Tesla’s key-person risk: What if Elon Musk leaves?
The fortunes of companies, like Tesla, can be overly tied to a CEO’s actions. We take a look at what key-person risk is, and why it matters for investors.
Key-person risk isn’t unfamiliar in the corporate sector. Consider Berkshire Hathaway (BRK.A) and its founder, Warren Buffett, widely considered to be one of the greatest investors of all time.
Berkshire investors expect shares to come under pressure if and when Buffett dies or if he becomes mentally incapacitated.
Berkshire is a prime example of key-person risk: After all, ratings agencies have downgraded Berkshire in the past precisely because of it.
Tesla's key-person risk
Tesla’s (TSLA) board should analyse the impact on investors if CEO Elon Musk or other key officials leave the company, a shareholder is proposing. Morningstar Sustainalytics, in a report, is advising investors to support the proposal at Tesla’s annual meeting this week.
The shareholder proposal asks the board to prepare and disclose a report on Tesla’s so-called key-person risk. That means the board would identify key persons, like Musk, on whom the company is overly reliant—and whose absence or behavior would affect the firm’s value. In addition, it says the report should have procedures for dealing with key-person risk. They include identifying the key persons, training successors, and mitigating the financial impact of the loss of a key person. The proposal was made by Karen Robertsdottir, a shareholder in Reykjavik, Iceland.
Some examples of key-person risk
Buffett's Berkshire Hathaway is an example of key-person risk through a leader's success, but sometimes, key-person risk arises from CEO misconduct.
Consider the case of Carlos Ghosn, the chair of Renault, Nissan, and Mitsubishi Motors, who was accused of underreporting his compensation. Ghosn is now a fugitive in Lebanon.
And the fortunes of companies, like Tesla, can be overly tied to a CEO’s actions.
Tesla’s shares fell sharply in April 2022 as news emerged that Musk was interested in buying Twitter. Since then, Musk has become Twitter’s CEO, and reportedly pulled dozens of Tesla engineers to reshape Twitter. News that Musk found a new CEO to replace him at Twitter lifted Tesla shares.
Underperformance can follow key-person risk
Indeed, underperformance often accompanies key-person risk.
Shareholder Robertsdottir cited a 2018 Morgan Stanley report that found that in 2017, 59 S&P 500 CEOs left their companies. These companies then underperformed the market by 11% in the subsequent 12 months.
“In light of widespread concerns that Tesla’s board does not exercise effective oversight of its CEO and, as a consequence, the significant key-person risk that Tesla’s shareholders face, we recommend a vote in support of this resolution,” Sustainalytics wrote.
In an interview, Jackie Cook, the author of the Sustainalytics report and director of stewardship at Sustainalytics, said the proposal “succinctly summarises some of the core governance problems at the company.”
Tesla opposes the shareholder proposal. It says the board and company management are best equipped to carry out succession planning and handling day-to-day hiring, promotion, and termination decisions. It also says that adopting the proposal would cause competitive harm to Tesla.
Nevertheless, in its most recent 10-K report, Tesla identifies key-person risk and says, “In particular, we are highly dependent on the services of Elon Musk, Technoking of Tesla and our Chief Executive Officer.”
Musk’s Twitter adventure shows key-person risk
The proposal “might have a good chance to pass,” Morningstar strategist Seth Goldstein said in an interview.
“If Musk stepped down operationally, I think it’s a risk for the stock.”
For example, Goldstein relates, when Musk purchased Twitter, Tesla’s stock fell. When Musk made politically charged tweets, Tesla’s stock also fell on worries that his tweets would drive away consumers, the analyst continues. Currently, Goldstein rates Tesla as undervalued.
In the past, Tesla has responded to some shareholder proposals. For example, after Calvert Research & Management, a unit of Morgan Stanley, was supported by a majority of shareholders on a proposal asking Tesla to provide more data about its diversity, equity, and inclusion efforts, Tesla provided detailed EEO-1 data from its filings with the US Equal Employment Opportunity Commission.
Even for non-Tesla investors, Tesla’s annual meeting is “the most interesting” of the season, partly because of the key-person risk proposal as well as Tesla’s decision to change the date of its annual meeting by several weeks, making it difficult for shareholders to file other proposals, Cook of Sustainalytics says.
