April 01, 2018
Dean Baker
The Hankyoreh, April 1, 2018
That wasn’t the reporting in most news outlets, but that is the most likely outcome from his new contract to head Tesla for the next decade. As explained in press accounts, Musk stands to earn $2.6 billion if he increases the valuation of Tesla stock from its current $55.8 billion level to $650 billion over the next decade. If he doesn’t hit this target, he gets zero. That sure looks like a commitment to spend the next decade working for free.
To be clear, the target of $650 billion is slightly less daunting if we adjust for inflation. It comes to about $530 billion, if we assume 2.0 percent average inflation over the next decade. That still implies a real return averaging just over 25.0 percent a year. That’s pretty good in anyone’s book.
Musk’s target is even more impressive when we consider where Tesla is at present. It is a company that has never made a profit or even come close to making a profit. Its main trait is consistently falling behind in its production dates and targets.
If we assume that in ten years Tesla will have a price-to-earnings ratio around 20-to-1; a reasonable level for what will be a relatively mature company in 2028. Musk’s target valuation implies profits of just under $32 billion for the year. That comes to around 1.5 percent of projected profits for US corporations in that year.
By comparison, Apple currently accounts for a bit more than 2.5 percent of all after-tax corporate profits, but few other companies have crossed the 1.0 percent threshold. In effect, Musk is betting that Tesla will turn around from big money loser to one of the most profitable companies in the history of the country.
While this may seem an unlikely story, Elon Musk is taking the risk. If Tesla doesn’t have a remarkable turnaround he takes home nothing. If he does manage to make the company immensely profitable, then shareholders will have no basis for complaining about his $2.6 billion pay for the decade.
Unfortunately, this scenario is uncommon for most corporate CEOs. Of course, they do well when the company prospers, but they usually can count on big paychecks even when the company flounders. The history of American business is littered with examples of CEOs who walked away with tens of millions or even hundreds of millions in pay after driving a company into a ditch.
The latest poster boy is former Wells Fargo CEO, John Stumpf. He walked away with more than $130 million in back pay and benefits even though he left the bank mired in scandal. In fact, former Federal Reserve Board Chair, Janet Yellen, sanctioned Wells Fargo as one of her last acts as Fed chair.
Typically, CEOs can largely set their own pay because of a corrupt corporate governance structure. The boards of directors, who have the most direct control over CEO pay, typically owe their seats on the board to the CEO and other top management. Since being a board member is a very lucrative position (typically providing hundreds of thousands in pay annually for maybe three hours a week of work), directors have little incentive to ever rock the boat by suggesting a reduction in CEO pay.
I recently did an analysis of CEO pay with Jessica Schieder of the Economic Policy Institute. We tested if a change in the tax treatment of CEO pay for health care insurers affected the pay for CEOs in the industry. Since the change unambiguously raised the cost of CEO pay to the companies by more than 50 percent, we would expect to see some reduction in compensation if CEO pay was closely related to their value to their company.
We beat up the data every way we could, but still found no evidence of any reduction in the pay of CEOs in the health insurance industry. It is difficult to see these results and still believe that high CEO pay reflects their value to companies, as opposed to just being the result of a broken corporate governance structure.
For this reason, the Musk pay package is a really great model. While we might not expect other CEOs to have such ambitious targets for themselves, pay packages in the tens of millions of dollars should depend on producing extraordinary returns for shareholders, not just filling the time and letting the company’s profits and stock price rise with the economy.
Forty years ago CEOs earned 20 to 30 times as much as ordinary workers. That would put their pay in the $1 to $2 million range today. This seems like a good starting point for corporate boards to target. If CEOs think they are worth 10 or 20 times this amount, then let them sign contracts under which their pay is contingent on returns that hugely outpace their competitors.
My guess is that few CEOs would go the Elon Musk route because they don’t believe they can produce outsized returns for shareholders. But if they don’t believe in their own abilities, why should the shareholders? It’s time to bring CEO pay back down to earth.
