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Jack L.B. Gohn: Diesels, directors and dogma

To a hammer, the proverb goes, everything looks like a nail. Even when it’s nothing like a nail at all.

The workings of this principle recently popped up in a New York Times column on the Volkswagen mess by James B. Stewart, a journalist whose beat is business, and who seems to have been covering it too sympathetically and too long. As of September 24, the day the column ran, and indeed today, as this column is written in mid-October, we did not and do not know who in management ordered or knew about the hidden software feature that fooled regulators into believing VW’s diesel fleet emitted far lower levels of nitrogen oxides than it actually did.

In fact, as cooler heads at the Times had previously admitted, we still do not even know what the feature was designed to do: save fuel, increase torque and acceleration, or both. Nor do we know how it worked.

Yet none of that deterred Mr. Stewart from using the scandal to make far-fetched but familiar arguments better suited to the editorial page at the Wall Street Journal than to a responsible contributor to the news hole of the national paper of record. The Volkswagen scandal, Mr. Stewart confidently informed us based on almost no facts, was the result of two things: a board on which founding family members and labor unions have a significant clout, and a commitment to maintaining a large labor force. Somehow – Stewart never tells us exactly how it came about – a board answerable to unusual constituencies, and a determination to see lots of German workers comfortably employed was to blame.

How, then, do we know there was a connection? Well, because a professor at the University of Delaware said the governance scheme constituted “an accident waiting to happen.” Oh, and “a longtime former senior Volkswagen executive … agreed that a scandal … was all but inevitable at Volkswagen.”

Right. That’s helpful and informative.

An externality

One could shrug this off as a simple instance of journalism unworthy of the Times – proof, if you will, that even Homer nods, and leave it there. But I see an unpleasant little agenda at work here. The constituents of the board that so offended Stewart were the family of the people who founded and built the corporation and the people who work there (all right, also Qatar’s sovereign wealth fund and the government of Lower Saxony, which also control board seats). Running a board as if it were about people! Stewart was so appalled he needed to denounce it, even if board’s makeup and goals may have had nothing to do with the engineers subverting the software.

None of which is to excuse what VW did here. Nitrogen oxides in diesel exhaust are very bad for people who breathe them and bad for the environment. They are what economists call an externality, defined (courtesy of Wikipedia) as a “cost or benefit that affects a party who did not choose to incur that cost or benefit.” By selling a car to a consumer, VW and the purchaser obtain the benefits of the transaction between them. By selling a car that belches illegally noxious fumes, however, VW also burdens everyone with lungs plus all the leafy vegetation in countries which not only had not bargained for that kind of burden, but had actively sought to prevent it by regulation.

The slick little ploy Mr. Stewart had sought to pull was to blame one form of externality (air pollution) on efforts to avoid another (unemployment). And what a terrible thing trying to avoid that second externality was! Imagine, as Mr. Stewart chronicled, VW using 600,000 people to build about the same number of vehicles as Toyota built with 340,000! Well, that Delaware professor knew just what to say about that: “[M]aximizing employment shouldn’t be the primary goal of a board.”

So take that, VW! If only you fired about half your workers, you too could be like Toyota and not pollute so much.

I’m going to assume (since Stewart didn’t bad-mouth Toyota’s board the way he did VW’s) that he would be happier with Toyota’s corporate governance and goals. But what, then, would Stewart say about the recent recall of the lethal Takata airbags in five million Toyota vehicles worldwide? A bit of an externality, too, I think you’d agree, but one you can’t blame on a board of directors trying to stem unemployment. Or what about those even more lethal GM ignition switches? Was there an issue with too much philanthropy on GM’s board that made those switches inevitable?

Investors over others

Mr. Stewart’s hysterical invocation of the quite possibly unrelated emissions scandal as a reason to distrust VW’s corporate governance scheme betrays a palpable fear of allowing unconventional stakeholders a voice on corporate boards. The Delaware professor he quotes says that there is a “fundamental conflict” between profit-seeking, the only true goal of management in his eyes, and workers’ interests, which unions promote, and that in view of that conflict, workers shouldn’t sit on boards.

Stewart acknowledges that workers do sit on typical German corporate boards. And how awful can that be? After all, Germany’s is the strongest economy in Europe.

The dogma Stewart wants us to accept unquestioningly elevates the interests of one set of stakeholders (investors) above the interests of all others when it comes to directing corporate agendas. Yet corporations affect a wide variety of stakeholders, including workers and (as in the present scandal) people who must breathe the air. Corporations are creatures of state law. Historically, corporations were created to implement state policy. Why, then, is it so unthinkable to have a policy of designating board seats for representatives of those affected by corporate externalities?

The notion that corporations are run in the interests of shareholders reflects reality about as well as VW’s former claims about its cars’ emissions. We haven’t reached the situation where a tiny sliver of the population controls the vast bulk of the wealth by having corporate boards look out for investors.

Corporate boards are primarily made up of and look out for the interests of senior executives. Two years ago, Bloomberg News calculated the ratio of the compensation of CEOs to the median compensation of other employees at the Standard and Poor top 250 companies. The ratios ranged from 1,795-to-1 down to 173-to-1. Those CEOs are a large proportion of the people who are getting the nations’ wealth. Even at the lowest ratio, can anyone honestly say either: a) the interests of the stockholders are being well-served? or b) the interests of the workers are being adequately protected?

To anyone who says yes, I have a used VW diesel to sell you. Trust me, it has super-clean emissions.

Jack L.B. Gohn is a partner with Gohn, Hankey, Stichel and Berlage LLP. The views expressed here are solely his own. See a longer version, with links to his authorities, at www.thebigpictureandthecloseup.com.