Photograph: Mark J. Terrill/Getty Images

Tesla is headed to court to defend Elon Musk's compensation package, earned by his dedicated work. Having not received a salary for years, the main condition for the payment of the compensation package was the achievement of certain milestones by the company under his leadership, which brought benefits directly to investors.

Tesla headed to court on Monday to defend a $56 billion compensation package that was crafted to pay out CEO Elon Musk for making Tesla a successful company. The Delaware Court of Chancery in Wilmington will hold a week-long lawsuit to review a 2018 compensation plan that the automaker's board of directors drafted for Musk. The CEO himself is expected to testify on Wednesday.

The shareholder suing is seeking to cancel the payout despite the majority of shareholders voting in 2018 to adopt the compensation plan. At the time, most did not mind that Musk would work without getting paid a single dollar for it and agreed that he would only deserve a reward if Tesla hit designated milestones. The plaintiff is Richard J. Tornetta, who sued four years ago because he disagreed with the approval of the plan. At the time, he owned just four shares of Tesla.

In January 2018, Tesla announced a new 10-year CEO performance award for Musk with vesting entirely contingent on achieving market cap and operational milestones that would make Tesla one of the most valuable companies in the world. In order to fully vest, Tesla's market cap would have to grow to $650 billion (an increase of almost $600 billion), and important revenue and profitability goals would also have to be achieved. The award is modeled after Musk's 2012 performance award, which helped bring about a more than 17-fold increase in Tesla's market cap in the five years after it was put in place.

Musk will receive no guaranteed compensation of any kind—no salary, no cash bonuses, and no equity that vests simply by the passage of time. Instead, the only compensation will be a 100% at-risk performance award, which ensures that he will be compensated only if Tesla and all of its shareholders do extraordinarily well. Because all Tesla employees are provided equity, this also means that Musk's compensation is tied to the success of everyone at Tesla.

CEO Performance Award Details

The performance award consists of a 10-year grant of stock options that vests in 12 tranches. Each of the 12 tranches vests only if a pair of milestones are both met.

Market Cap Milestones: To meet the first market cap milestone, Tesla's market cap must increase to $100 billion. For each of the remaining 11 milestones, Tesla's market cap must continue to increase in additional $50 billion increments. Thus, for Musk to fully vest in the award, Tesla's market cap must increase to $650 billion.

Operational Milestones: To meet the operational milestones, Tesla must meet a set of escalating Revenue and Adjusted EBITDA targets (the only adjustment to EBITDA is for stock-based compensation). These milestones are even more directly aligned with shareholder value creation than those used in Musk's 2012 performance award. They are designed to ensure that as Tesla's market cap grows, the company is also executing well on both a top-line and bottom-line basis.

For each of the 12 tranches that are achieved, Musk will vest in stock options that correspond to 1% of Tesla's current total outstanding shares (1% of that amount is approximately 1.69 million shares). If none of the 12 tranches is achieved, Musk will not receive any compensation.

Leading Tesla Through Its Next Phase of Growth

For vesting to occur when the milestones are met, Musk must remain as Tesla's CEO or serve as both Executive Chairman and Chief Product Officer, in each case with all leadership ultimately reporting to him. This ensures that Musk will continue to lead Tesla's management over the long-term while also providing the flexibility to bring in another CEO who would report to Musk at some point in the future. Although there is no current intention for this to happen, it provides the flexibility as Tesla continues to grow to potentially allow Musk to focus more of his attention on the kinds of key product and strategic matters that most impact Tesla's long-term growth and profitability.

Patterned After 2012 Performance Award

The 2018 performance award is similar to the structure of Musk's last compensation award, which was put in place in 2012. Under that plan, he was awarded stock options that vested only if the company's market cap continued to increase in $4 billion increments and if it achieved matching operational milestones, including vehicle production targets and developmental milestones relating to the Model X and Model 3 programs. While these milestones were viewed at the time as very difficult to achieve, all of the market cap milestones and 9 of the 10 operational milestones have been achieved. The 2012 plan formed the biggest part of the executive compensation program that Tesla shareholders overwhelmingly supported in the company's 2014 and 2017 Say on Pay votes. That plan was instrumental in helping Tesla complete the roadmap laid out in its original Master Plan, and in ensuring that Musk only received compensation based on the enormous success of the company, its employees, and all its other shareholders.

© 2022, Eva Fox | Tesmanian. All rights reserved.

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