Why Elon Musk's Trillion-Dollar Tesla Pay Package Isn't as Crazy as It Sounds

Key Points

• Tesla's valuation is sky-high, in large part due to Elon Musk's vision for the company.

• Musk could pursue his artificial intelligence (AI) and robotics plans through other companies.

• Because the trillion-dollar compensation is tied to performance metrics, it's a sound strategy.

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What can you give to the man who has everything?

The board of Tesla (NASDAQ: TSLA) recently answered this question when it revealed its proposed compensation package for CEO Elon Musk, which could be worth more than $1 trillion.

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At first glance, that sounds crazy. However, if you look at the details, it may not be so crazy after all.

Image source: Getty Images.

Tesla needs Elon...

Tesla currently trades at a trailing price-to-earnings (P/E) ratio of about 200 -- unlike more traditional car companies like Toyota (NYSE: TM) and General Motors (NYSE: GM), which both trade at P/E ratios of about 9. That's largely because of Musk's high-tech vision for the company, which includes developing fully self-driving robotaxis and autonomous humanoid robots. That's a powerful incentive for Tesla's board to keep Musk at the helm.

But is it really worth $1 trillion?

Well, although the "trillion-dollar" aspect of the pay package has been highlighted, it's not like Tesla's board is just planning to hand Musk $1 trillion in cash. Instead, the compensation -- which consists largely of additional Tesla stock awards -- is broken up into 12 "tranches," with each tranche tied to a particular performance-based milestone. If Musk doesn't meet that milestone within 10 years, he doesn't get that tranche of shares.

One milestone requires Musk to revitalize Tesla's struggling auto sales, reaching 20 million total cumulative vehicle sales within 10 years (the company has currently sold about 8 million over its lifetime). Others require him to successfully develop new products, including full self-driving EVs, robotaxis, and autonomous humanoid robots.

The remaining metrics include adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) minimums, which are tied to the company's earnings and not its share price, and increasing Tesla's market capitalization to $8.6 trillion, roughly an eightfold increase from its current $1.1 trillion valuation. Those are tall orders.

...more than Elon needs Tesla

Lately, Musk seems to have lost interest in electric vehicles. That's hardly surprising: He's always been a futurist, and now that EVs are everywhere -- practically every major automaker currently produces at least one -- he's more excited by the potential of artificial intelligence (AI) and robotics.

But he doesn't necessarily need to pursue those technologies through Tesla.

Musk already owns an AI company (xAI), where he could easily pursue future autonomous technologies. He could also develop them through a brand-new company: He could call it "Musk's Marvelous Mannequins!" Given his past successes, personal wealth, and current high profile, he'd likely have no trouble raising capital.

True, Tesla has already done a lot of work on autonomous self-driving and its Optimus line of humanoid robots, but Musk exercises significant control over Tesla's board, so it would probably be pretty easy for him to engineer a spinoff or sale of those business lines to a different company he controls.

What Tesla can offer

One thing Musk can't bestow on himself is the title "World's First Trillionaire."

Departing Tesla and trying to pursue automation, AI, and robotics through xAI or a new company would involve a lot of costs and complications. Meanwhile, Tesla's stock would almost certainly take a hit, and although Musk's 13% stake in Tesla only makes up about one-third of his current $435 billion net worth, nobody likes to lose tens of billions of dollars (though, to be fair, most of us will never have that opportunity).

While I can't speak for Musk, I know that if someone offered me a job that could result in my becoming the world's first trillionaire, I'd be unlikely to turn it down, even if I wasn't particularly excited about some of the job duties, and even if some of the milestones would be difficult to achieve. For Musk, it's probably a worthwhile trade-off.

From a Tesla investor's perspective, if Elon Musk can develop working self-driving cars, robotaxis, and autonomous humanoid robots within 10 years, plus grow Tesla's market cap eightfold, he probably deserves the payout he'd get. This makes this pay package -- eye-popping though it is -- a win-win for Tesla shareholders.

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John Bromels has positions in Tesla. The Motley Fool has positions in and recommends Tesla. The Motley Fool recommends General Motors. The Motley Fool has a disclosure policy.