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Reward Success, Not Just Scrutiny: The Fight for Fair CEO Compensation in a World Obsessed with Envy

6/11/2024

By Tony Misura


How much should a CEO be rewarded for leading a company to $700 billion in wealth for its shareholders? The profits and equity numbers may be vastly enormous compared to the LBM space, but the portions and percentages are similar. Elon Musk’s situation carries a critical message for our industry’s leaders.



In 2018, the Tesla Board of Directors, 73% of shareholders, and CEO Elon Musk agreed on a substantial compensation package. A Delaware judge recently nullified Musk’s $56 billion package, deeming it unfair to shareholders and indicating a lack of oversight by Tesla’s board. This decision came despite Tesla's incredible shareholder value growth under Musk's leadership.


This story matters in our industry because LBM compensation packages for presidents and CEOs commonly includes earn 2% to 10% of equity based on hitting certain targets. Properly designed, equity incentives align the ownership with operators' long term performance around the sustained value created, with a standard five-year Golden Handcuff vesting to ensure the CEO is retained until the goals are achieved.


Everybody Wins


Suppose that, under such an equity plan, a CEO takes over a company with a capital account of $20 million, with Zero EBITDA. Over the next five years, through organic and M&A growth, the company’s EBITDA swells to $25 million. The company then is sold for $320 million, or 12.8x EBITDA. After the debt is paid off and selling fees are counted for, the net equity is $200 million. Every investor who bought in before the CEO’s arrival at $100 per share is popping the champagne as they collect $1,000 per share. If the CEO had a 2% earned equity deal, they’d collect $4 million. If they had a 10% equity deal they’d walk away with $20 million.


Now, let’s look at Musk’s deal.


In January 2018, Tesla stock was $23 per share, the market value was $53 billion, and the company had massive production problems. Musk’s compensation agreement from the previous five years had just ended, and over that time he had generated a 17x return for shareholders. Musk proposed the same outline for the 2018 agreement: No guaranteed compensation, no base salary, no bonuses. Instead, Musk asked for 12 tranches of stock options, the first occurring when $100 billion of additional market capitalization was achieved, and the next 11 coming each time market capitalization went up another $50 billion. Musk would have to generate $650 billion in wealth for the shareholders to earn the maximum bonus. The board also included revenue and EBITDA hurdles to ensure the company was healthy.


The Board of Directors approved the agreement and the shareholders voted 73% a super majority to support the deal, valued at $56 billion. Privately, many thought Elon was nuts about taking this deal, given the milestones, and they were concerned about keeping his interest in Tesla when he failed.


That didn’t happen. By October 2021, Tesla shares had reached $370 per share and the company’s value had hit $1 trillion. Remember, Musk needed to achieve a $700 billion valuation ($650 billion in growth atop the original $53 billion) to earn his full compensation plan. In just 3 years and 11 months, Tesla's capitalization was 43% above Musk’s five year target.


The $56 billion in stock options Musk was slated to achieve for hitting the $700 billion target works out to just 8% of the wealth he created for shareholders. (and it’s much less, 5.8% if calculated when Tesla became a $1 trillion company). Based on the payouts I have seen in our LBM Industry, I can make a solid argument that Elon should have been paid more. 


What Is Too Much?


Judge Kathleen St. J. McCormick called Musk’s pay agreement “an unfathomable sum” and criticized the board’s negotiation process. However, was the $700 billion return for shareholders under Musk’s leadership unfathomable? The board included formidable professionals like Larry Ellison the legendary founder of Oracle, Kathleen Thompson-Wilson from Walgreens, McKesson, and Kellogg, James Murdoch from News Corps, and Robyn Denholm from Toyota. Hiromichi Mizuno, the leader of GPIF the world’s largest pension fund at $1.43 trillion, just completed a 3 yrs. stint on the board.


This situation underscores the media narrative today: "If you are successful, wealthy, or formidable, you must be evil." The same principles apply to LBM industry compensation. It's always the other guy who is greedy. Owners will always want more. What is an incredible achievement today is an unrewarded mundane expectation tomorrow. Executives should avoid weak negotiating positions, know their market value, and secure agreements in writing.


At Misura Group, we help executives understand and realize their value. Reach out to us to ensure you receive the compensation you deserve. There's nothing evil about shareholder and operator wealth creation. Just ask us.


Hire Smarter™ – Tony Misura


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