Just months after persuading shareholders and Tesla's board of directors to reinstate an unprecedented $44.9 billion compensation package that had been rejected by a Delaware court, Tesla CEO Elon Musk is defying conventional wisdom again by persuading the company's shareholders to ask Tesla's board to invest $5 billion in his AI startup, xAI. If he succeeds in persuading Tesla's board to invest in his startup, will it encourage other CEOs and directors to “invest” in their own private ventures? Such transactions have generally been viewed as conflicts of interest.
Musk reportedly asked users on his social media platform X whether they thought it would be a good idea for Tesla to invest $5 billion in his AI startup. The vote generated a positive response, leading Musk to say he would discuss the idea with Tesla's board of directors. Musk's startup, xAI, is developing a chatbot that competes with ChatGPT.
“$5 billion is a significant amount of money, so the board would need to demonstrate that sufficient due diligence was conducted before approving such a transaction. The fact that the company's CEO, who sits on the board, is receiving this large investment puts the entire situation under increased scrutiny. Additionally, CEO Musk's high profile will bring additional scrutiny to the Tesla board's decision.”
The situation has already caught the attention of U.S. Senator Elizabeth Warren. In a recent letter, Warren accused Tesla's board of directors of neglecting its corporate governance duties, writing that “the board has 'done nothing' even as Tesla shareholders allege that Musk has diverted value, personnel, data and resources from Tesla to xAI.” In the letter, she points out several issues that Senator Warren believes are conflicts of interest for Musk and calls on the board to investigate and address these concerns.
“This strategic move positions Tesla well in the evolving AI space while focusing on our core competencies and near-term goals,” Tesla shareholders in support of the investment wrote in a letter to the board. It's not yet clear what financial benefits the deal will bring to Tesla shareholders.
A key question regarding this $5 billion investment is whether a company's board of directors is willing to invest company funds in a company that is owned in whole or in part by the CEO or other directors. What will your board do? Here are some points to consider:
If such transactions are approved, will it become common for directors to fund each other's business deals? Sometimes the appearance of the situation matters much more than the intent. When a board approves a loan to another director’s start-up with shareholder funds, it creates the appearance of favoritism and a conflict of interest. Directors typically have a great deal of discretion in making the company’s business decisions, but if those decisions may lead to significant benefits for the directors themselves, they may be subject to accusations of self-interest or personal dealings. Such accusations expose all directors to the risk of personal liability in litigation if those “investments” fail. If this type of practice becomes the norm, directors may be encouraged to choose to allow the company to loan directors’ transactions rather than to seek other opportunities that may be similarly beneficial to shareholders. While the potential financial benefits to shareholders may be great, the reputational risks to the board and legal risks to the company are unacceptable.
If the CEO is already simultaneously running a public company with a market cap of $627 billion and several other private companies (SpaceX, The Boring Company, Neuralink, etc.), does it make sense to invest billions of dollars in a startup that needs funding? Corporate governance experts suggest that CEOs should not sit on more than a few boards because it impacts their ability to focus on the primary organization. If that is a reasonable expectation, how many companies can a CEO run before it negatively impacts his ability to operate effectively in the primary organization? Tesla CEO Elon Musk already runs multiple companies and even has a startup that is currently working on raising funds. Observers are wondering, “Where is the CEO's primary focus?” This is why questions are being asked about how Tesla's board is addressing conflict of interest concerns.
No one questions Musk's intelligence, but running a large company is stressful. Musk runs several sophisticated companies at the same time, and the stress could lead to health problems. If the board of directors approves an investment in Musk's personal business and Musk gets ill, what happens to the investment? Some shareholders support investing in Musk's startups because of his impressive track record of success, but others question whether the risk is worth it. Company directors would do well to ask themselves whether they would be able to trust their CEO to run their own company while also running other companies.
What business does Tesla want to get into? While Tesla is widely known as an electric car maker, Elon Musk has spent a lot of time linking the company to advances in artificial intelligence, including self-driving technology. If Tesla wants to be a leader in AI, Tesla's board of directors should lay out their vision for how they intend to achieve this as part of Tesla's overall business plan. If Tesla “invests” in xAI, does the company end up owning a portion of the technological advancements that the startup produces? Answering questions like these would go a long way to clarify why a $5 billion investment in xAI is in the best interest of Tesla shareholders.
