General Motors, The Bailout, and Corporate Governance Reform

There is much talk in Washington about possibly bailing out the automobile manufacturers, the three large ailing car companies in the United States.  In particular, General Motors seems to be hemorrhaging money.  It recently announced short term efforts to raise cash but appears to be running out.  The company reported a net loss of $2.5 billion or $4.45 per share for the third quarter, including special items.

Some think that the car companies should simply be allowed to fail.  Others favor some type of government aid in the form of a bailout.  In truth, whatever the merits of allowing the companies to fail, this is not the time for it.  The economy is simply too fragile to have to absorb this type of blow.

To the extent a bailout is approved, however, there should be dramatic changes in management, with the CEO and much of the board ousted.  The current financial state of the companies, while exacerbated by the current turmoil, reflects weaknesses at the top, the protestations of the current CEO notwithstanding.  After all, Toyota and Volkswagen are by comparsion in no where near the same bad shape, suggesting that different managers were able to navigate the current turmoil. 

The current CEO is Richard Wagoner.  He is a lifer at GM, joining the company in 1977.  Having spent his career at GM, he has no doubt been captured by the GM culture and the GM way of doing business, an approach that has not worked.  Replacing him is less about incompetency and more about a type of leadership atypical of GM, quick. entrepreneurial, future looking.  

But the changes cannot stop there.  Cuts also must take place at the board of directors. Wagoner joined the board in 1998 and was elevated to chairman in 2003.  Of the 13 "independent" directors on the board, eight of them have served with Wagoner since 2003 (five since he joined the board in 1998).  In other words, this is a board that would fit Jon Macey's definition of "capture."  As he notes in his book Corporate Governance (a book we will review next week), "[t]he problem with boards is their unique susceptibility to capture by the managers they are supposed to monitor." Id. at 57.  The problem enhanced by the incentive of managers "to develop close personal ties with directors."   Id. at 61.  Wagoner has had five to ten years to develop "close personal ties" with much of the board.  As such, they are not in a position to give his managerial approach the close supervision that he ought to receive.

In addition, the portion of the board that has served the longest is remarkably undiverse.  Most are in the same age group and all of the directors serving since Wagoner became chairman have essentially identical backgrounds, having served as the CEO or Chairman (currently or retired) of mostly public companies.  The more recent additions to the board have more diverse backgrounds.  But those serving the longest are not likely to provide the type of diverse kind of advise that Wagoner ought to hear.

Finally, as a matter of structure, Wagoner dominates the board, further limiting its ability to act independently.  All of the directors except Wagoner are listed as "independent."  They presumably have no source of information about General Motors except what they gain through their position on the board (and what they read in the press).  Wagoner, however, is the chairman and as such, he controls the information flow to the board. 

This is a board that has shown itself incapable of providing the kind of oversight expected and needed at General Motors.  Certainly, the majority of the board ought to be required to step down as a condition to a bailout.  More than that, however, the company should agree to the election of a percentage of directors (perhaps a third) by large shareholders.  These directors will not be susceptible to capture and will watch out for the interests of shareholders.  They are more likely to bring a perspective to the management at GM that is desperately needed.