Boeing's ethical lapses and governance reform under CEO McNerney

Ethics

After being rejected for a lucrative Air Force rocket contract, Boeing made several acquisitions to raise their profile in aerospace and put them back on the Air Force's radar. However, the pursuit of the rocket contract and other big Air Force deals led to a pair of major ethical lapses.

In one case, the Air Force purchasing czar, Darleen Druyun, essentially gave Boeing a deal overvalued by $6 billion in exchange for jobs for herself, her daughter and her son-in-law. Druyun's backroom dealings with Boeing CFO Mark Sears also included a $4 billion aircraft upgrade deal. The other scandal was with respect to industrial espionage. Boeing hired engineers from rival Lockheed Martin. These engineers brought trade secrets from Lockheed with them, giving Boeing an advantage in the competition for a $20 Air Force rocket deal.

Boeing had to that point paid little attention to governance issues. The firm's governance policies were vague. Several board members had potential conflicts of interest. However, the ethical lapses were deemed to be isolated incidents rather than systemic problems.

When current CEO W. James McNerney took over in 2005, he decided that the top priority for Boeing was to clean up its ethical act. He made a few symbolic gestures, and then arranged for the board to be overhauled. The committee responsible for governance was also overhauled in the process and the directors with the highest potential conflict of interest were removed. McNerney then re-wrote the code of conduct, making it more explicitly related to ethical conduct issues.

Company Background

Boeing is the world's largest manufacturer of commercial airliners, military aircraft and is a world aerospace leader (Boeing, 2009). In addition to aircraft, Boeing manufactures satellites, missiles, human space flight vehicles, and launch systems. The company operates five different segments: Commercial Airplanes, Military Aircraft, Network and Space Systems, Global Services & Support, and Boeing Capital Corporation. The company has attained some degree of vertical integration with respect to software development for its products.

Though today headquartered in Chicago, Boeing had its start in California, when William Boeing developed two floatplanes. The company's first production order was for 50 seaplanes, in 1917 to help with the war effort. The company participated in a handful of firsts, including the first international air mail delivery, from Vancouver to Seattle. The Army Air Service continued through this period to be Boeing's biggest customer. Boeing Air Transport was developed to run regular mail routes, including the 22 1/2-hour San Francisco to Chicago run. By 1958, it had developed the 707, the first American commercial jet liner. The 707 established Boeing as the leader in this market. Boeing later contributed to the Space Shuttle (Boeing.com, 2009).

In the decades following World War Two, several major aerospace firms gradually came together. McDonnell and Douglas merged in 1967, with that firm joining Boeing in 1997. The other major constituents of the modern Boeing are North American Aviation (by way of Rockwell International) and Hughes Aircraft, which came to Boeing via a complicated set of deals involving Raytheon and GM.

The company restructured itself into its major division, with former executives at its acquisitions taking a variety of positions within the Boeing hierarchy. Despite its longstanding history with the military, Boeing had become better known for its civilian aircraft and associations with NASA. With the series of acquisitions in the mid-90s, it moved aggressively back into the military market. Prior to the acquisitions, Boeing's defense revenues were just 1/3 of its commercial aircraft revenues, but the company felt that the defense market had tremendous growth potential (Bowermaster, 2005).

In March of 2001, Boeing announced its move to a new headquarters in Chicago, leaving Seattle behind. Having acquired a variety of defense companies piecemeal, Boeing restructured them into a new Integrated Defense Systems unit. The company had by this point established all of its major commercial and military businesses, including its finance arm, its air traffic control business and its Homeland Security Business followed shortly.

By this point, all of the major players in the corporate governance scandal were in place as well. Phil Condit was named CEO in 1996. Michael Sears, a former President of Douglas Aircraft, was Chief Financial Officer. The firm had established a relationship with Darleen Druyun, both through her work at the Air Force with McDonnell Douglas and through her getting her daughter and son-in-law hired at Boeing in 2000.

Executive and Board Review

Philip Condit was elected to the board at Boeing in 1992, the same year he ascended to the President post. He was subsequently named Chairman of the Board in 1997. In 2003, he resigned both posts as news of the twin scandals emerged. The Air Force froze the contract that Druyun had negotiated, precipitating Condit's resignation and retirement.

Condit had joined Boeing in 1965 as an engineer and moved into management in 1973, working on marketing the 727. He completed an MBA at Sloan in 1975 and returned to Boeing, progressing rapidly up the ranks. By 1983, he became VP and General Manager of the 757 division before moving on to other VP posts. In 1996, he moved from President to CEO and a year later was named Chairman.

