7 Signs of Ethical Collapse at Tesla $TSLA $TSLAQ
A book published in 2006 has recently resurfaced in the context of Tesla (TSLA) (latest share price $268, market cap $46 billion).
Disclaimer: I haven’t read the book, and of course the book itself does not mention Tesla. But I do think it’s interesting to compare the book’s “seven signs” with a real-life case study.
The signs are:
1. Pressure to Maintain Numbers
Rushing to meet short-term, quantitative goals is the first sign of ethical collapse. It shows that a company’s objectives have been skewed away from creating value over the long-term, and have instead been skewed towards keeping up short-term appearances.
To me, Tesla is an easy example of a company which has prioritised short-term objectives at the expense of long-term value creation. Consider this e-mail sent by Elon Musk to employees in August 2018. The emphasis added is mine:
I thought it was important to write you a note directly to let you know how critical this quarter is….
We are on the razor’s edge of achieving a good Q3, but it requires building and delivering every car we possibly can, while simultaneously trimming any cost that isn’t critical, at least for the next 4.5 weeks…
The rationale for the mad dash was that a good Q3 would deliver better headlines and make it easier to convince investors to bet on the company.
This cycle seems to get repeated every quarter, with employees being asked to perform extraordinary feats and even volunteer to help out with deliveries, regardless of their job function. Strategy seems to bend as each quarter-end approaches, to get the pre-determined result desired by Elon Musk.
This is not the sign of a healthy company in control of its destiny. Instead, it’s a fertile environment for ethical failure.
When I studied risk management, we were taught about the “fraud triangle“. In that model, the pressure to hit inappropriate targets could represent the first piece of the triangle – the incentive.
2. Fear and Silence
Ethical failure thrives in an environment where people are afraid to speak up about their concerns.
It has also been reported that Elon Musk has engaged in dramatic and unpredictable “firing sprees”, to the extent that employees have been warned not to walk past his desk for fear of getting randomly fired.
3. Young ‘Uns and a Bigger-Than-Life CEO
The second part of this goes without saying. Elon Musk is probably the most famous CEO at the present time, and has a legion of fanatical supporters. He has 25.6 million twitter followers and his personal life is an object of fascination for the media.
What about “young ‘uns”, i.e. young executives? This also holds true.
- Tesla’s CFO is a 34-year-old who was hired internally after an external hire quit.
- The company’s General Counsel is a 40-year-old, another internal hire after an external hire quit
- The CAO (Chief Accounting Officer) is a little older. He is another internal hire, after an external hire quit.
The key financial and legal functions are therefore manned by insiders who will struggle to say “no” to Elon Musk, for example in relation to a fake buyout offer.
Musk himself is 47. Prior to Tesla and SpaceX, he was never the CEO of a company for longer than a year.
Youthful executives are common in Silicon Valley, but they are a risk factor when it comes to ethics, particularly in combination with a charismatic CEO, since they are unlikely to have the experience or the authority needed to stand their ground.
4. A Weak Board
Boards play a critical role in corporate governance. Indeed, you could argue that this is their main function (along with overall corporate strategy).
Tesla’s board has never provided anything less than 100% support to Elon Musk, even with respect to his fraudulent tweeting of a fake buyout offer. I think an ordinary observer can deduce that the board is weak from this fact alone.
The typical board director at Tesla earned between $7 million and $10 million last year for their services to the company, nearly all of it in stock option awards. With rewards like that, it’s hardly a surprise that they approve of the CEO and his influence on the company’s share price.
However, a weak board means weak controls, making ethical collapse all that much more likely. In fraud triangle terms, this is the opportunity.
5. Conflicts of Interest
Ethical collapse is more likely when executives have interests which aren’t aligned with their shareholders.
Consider, for example, Elon Musk’s brother, Kimbal. He earned $7 million in compensation last year, as a Tesla board member, and it is hard to figure out what value (if any) he might have provided for Tesla shareholders.
Another conflict of interest can be seen with Tesla’s purchase of SolarCity (now rebranded Tesla Energy) from shareholders including Elon Musk and his cousins, who ran the company.
SolarCity is now considered worthless by most analysts, and it has no synergies with the car company. And yet Tesla bought it as recently as 2016 for $2 billion, also taking on $3 billion of debts. Another clear conflict of interest, based on a family connection.
We might also point to the matter of Elon Musk having pledged a large quantity of shares for borrowing purposes (about $3.7 billion worth). This requires him to keep the Tesla share price high enough to avoid a messy margin call. Kimbal Musk and other board directors have also pledged their shares for borrowing purposes.
This creates some strange incentives at the top of the company. For example, it might be in the ordinary Tesla shareholder’s best interests to reset the share price at a lower level, in the short-term, through an equity capital raise. However, if this would set off a margin call for Musk and other directors, they might be disinclined to do it. Risk levels are increased.
6. Innovation Like no Other
Delusional beliefs about the pace of innovation at your company can increase the risk of ethical collapse. Believing that you are different and special, despite the reality being somewhat more mundane, creates a gap where ethical failures can occur.
Today, for example, Elon Musk has been tweeting about the autonomous driving capabilities of cars currently being produced by Tesla:
Tesla is alone in believing that its cars currently being produced will ever be autonomous. It acknowledges that it doesn’t currently have the software to achieve this, and that regulators might not agree that its cars are capable of being autonomous.
In 2018, Tesla did not test any vehicles in autonomous mode or operate any autonomous vehicles in California. There is simply no evidence that the company is close to achieving autonomy, and there is certainly no evidence that it is closer than its competitors (such as Google’s Waymo).
And yet Tesla continues to believe that its innovation in this field is special. If it’s wrong, then it’s not hard to imagine how such delusions could lead to ethical failures (e.g. charging customers for “full self driving” capabilities which it will never deliver).
7. Goodness in some areas atones for evil in others
Tesla company culture is organised around the “mission” of sustainable energy. The company believes it is at the forefront of changing the way the global economy works, for the benefit of humanity.
Perversely, feelings of self-righteousness can increase the risk of ethical collapse. If you think you are saving the planet, is it really such a big deal if you commit market abuse or break promises to customers along the way? In terms of the fraud triangle, this is the ability to rationalise the crime.
Tesla satisfies most, if not all, of the seven signs of ethical collapse. It also satisfies all three indicators of the fraud triangle. These frameworks help to bolster its attractiveness as a shorting opportunity.
At the time of publication, the author has a short position in TSLA and a long position in TSLA put options.