Could Elon Musk's battle against Delaware impact the way corporations make significant decisions?

• The Delaware Chancery Court's decision to invalidate Elon Musk's $56 billion Tesla compensation package could have significant repercussions on corporate board appointments, CEO compensation, and state incorporation choices.
• On Wednesday night, Musk announced that SpaceX was reincorporating in Texas, and earlier this week, Neuralink moved its legal home to Nevada, where X is already based.
• Experts predict that challenges to Delaware's status as a hub for big business will intensify, yet there are numerous reasons why many corporations will continue to base their operations in the state.

The outcome of Elon Musk's pay remains uncertain after a Delaware judge voided his $56 billion compensation package. However, Musk has already made significant decisions, such as declaring war on the state of Delaware as the ideal location for businesses.

Musk urged other companies to avoid Delaware as a legal corporate home after SpaceX reincorporated in Texas and Neuralink moved to Nevada.

The Delaware Chancery Court Chancellor Kathaleen McCormick ruled that Tesla's board had not proven the fairness of their compensation plan or shown much evidence of negotiating with Elon Musk. Since then, the board has been silent. However, it is clear that the Delaware court decision will have significant implications for corporate governance, as over 60% of the Fortune 500 companies are incorporated in the state.

This was something that had never been done before, as McCormick noted, but it was, in fact, the right time to do it; it was the perfect storm," said Charles Elson, founding director of the Weinberg Center for Corporate Governance. "It's a landmark case.

The case involving Musk and his corporate board raises questions about the future of executive-board relationships and whether Delaware will continue to be the preferred location for large corporations.

CEO pay and board independence

The Delaware court's decision on the Tesla acquisition was heavily influenced by Musk's relationship with board members, as ruled by McCormick. She stated that Musk had "extensive ties" with those negotiating for Tesla, including members of management who were "beholden to Musk," such as General Counsel Todd Maron and his former divorce attorney. A recent Wall Street Journal report contained inflammatory allegations about how far those board relationships extended into Musk's personal life.

She wrote that the Compensation Committee and the Board did not act in the best interests of the Company when negotiating Musk's compensation plan, and there is little evidence of negotiations.

Elson stated that the rules regarding director and committee independence were not strictly enforced, typically only inquiring if directors were employees or consultants.

Elson stated that McCormick's perspective on independence was more nuanced than Delaware's typical approach. She added, "We were moving in that direction, but she got us there."

The board's independence will be a major concern, and the negotiation process will be scrutinized more closely, leading to a greater emphasis on real independence and careful compensation decisions.

Elson stated that one problem in this scenario was that because of Musk's large compensation package, other CEOs could make demands based on it. He now anticipates that this practice will cease due to the fear of facing such challenges.

The mean total compensation for S&P 500 CEOs in 2023 was $15.4 million, as reported by The Conference Board and ESGAGUE.

Musk's compensation would still be an outlier among outliers, even as those figures have increased, according to Matteo Tonello, managing director at The Conference Board.

Despite an increase in total compensation, the number of successful challenges on say-on-pay votes has decreased, according to Tonello. Additionally, he stated that the likelihood of a compensation package being challenged in court is still low even after a successful say-on-pay vote.

In 2018, Tesla's board granted Musk a series of stock options that would vest by 2022, contingent on achieving specific stock price milestones.

In the period from 2018 to 2022, Tesla shares experienced a nearly 500% increase as Musk aimed to transform the company into a leading EV brand, robotaxi service provider, and solar energy powerhouse. During the same time, the S&P 500 saw a 44% gain, while the Nasdaq experienced a 52% rise.

While Tesla's former SEC Chairman Jay Clayton stated on CNBC's "Squawk Box" that the company's "outsized, unique pay package" was "nearly impossible" at the time, he also acknowledged that shareholders profited from Tesla's "remarkable rise."

Be cautious when making judgments, as hindsight can often cloud your judgment," Clayton advised. "Delaware's longevity can be attributed to the fact that the process safeguards judgments from hindsight and substance is crucial.

Texas, Nevada challenges to Delaware

Delaware's reputation as the go-to state for company incorporation is being challenged by Musk's high-profile campaign to relocate companies and other states' efforts to lure businesses away.

Texas Governor Greg Abbott welcomed Musk's suggestion that Tesla would move from Delaware, as he has been looking to challenge Delaware's position as the leading business court in the US. In June, Abbott signed a law creating business courts in Texas to handle complex commercial disputes, which will begin operating in September.

William Barr, the former U.S. Attorney General, advised companies to shift away from Delaware in a November WSJ op-ed, arguing that the state's courts prioritize ESG over shareholder value. Instead, Barr suggested companies explore Texas, Georgia, Utah, or Wyoming, which have established separate business courts.

On "Squawk Box" on Monday, Walter Isaacson, the former CNN CEO who wrote Musk's biography, stated that if the Delaware Supreme Court does not overturn the decision, it will harm Delaware because people will question the validity of the court's decision.

Isaacson acknowledged the reasons for people's dissatisfaction with Musk, but he questioned the validity of revoking the compensation deal granted to him five years ago and taking the money away from the 75% of stockholders who agreed to it.

Fortune 500 exodus not likely, experts say

Both Elson and Tonello doubt that there will be a Delaware exodus resulting from this decision.

“Delaware has been the go-to state for incorporation in the US for many years due to its business-friendly corporate law and a specialized court that can quickly resolve corporate disputes without a jury. This has resulted in a wealth of case law that is highly valued by institutional shareholders. However, even if shareholder approval is not mandated by organizational documents, a board of directors of a publicly traded company would likely seek approval from shareholders for a critical organizational decision such as reincorporating in another state. Such a decision could potentially lead to a shareholder lawsuit.”

In the past, several states, including North Carolina, North Dakota, Nevada, and Michigan, have attempted to attract companies not incorporated in Delaware.

Elson stated that Delaware's continued advantage is due to several factors, including a top-notch corporate law statute, a highly skilled bench with expertise in corporate law, and a body of law in this area that is unmatched by any other state.

Elson stated that "there is no hometown advantage in Delaware as there isn't much else happening apart from corporate regulation, making it viewed as neutral by investors and managers."

In 2022, the Delaware courts ruled in favor of Musk in a shareholder lawsuit over Tesla's $2.6 billion acquisition of SolarCity. The lawsuit alleged that the acquisition was a bailout, pushed through by Musk who sat on both company boards at the time. Additionally, the lawsuit claimed that Musk controlled the board of Tesla, despite appearing to recuse himself from some deal negotiations concerning SolarCity.

If he had lost, Musk could have been required to pay up to $2 billion.

Regardless of whether you agree or disagree with an opinion, it will be carefully considered and unbiased towards any particular group," he stated. "They call things as they see them.