Elon Gone Wild

Last week, Tesla[1] shareholders voted both to reincorporate in Texas and to reapprove Elon Musk’s pay package which had been invalidated by the Delaware courts. Now, there’s a lot we could ask about the vote. Did it actually resolve anything? Will the newly approved pay package have unintended accounting implications?[2] How will the Delaware court respond?

In its proxy statement, Tesla framed the vote as affirming shareholder rights:

Corporate democracy and stockholder rights are at the heart of Tesla’s values … Because the Delaware Court second-guessed your decision, Elon has not been paid for any of his work for Tesla for the past six years that has helped to generate significant growth and stockholder value. That strikes us — and the many stockholders from whom we already have heard — as fundamentally unfair, and inconsistent with the will of the stockholders who voted for it.

…We do not agree with what the Delaware Court decided, and we do not think that what the Delaware Court said is how corporate law should or does work.

Let’s discuss just one issue. Should Elon be allowed to do whatever he wants? It’s pretty clear that the shareholders of Tesla would say yes. But consent from shareholders is not a license for Elon to go wild.

Let’s contrast how corporate law for publicly traded companies “does work” in the U.S. today vs. how the law “should work” according to Elon’s fans. I should caution that I am not a lawyer, and you should not take legal advice from me; the same holds for Elon, who tweeted “Never incorporate your company in Delaware.”

Current U.S. system: The board of directors represents shareholders within the framework of various different rules enforced at the state, federal, and exchange levels. The directors must exercise both a duty of care and a duty of loyalty to the company, supervising Elon and negotiating with him to determine his compensation.

Musktopia: Elon is allowed to do whatever he wants with no constraints. The board will continue to act as “supine servants to an overweening master” as described in the Delaware decision. It’s fine for Elon’s compensation to be determined, in Elon’s own words, by “me negotiating against myself.”

Here’s the argument in favor of Musktopia. Elon has proven he has the ability to generate shareholder wealth. If shareholders are willing to own Tesla knowing that Elon has zero constraints, they should be allowed to own Tesla. Why should a heavy-handed government, led by activist judges, prevent consenting adults from letting Elon be Elon? If you don’t like Tesla’s corporate governance, no one is forcing you to buy Tesla. Let competition reign.

Here’s my view. Musktopia is a perfectly logical system, but it bears little resemblance to actual corporate law as developed over centuries in the U.S. and other countries.

Suppose that Tesla shareholders approved the following hypothetical Musktopian proposal:

We, the shareholders of Tesla, hereby give our consent for Elon Musk to do whatever he wants. Elon is given 100% of all votes on any decision. Directors who are not named Musk are forbidden from speaking during board meetings. We hereby waive all our rights in perpetuity. Let Elon be Elon.

Under this proposal, anyone buying equities would have zero legal rights, but that’s okay, because we trust Elon. I’m not sure we should call Musktopian shares “equities,” perhaps “inequities” would be more accurate.

This Musktopian proposal is contrary to U.S. law and would be immediately struck down by any court in the land (even Nevada, where Elon recently reincorporated Neuralink). Just because shareholders vote for something does not make it legal. The U.S. has a well-developed system for protecting shareholder rights, and Musktopian corporate governance is simply inconsistent with this system. In the U.S., you are just not allowed to waive your rights as a shareholder.

Let’s compare corporate law with constitutional law using a hypothetical scenario. Elon runs for president and wins. However, the courts invalidate this election, because Elon is not a natural-born U.S. citizen and thus is ineligible to be president according to Article II of the Constitution. Has the will of the people been thwarted by activist judges? I don’t think so. If the people want to live in a country where immigrants are allowed to be president, they should amend the Constitution. Just ignoring the Constitution is not an option.

Why does our current system shackle Elon with rules and regulations? Because our system is set up to limit self-dealing. Here’s a definition of self-dealing from Djankov, La Porta, Lopez-de-Silanes, and Shleifer (2008): [3]

… those who control a corporation … can use their power to divert corporate wealth to themselves, without sharing it with the other investors. Various forms of such self-dealing include executive perquisites to excessive compensation, transfer pricing, taking of corporate opportunities, self-serving financial transactions such as directed equity issuance or personal loans to insiders, and outright theft of corporate assets.

Here is the indispensable Matt Levine discussing Elon and self-dealing:[4]

Elon Musk is exactly the sort of bundle of conflicts that Delaware law is designed to protect against. Practically every story about Elon Musk has the form “Elon Musk controls six companies, each with different minority shareholders, and he treats those companies as his personal property.” He shifts employees and resources and projects and computer chips among the companies without oversight. He borrows money from one company to finance another. He asks his employees to have his children. This is not a man who respects corporate formalities or the rights of minority shareholders, and this is not a board of directors that is keen on telling him no.

And so Musk, as Tesla’s controlling shareholder, did a whimsical thing that was arguably bad for minority shareholders (pay himself a ton of money), and Delaware stopped him. So Musk and Tesla decided to leave for Texas so they can do their whimsical stuff without Delaware interference. And, apparently, shareholders think that was a good idea.

Elon seems to feel that the courts in Texas will be less intrusive than in Delaware. Could be. Here’s Djankov et al (2008) discussing the range of possibilities:

One approach is to do nothing, and to count on market forces to sort out the problem. Virtually no society uses this approach: the temptation to “take the money and run” in an unregulated environment is just too great. At the other extreme, a society can prohibit conflicted transactions altogether: all dealings between a corporation and its controllers … could be banned by law. Yet no society finds it practical to use this approach either, perhaps because in many instances related-party transactions actually make economic sense.

So in their view, uninhibited Musktopia (“count on market forces to sort out the problem“) is a logical possibility but can never work; we need checks and balances. On the other hand, excessive limits on Elon’s freedom of action are also not optimal. The current U.S. system is a middle ground based on the idea that someone is supposed to supervise Elon for the benefit of the other shareholders.

Djankov et al (2008) create quantitative measures of each country’s legal framework for self-dealing and investor protection. They find the country with the fewest limits on self-dealing and the least intrusive investor protection is Bolivia. The country with the strongest anti-self-dealing rules and the most investor protection is Singapore, with English-speaking countries generally scoring high.

Thus if Elon craves true freedom, moving to Texas is not enough. He should move farther south. To truly escape the pettifogging limits of the U.S. legal system, Elon should try Bolivia (a strategy featured in Butch Cassidy and the Sundance Kid). I am sure the Bolsa Boliviana de Valores would be happy to have him.