Why did regulation, corporate governance, and fear of repetitional harm fail to prevent the Boeing 737 Max debacle from happening? A new paper explores what went wrong in the Boeing case and how to prevent all these defense mechanisms from failing again.
The Boeing 737 Max debacle continues to draw public attention. A Netflix documentary (Downfall) and a popular book (Flying Blind) were recently dedicated to the two fatal crashes from 2018-2019. And last month, another deadly 737 crash in China (this time the model was the Max’s predecessor) has refocused attention on Boeing’s safety culture. Coverage of the debacle tends to focus on what happened and how it happened. “What happened” accounts detail how Boeing installed a flight-control system that relied on a single faulty sensor (a big no-no in flight safety), and ended up causing two fatal crashes. “How it happened” accounts ask how such chain of safety failures occurred in a highly-reputable company, and locate the culprit in an apparent shift in corporate culture that occurred following Boeing’s 1997 acquisition of rival airplane manufacturer McDonnel-Douglas: from safety-first to profits-first.
But from this vantage point, the more interesting question is “who let it happen.” After all, stories about managers looking to maximize stock returns and beat the competition by aggressively cutting costs and pushing new products to markets are not really unique. They happen everywhere, all the time. In fact, precisely because we expect management to prioritize profits, there exist various social institutions meant to monitor management and ensure that within their pursuit of profit they do not impose significant costs on others, such as by degrading the environment or risking consumers’ safety. There is external regulation (in the case of Boeing, the FAA), internal compliance programs, and boards of directors that are in charge of risk oversight. And there is the threat of market discipline, namely, the prospect of the company and the individuals involved suffering reputational fallouts and losing future business opportunities.
The interesting question, therefore, is where were all these mechanisms leading up to the 737 Max debacle. Why did they fail, and what we can do to reduce the risk that they will fail again going forward? My new essay addresses these questions.
External regulation failed both before the crashes—in certifying the 737 Max—and after the crashes, in (not) holding those responsible accountable. Before the crashes, even though Boeing had a history of safety violations, the FAA granted the company “too much sway over its own oversight” according to a congressional report. After the crashes, the Department of Justice settled the criminal conspiracy investigation against Boeing for misleading the FAA with a deferred prosecution agreement. The agreement required Boeing to pay $2.5 billion, but it did not require it to appoint a monitor, did not charge any individual executive, and did not require any admission of wrongdoing. Columbia law professor John Coffee called the agreement one of the worst he has ever seen.
There exist various possible reasons for these regulatory failures, ranging from the benign (regulatory enforcers stymied by limited resources and information asymmetries and complexity), to the cynical (the Trump Administration pushing to get Boeing cleared and back to business at all costs), to the very cynical (a lead prosecutor in the case subsequently joining Boeing’s corporate criminal defense firm Kirkland & Ellis). Interestingly, the same vectors—from “revolving doors” between the regulators and the regulated, to regulators overly relying on self-reporting by the industry—appear in post-mortem analyses of other deadly corporate debacles.
Internal corporate governance too often fails in such scenarios as well, if only due to top managers’ tendency toward willful blindness. Corporate directors have strong incentives to remain ignorant about decisions that prioritize profits over safety or skirt regulatory requirements more generally. Prioritizing profits is good for directors who receive substantial stock-based compensation. And remaining ignorant about how profits were obtained is good for directors’ ability to maintain plausible deniability and escape accountability.
“The emphasis that corporate law puts on better paper trails in turn can help regulatory enforcers hold top-level individuals to account.”
Finally, the prospect of reputational fallouts also too often fails to deter such corporate misbehavior. Lawyers and economists alike tend to suffer from indefensible optimism about the operation of reputation markets, assuming that whenever bad news surfaces, the market will discipline the misbehaving entities. In reality, reputations are noisy, with the result that the market systematically overreacts to some news and underreacts to other news. With Boeing, content analysis of the first months of media coverage showed that the framing in the media was initially controlled by the company, and blame was shifted to (supposedly) incompetent third-world airline operators. The upshot is that when left to its own devices, the market often has a hard time discerning how things happened and whether past events are indicative of a rotten company culture or just one-off mistakes.
What can be done to mitigate such failures of regulation, reputation, and corporate governance? Part of the answer comes from corporate law. In September 2021, a Delaware court allowed a derivative lawsuit brought by Boeing shareholders to proceed, based on the theory that Boeing’s directors breached their oversight duties by not doing enough to monitor, prevent, and react to fatal airplane safety issues. This Boeing decision signifies corporate law’s newfound emphasis on director oversight duties. Historically, corporate law has stayed remarkably silent on corporate compliance, and oversight duties were virtually unenforceable. But over the past two years, corporate law courts have been increasingly willing to apply enhanced scrutiny of board oversight efforts, and increasingly willing to grant outside shareholders access to internal company documents, in order to investigate potential failure-of-oversight claims. There is ample reason to believe that this revamped approach to oversight duties may prove desirable from a societal perspective, as it can help balance the flaws of the abovementioned mechanisms.
The revamped approach can reverse the tendency toward willful blindness, along the following two dimensions. First, Boeing illustrates how courts now give more weight to culpable ignorance, in the sense that directors can now face liability not just for what they knew, but also for what they should have known. Second, Boeing illustrates the expansion of shareholders’ rights to information from the company, and the increased emphasis on proper documentation, which in turn incentivizes more upward flows of information inside large organizations. Going forward, directors and their legal advisors in all likelihood will attempt to create a proper record of their efforts to monitor and address safety issues. This, in turn, will force directors to ask others in the organization to prepare written materials for them, thereby bringing thorny issues to the fore.
Private corporate law litigation could also complement what is often limited public (regulatory) enforcement. Corporate law litigation provides strong incentives for “bounty hunters” (institutional investor plaintiffs and their attorneys) to find out what went wrong and how. That is, plaintiffs can collect a hefty fee if they manage to produce new evidence about top-level individuals: what directors knew, when they knew it, and what they did (not do) to stop it. The emphasis that corporate law puts on better paper trails in turn can help regulatory enforcers hold top-level individuals to account, by creating a traceable record of who knew what when.
Finally, the new mode of director oversight duties contributes to the ability of the market to discipline itself. Corporate law litigation helps the market by providing “objective” internal documents to which market actors were not privy. It also provides “subjective” interpretations by well-respected independent arbiters (Delaware judges). Put differently, corporate law litigation in its revamped approach comes with the added benefits of shaping norms (how market actors ought to behave) and reputations (how specific market actors behaved in given instances) in the business community.
To be sure, there are also potential downsides to this new approach to director oversight duties. For example, it may end up increasing the costs of judicial hindsight bias, and creating perverse incentives for boards to be overly confrontational with management once crisis hits. We therefore should not treat the Boeing development in corporate law as an unalloyed good. What we should do is think harder about the interactions between the different mechanisms of enforcement. Regulation will always be prone to forms of capture, reputation markets will always be noisy, and the diffusion of responsibility and knowledge within large organizations will always create pressures to prioritize profits above everything else. When we evaluate the pros and cons of private enforcement, we should consider its ability to mitigate these flaws in the other systems.
On March 21, after this blog post was completed, a Boeing 737 crashed in southern China, killing all 132 on board. As of this writing, we do not know what caused the crash. But we do know that a more robust oversight of companies’ compliance efforts is needed. Hopefully the Boeing decision signifies a step in the right direction.
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