Did Boeing’s Compensation Committee Play a Role in the 737 Max Scandal?

The Boeing 737 Max scandal is one of the most serious corporate crises in U.S. history.  While companies like Enron, Arthur Andersen, and Lehman Brothers were replaceable, Boeing is not.  Consumers and airlines around the world now view the 737 brand as toxic, a point echoed by a recent tweet by President Trump.[1]  Boeing is more than just an industrial company.  It represents American industrial and engineering prowess to the world.  Boeing’s failure is a national failure and represents a loss in American power and influence.  This may be the first time the world followed China’s example on an important international issue.  China was first to ban the 737 Max, and the FAA acted only after its hand was forced when the rest of the world followed China’s lead.

The Boeing scandal represents a failure of corporate governance just as much as a failure in engineering.  In 2011, Boeing made the fateful decision to place new engines on an old airframe.  This decision was made partly to save money on airplane development and partly to avoid expensive pilot training.  Subsequently, the placement of the new engines required special software known as MCAS, which was deemed the cause of the crash of the two 737 Max jets.  Pilots were not told about the MCAS feature, which caused the nose to pitch down under certain circumstances.[2]

Was MCAS a failure of corporate governance or just a tragically mistaken engineering decision? One clue lies in the makeup of Boeing’s compensation committee in 2011.  A second clue lies in the CEO’s 2011 letter to shareholders.  A third clue lies in the compensation committee’s assessment of corporate performance in 2011.

The 2011 compensation committee was charged with assessing the performance of top management, including CEO Jim McNerney, who came to Boeing after a long career with General Electric and a shorter stint at 3M.[3]  Two of the four members of the compensation committee were McNerney’s former colleagues from General Electric.[4]  These two directors remain on the Boeing board, and one (David Calhoun) is now the lead director.[5]  The other two members of the 2011 compensation committee had served together on the McDonnell Douglas board for many years before it was acquired by Boeing in 1997.[6]  Consequently, two of the four were new and not independent (in spirit) from the CEO, while the other two were long-standing “zombie” directors who were unlikely to provide a fresh perspective or question each other’s assumptions (Huang and Hilary, 2018).[7]  According to aerospace analyst Richard Aboulafia, the McDonnell Douglas culture came to dominate Boeing and resulted in excessive aversion to business risk.[8]

The compensation committee’s impact on corporate governance goes well beyond the cost of compensation.  The compensation committee effectively sets corporate strategy by approving incentives for top management.  In the case of the 737 Max, CEO McNerney stressed the importance of reducing business risk (2011 annual report’s letter to shareholders, emphasis added):

“With development costs and risks far below an all-new airplane, the 737 MAX will provide customers the capabilities they want, at a price they are willing to pay, on a shorter, more certain timeline. This approach is an all-around winner for Boeing, too. We maintain our qualitative advantage over competitors in the segment, we free up resources to invest in other growth projects, and we reduce our business risk substantially for the next decade.”

In hindsight, this claim of reduced risk is more than ironic; it is nothing short of tragic.  However, at the time, this claim of reduced risk was not merely an investor-relations pitch.  It actually played a critical role in the compensation committee’s positive assessment of CEO performance for the year.  The committee’s 2011 annual incentive assessment (2012 proxy statement, emphasis added):

“Economic profit for 2011 was 1.6 [60 percent above target] … primarily due to strong integrated performance across the Company, including better than-expected mitigation of risks.”

By the time Dennis Muilenburg became CEO in 2016, the 737 Max was already fully developed, and Muilenburg did not come from Boeing’s commercial airplane division.  With McNerney long gone, the board needs to accept its responsibility for the 737 Max debacle.  While Muilenburg’s handling of the crisis was far from perfect, it would be a mistake to fire him.[9]  This would only further entrench the power of a board directly responsible for the development of the 737 Max.

CEO Muilenburg recently formed a committee to study the company’s product development process.[10]  In a positive sign, the four members of the committee do not include the current lead director, who sat on the 2011 compensation committee.  A true investigation would require deep scrutiny of the board’s effectiveness and the functioning of its various committees.

ENDNOTES

[1] https://twitter.com/realdonaldtrump/status/1117736685721223168?lang=en

[2] https://www.seattletimes.com/business/boeing-aerospace/u-s-pilots-flying-737-max-werent-told-about-new-automatic-systems-change-linked-to-lion-air-crash/

[3] https://www.boeing.com/history/pioneers/w-james-mcnerney-jr.page

[4] Mike Zafirovsky and David Calhoun, from Boeing 2012 proxy statement, director biographies

[5] https://boeing.mediaroom.com/2018-03-16-Boeing-Board-Elects-Calhoun-Lead-Director-Effective-April-30th-Duberstein-to-be-nominated-as-Director-for-2018-2019-to-aid-transition

[6] John McDonnell and Kenneth Duberstein https://www.boeing.com/history/pioneers/john-f-mcdonnell.page ; https://www.upi.com/Archives/1989/05/08/Duberstein-joins-McDonnell-Douglas/3457610603200/

[7] https://onlinelibrary.wiley.com/doi/abs/10.1111/1475-679X.12209

[8] https://www.reuters.com/article/us-boeing-dreamliner-idUSTRE70J2UX20110120

[9] https://www.npr.org/2019/04/16/713483867/boeing-slow-to-own-recent-air-disasters-analysts-say

[10] https://boeing.mediaroom.com/2019-04-05-Statement-from-Boeing-CEO-Dennis-Muilenburg-We-Own-Safety-737-MAX-Software-Production-and-Process-Update

This post comes to us from Professor Dov Fischer at Brooklyn College. It is based on his recent paper, “Was Boeing’s Compensation Committee Sufficiently Independent in Judging the Business Risk of the 737 Max?,” dated May 8, 2019, and available here.