Tesla's close-knit leadership team goes under the spotlight in court

Washington, DC(CNN) The Tesla board of directors that created the largest compensation package in history for CEO Elon Musk was stocked with friends of Musk, according to court testimony this week.

"Yes we're friends," former Tesla board member Antonio Gracias said after a long line of questions about his relationships with Elon Musk and his brother Kimbal Musk, who is also on Tesla's board. "Yes, I mean, yes, yes, yes, yes."

This potential conflict of interest may be problematic as Tesla says its board of directors has a legal responsibility for shareholders' money in addition to overseeing management, which includes Elon Musk.

Plaintiff Richard J. Tornetta has claimed on behalf of Tesla's shareholders, however, that Musk exploited his control over the company's board of directors to secure the compensation package that's worth $50.9 billion today and to fund his plans to colonize Mars. The 2018 compensation package helped launched Musk from No. 41 on the world's richest list, all the way to No. 1.

The week-long trial is being held at the Delaware Court of Chancery in Wilmington. Tornetta accuses Tesla's board of breaching its duties to shareholders. Tesla says its board members are supposed to manage potential conflict of interests and act in the best interests of Tesla and its stockholders.

The plaintiff's attorneys have highlighted the closeness of Musk's relationships with some board members to raise questions about their independence. Testimony is expected to conclude Friday, but Chancellor Kathaleen McCormick may not make a decision for weeks or months.

The Tesla board approved Musk's unprecedented pay package without negotiating how many shares Musk would receive in the plan, according to testimony Wednesday from Gracias. The failure to negotiate may indicate the board isn't independent of Musk.

One board member, Ira Ehrenpreis, explored how the disclosed public value of the plan could be limited, according to his testimony. An interest in not disclosing the value of a pay package to shareholders could be interpreted as having more interest in maximizing executive pay than helping shareholders evaluate executive compensation.

The pay package from Tesla's board granted Musk large sums of shares every time Tesla hit certain milestones, including earnings and share price targets.

But when the board sought shareholder approval of the package it did not consider revealing publicly that Tesla's internal forecasts expected three milestones to be achieved in roughly 18 months, according to testimony from Gracias. That's at odds with earlier testimony at this week's trial in which Tesla leaders described the plan as difficult to achieve.

"Even though I believe in Tesla deeply I felt the level of difficulty of these milestones was so high that for a mere mortal like me, I did not find this as a compelling incentive plan at a personal level," former Tesla chief financial officer Deepak Ahuja testified earlier this week.

Musk's pay package was also unusual, because there was no traditional benchmarking study conducted by Tesla to compare Musk's compensation to other leaders, according to testimony by Tesla board member Ira Ehrenpreis.

Vivek Wadhwa, a former Distinguished Fellow at Harvard Law School and Carnegie Mellon University's College of Engineering before retiring, told CNN Business that it's common for Silicon Valley boards like Tesla to lack adequate checks and balances. CEOs often end up with too much control of their boards and companies.

"It's an incestuous relationship. It's a serious problem," Wadhwa said in a phone interview conducted while charging his Tesla. He's described himself in the past as a "Tesla fanboy."

Too close for business comfort?

A plaintiff's attorney questioned Gracias Wednesday about his relationship with Elon Musk, as well as Musk's brother Kimbal Musk, who remains on Tesla's board of directors.

Gracias described vacationing with Elon Musk's family in the Bahamas, and having had an annual tradition for eight to 10 years of spending President's Day weekend with Elon, Kimbal and their families. They've attended birthday parties for each other's children, and Gracias has spent Christmas at Kimbal's home. Gracias also said he was a groomsman in Kimbal's wedding.

Elizabeth Umphress, a University of Washington business school professor who researches ethical decision making, says that friendships between board members and CEOs are concerning. Personal relationships can impact the quality of decision regarding pay and performance, research has shown.

She said this is a problem at all levels of organizations, but can be especially problematic at higher levels as high-status people are more likely to think they're immune to conflict of interests.

"When you do have these friendships," Umphress said. "You are compromised."

James Murdoch, who described himself in testimony as a friend of Elon Musk since 2006, described joining the Tesla board of directors in 2017 after being approached by Gracias. (Murdoch is the son of media titan Rupert Murdoch.)

Murdoch, Gracias and Elon Musk vacationed together with their families in the Caribbean shortly before Murdoch joined the board. Murdoch said he also spent time with Musk and his family in Jerusalem and Mexico.

Ehrenpreis, a Tesla board member who led the automaker's compensation committee, has exchanged messages with Musk referring to each other with things like "love you man," he testified earlier this week. Ehrenpreis also had the rights to the first Model 3, Tesla's breakout product, but gave it to Elon Musk as a birthday gift.

Ehrenpreis is also the Tesla board member who asked consultants if hypothetically Tesla could lower the disclosed costs of Musk's compensation plan.