There is little to indicate that Condit himself was a significant contributor to the governance problems at Boeing. Although he was an engineer by training, he spent much of his time at Boeing in marketing. The hiring manager, Bill Erskine, who had hired Ken Branch in the first place, had just completed ethics training. However, the subsequent denial of the scope of the problem, even at the highest legal levels of Boeing, indicates that the corporate culture did not value ethics at this time, at least not as much as it valued the rocket contract. Condit's immediate resignation may be taken as a sign that he realized he had failed to preserve Boeing's ethical standards, and did not have the degree of control over the company that he thought he had. However, some of the evidence that turned up during the Druyun investigation indicates that Mark Sears' actions where known in other parts of the executive suite. Though it cannot be concluded definitively, it can be inferred that the lack of attention to ethical issues was at least tacitly accepted by Condit.

Compounding this issue is the fact that Condit came to the CEO position when Boeing was making its big push back into the military business. Thus, he may have staked his personal future and reputation with the company on the rocket contract and therefore been willing to overlook the espionage committed by Ken Branch.

Another powerful board member at the time was Harry Stonecipher. He was President and CEO of McDonnell Douglas prior to its acquisition by Boeing. After the acquisition, he remained head of the McDonnell Douglas business, became COO of Boeing and was Vice Chairman of the Board. Stonecipher had a long relationship with the Department of Defense, such that he was hired by Sundstrand, another aerospace firm. His main role there was to repair the relationship between that company and the DoD (Boeing, 2009).

Stonecipher's functional roles put him in charge of many human resources-related tasks, as well as building relationships between the company's myriad stakeholders. As such, Stonecipher was in position to strongly influence governance issues with respect to hiring, in particular with respect to ex-Lockheed staffers like Ken Branch. Moreover, Stonecipher was in charge of McDonnell-Douglas, the firm at the center of the rocket competition. During this competition, Druyun apparently gave Stonecipher, illegally, confidential information regarding Lockheed's bid (Bowermaster, 2005).

Stonecipher replaced Condit as CEO, with a stated mandate to clean up Boeing's governance issues. Yet there is a strong case to be made that Stonecipher had more at take personally in the rocket contract, a stronger relationship with Druyun, and more direct involvement in Boeing's hiring practices through his background in human resources than did Condit. Ultimately, Stonecipher's tenure lasted only a couple of years, before he was forced to resign as the result of a sex scandal.

As of 2002, Boeing had already met most of the requirements of the newly enacted Sarbanes-Oxley. These included having independent, non-employee board members; having a written charter for key board committees and that key board committees are comprised of independent directors (Boeing 2002 Annual Report). Some of these included John E. Bryson, who was a Chairman of the Board. He served on Boeing's Board since 1995 and was on the Compensation, Governance and Nominating Committee. Bryson was President of Edison International, the public utility holding company. Bryson, a lawyer and former environmental activist, Bryson was seemingly unaware of the issues facing Boeing.

The Compensation, Governance and Nominating Committee was entirely comprised of non-employee directors, including Kenneth Duberstein (Chairman of the Duberstein Group, a lobbying firm), Paul Gray (an engineering professor at MIT) and John F. McDonnell (retired, McDonnell-Douglas). The chairman of the committee was Lewis Platt, then President and CEO of Hewlett-Packard. Of these, John F. McDonnell cannot be considered truly independent, as the son of the founder of McDonnell Aircraft Corporation. Duberstein's independence from military work is questionable, as a former Chief of Staff to Ronald Reagan. Only Gray and Platt can reasonably be assumed to have independence on this committee.

Other board members included W. James McNerney (CEO of 3M), Rozanne Ridgeway (former assistant Secretary of State), John Shalikashvili (former Chairman of the Joint Chiefs of Staff) and John Biggs (former CEO of Teachers Insurance and Annuity Association). This high-powered board contains many individuals of strong integrity. Few, however, have any specific knowledge of or skill with respect to governance issues. They appear selected mainly for strategic reasons, evidenced by the number of senior government officials on the board. Overall, the board's composition is not conducive to strict governance.

Corporate Governance Analysis

The presence of a pair of directors lacking independence on the governance committee is a red flag. John F. McDonnell in particular could have had strong motivations to overlook issues pertaining to the McDonnell-Douglas rocket bid. As well, it is conceivable that impropriety with respect to negotiations with the Air Force could have been overlooked by the former government officials on the board. It is worth noting, however, that the Druyun situation occurred without the knowledge of seemingly anybody within the Air Force's purchasing department, including her boss. Therefore it is conceivable that the specific actions that led to Boeing's governance problems were entirely unknown to board members. However, the culture that permeated the company stemmed from the top, and the two top executives in Condit and Stonecipher were not only on the board, but were in a position to know of both of the ethical situations unfolding.

