equity.
For companies that have executives who are (i) significant stockholders (holders of greater than 10% require special attention), (ii) “Superstar CEOs” (or exercise similar control/influence) or have important positions such as chair, CEO, and/or founder, and/or (iii) significantly personally and/or financially involved with board members (including if board members have substantial wealth tied to the company), we recommend working to ensure that the following factors are present when considering granting significant equity awards or other outsized compensation to such executives:
The holding of Tornetta v. Musk and its underlying reasoning (along with any rulings entered on appeal) will invariably have application outside of the moonshot award context and the specific facts of this case, as the court’s extensive analysis of the principles governing controlling stockholders will have applicability in a wide variety of transactions where general and transaction-specific control may be implicated.