One of two major U.S. proxy advisory firms, Glass Lewis, has recommended shareholders of electric car marker and solar panel installer Tesla Inc. (TSLA) vote against a proposal to grant CEO Elon Musk performance-based stock options the company says are worth about $2.6 billion at Tesla's annual meeting set for March 21.

Unlike a typical Say for Pay vote, shareholders' votes will be binding for the company, and notably, Elon Musk recused his roughly 20% stake from voting.

Tesla's board argued in its 2018 proxy statement that the stock option grant will strengthen Musk's incentives and further aligns his interests with those of Tesla's stockholder, ensure the founder and CEO's continued leadership of Tesla over the long-term and serve as a catalyst for the achievement of Tesla's strategic and financial objectives.

Musk will be provided options on almost 20.3 million shares in 12 tranches, each representing 1% of the company's outstanding shares at the approval date. The options vestment is performance contingent, and shares from the exercised options must be held for five additional years.

Those performance milestones are tied to Tesla's market capitalization, revenue, and adjusted Ebitda. The first hurdle is a market cap of $100 billion, revenue of $20 billion and adjusted Ebitda of $1.5 billion. At the time of the grant announcement, Tesla's market cap was around $59 billion, and the company posted fiscal 2017 revenue of $11.76 billion and adjusted Ebitda of $644.2 million.

The final hurdle would see Tesla become one of the largest companies in the world with a $650 billion market cap, $175 billion in revenue and $14 billion in adjusted Ebitda.

Using the Monte Carlo pricing model considering probable achievement and including a $311 million reduction due to the post-exercise holding period for the options, Tesla disclosed the grant would be worth $2.62 billion. According to Glass Lewis, which used the Black-Scholes valuation, the grant is worth closer to $3.7 billion, however.

Tesla CEO Elon Musk.
Tesla CEO Elon Musk.

"Although we do not consider the practice of providing front-loaded grants to be inherently problematic, shareholders should generally be wary of this approach to granting," Glass Lewis warned in its report. "In our view, the enormous emphasis on a single grant can place intense pressure on every facet of its design, amplifying any potential perverse incentives and creating greater room for unintended consequences. As such, several aspects of the grant deserve more careful attention."

One of those aspects is the performance goals set for the grant. Glass Lewis feels that while the highest goals are seemingly challenging enough, the lower tiers of the targets are "much more attainable given the time periods in question, potentially allowing for sizable payments without commensurately exceptional achievement."

Chief among the proxy advisory firm's concerns, however, is the high compensation level and the potential cost of the grant. On an annualized basis, the disclosed value of the full grant reflects $262 million per year, or about $370 million using Glass Lewis' valuation methodology - a staggering sum compared to typical executive compensation levels among public companies worldwide, the firm argued.

"Total compensation for CEOs of blue-chip US companies is almost universally only a small fraction of this annualized figure even while it is considerably less at-risk (and risky), with salary a guaranteed income and annual bonus targets set based on goals considered by to be achievable," Glass Lewis wrote. "In our view, attaching some premium to compensation based on the riskiness of the blend of compensation and to extended time horizons is not unusual or contentious, but we are quite wary of the size of the markup in this case."

And Musk doesn't have to hit all the milestones to be paid an extraordinary sum. The firm illustrated that if Tesla were to merely hit two of the milestones, a 21% compound share price growth, and a 24% compound revenue growth over five years, Musk's annual pay would be around $280 million.

In 2016, Walmart Inc.'s (WMT) CEO of U.S. e-commerce Marc Lore was the highest paid executive in the country, according to Bloomberg data, with $237 million in total compensation, and that was only due to $235 million in acquisition awards, likely thanks to the $3 billion pickup of Jet.com Inc.

The next highest paid executive is Tim Cook, the CEO of the world's largest company by market capitalization, Apple Inc. (AAPL) , who made $150 million in 2016, including $141 million in stock awards.

Apple is a holding in Jim Cramer's Action Alerts Plus

By Glass Lewis' analysis, average CEO pay among Tesla's five largest market peers is $15 million, while the average executive compensation among the nine largest U.S. publicly traded companies, excluding Berkshire Hathaway Inc. (BRK.A) , was $36.7 million.

Notably, the share price growth Tesla would have to hit for Musk to make over $100 million more than the CEO of the world's biggest company - 21% - would only slightly outpace the S&P 500 over the past five years, and both those marks would pale in comparison to Tesla's trailing five years compound growth rates of 68% for market cap and 95% for revenue.

In other words, for Musk to become the highest paid CEO in America by a long shot, his company would have to do substantially worse regarding share price and revenue growth, by Glass Lewis' reasoning.

"To the board's credit, the incentive design is in theory quite well balanced in precluding a number of otherwise plausible perverse incentives and inappropriate payout scenarios, as well as in rewarding a particularly accomplished individual for transformative achievements," Glass Lewis said in summary. "On balance and in practice, however, the potential up-front and future dilutive impacts to shareholders, along with the possibility of extraordinary pay levels even without commensurately exceptional performance, lead us to recommend that shareholders oppose this proposal."

Tesla did not respond to a request for comment.

Editor's Note: This story first appeared on TheStreet's sister publication The Deal

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