The first response from Boeing with respect to the twin crises was to fire Mark Sears. This was followed by the resignation of Condit. However, the situation was not resolved at that point, for two reasons. One was that the company replaced Condit with Stonecipher, a man who if anything had greater influence over the hiring of ex-Lockheed employees and greater personal stake in the success of the rocket bid. That the board hired Stonecipher could be considered evidence that board members did not grasp the scope of the problem at Boeing.

The scope of the problem was revealed over the coming couple of years. Both Mark Sears and Darleen Druyun were convicted and sentenced for their roles in bilking taxpayers our of billions of dollars in defense contracts in exchange for Boeing's hiring of Druyun, her daughter and her son-in-law. In response to a racketeering lawsuit filed in 2003 by Lockheed Martin, Boeing was forced to investigate the espionage issue further, culminating in the finding of thousands of more pages than originally known. Stonecipher was forced out as the result of a sex scandal.

Stonecipher was replaced by W. James McNerney, the former CEO of 3M who had sat on Boeing's board since 2001 and was a member of the audit and finance committee in 2002. Whereas Boeing completely dropped the ball in hiring Stonecipher to replace Condit, they appeared to do better with McNerney. He began his tenure by launching a series of investigations, both with respect to the specific incidents that had brought the troubles to the company, and with respect to Boeing's governance practices overall.

In 2006, McNerney noted that the reviews revealed that the ethical breaches were isolated incidents, rather than systemic failures. However, he also noted that the corporate culture had led some in the company to "look the other way" with respect to the breaches. Some of the considerations that went into this were cited as wanting to win a contract, fearing retaliation, not wanting to "rock the boat" or lacking courage to speak up in Boeing's command and control culture (Bigelow, 2006).

Under McNerney Boeing created a new office of internal governance. The objective of this office is to create data-mining techniques that can correlate information gathered from a number of different sources. This would allow information from different departments to be put together, revealing potential ethical lapses. McNerney also recognized that the culture is driven from the top, thereby taking personal responsibility, something that his predecessors did not do.

As most of the directors had their terms due within a couple of years of 2002, Boeing was able to turn over its board significantly. Condit and Stonecipher were long gone by 2006, along with Shalikashvili, Platt and Gray. This overhaul removed the weakest link in terms of governance issues (Gray), Shalikashvili's strong military connections, and the lead of the governance committee in Platt. They were replaced with William Daley (a chairman at JP Morgan), Richard Nanula (CFO, Amgen), Arthur Collins (CEO, Medtronic), Linda Cook (an executive director at Royal Dutch Shell) and Mike Zafirovski (CEO, Nortel).

Boeing also restructured the Compensation, Governance and Nominating Committee. Governance was decoupled from compensation and reconstituted as Governance, Organizing and Nominating. Rozanne Ridgeway, a board holdover, was now chair of this committee. She had not been on the committee in 2002. Other committee members were John Bryson, Ken Duberstein and John McDonnell. It is interesting to note that neither new CEO McNerney nor Committee chair Rozanne Ridgeway were members of the Committee in 2002. The only committee holdovers were McDonnell and Duberstein (Boeing 2006 Annual Report).

As of 2006, the investigations had ended with a $615 million settlement with the U.S. government (Ibid.). The company chose not to deduct the settlement on its taxes, although it could have. This was a symbolic gesture that the company had left its old ways behind. This show on contrition was intended as a symbol from the top of the company that it would not tolerate ethical lapses and that responsibility for those lapses would be borne by all.

Boeing also adopted a Code of Ethical Business Conduct, and there are separate versions of the code for members of the board, employees and finance employees. The code addresses conflicts of interest, corporate opportunities, confidentiality, fair dealing, compliance and whistle-blowing. These topics deal more explicitly with issues of ethical conduct than did the previous code, which focused more towards matters of board function such as succession, performance evaluation and committees.

Conclusion

Boeing believes that its ethical problems are behind it. The company determined that the lapses were not systemic in nature, but individual lapses in judgment. Aside from Mark Sears, no Boeing employee has faced legal action. No board member or executive aside from Sears has been implicated in the scandals. However, the company has been forced to improve its corporate governance as a result of the scandals. New CEO W. James McNerney has overhauled the board, reconstituted the committee responsible for governance and removed a few of the board members who were most likely to be at fault for the lack of oversight. The company has re-written its internal code of conduct to explicitly focus on ethical issues and McNerney has made several symbolic gestures to show that the company is committed to high ethical standards.

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