How Much has Changed Since Dieselgate?
Volkswagen stock is soaring, but its governance still seems a mess
Six years ago, Volkswagen admitted installing software in 11m vehicles that could manipulate nitrogen oxide tests. It quickly became one of the biggest corporate scandals to date, for which the German car manufacturer is still paying the fines and destroying its shareholder value — nearing a stunning 40 Billion euros by now.
Although sales have plummeted since the outbreak of the Covid-19 pandemic, Volkswagen’s stock price has peaked. It hit pre-dieselgate levels in March, after the company announced its plans to dethrone Tesla by 2025, by heavily investing in electric car development.
Clearly VW’s management is pressured to show results. Therefore knowing what caused the company’s wrongdoing during the scandal, how it has changed since then, and to what extent its current shareholders can rely on it acting ethically and in their best interest, is as relevant as it gets.
Tyco, Valeant, Enron — history shows that companies that do not embrace cultures of integrity and transparency, end up failing sooner or later. And Volkswagen during Dieselgate has been a great example.
The scandal happened silently. Under leadership of its then-CEO Martin Winterkorn, VW wanted to dominate the industry. Growth was a top priority — as he followedhis predecessor Ferdinand Piëch, who acquired the brands that make the group what it is today (Bugatti, Bentley, Lamborghini, Scania, MAN. That may be what ignited the scandal. In 2005, engineers started installing software in Diesel vehicles that could manipulate NOx test, enabling the company to sell cars in the US that far surpassed legal emission limits.
Somehow, the miscreants must have believed subverting the law was in their best interests and, in their working environment, acceptable.
If that’s something your employees believe, your corporate culture is rotten. But there is more to the story than just an unbroken chain of unethical behaviour and bad management:
Ineffective oversight of its supervisory board.
VW’s board structure was, and is, based on a two-tier system. This means it has a separate supervisory board to hold its management to account. It was this board that should have caught and addressed the cultural issues. But its structure and composition was ‘complicated’, so to say, and caused many conflicts of interests, which blinded it from doing its monitoring job.
- Its voting rights were non-balanced
- Its backgrounds were non-diverse
- Every member had its own interests for the company — none of the board members was completely independent
- The interests of the board members were highly diversified and more often than not different than those of public equity providers
German law subjects companies to co-determination, so half of VW’s board was made up of labor representatives. This poses an interesting problem. Naturally, workers want what is best for VW’s employees (high wages, job security). Public equity investors on the other hand, want wages to stay at competitive levels and the company to be as efficient as possible. In many firms subject to co-determination, these direct opposites often lead to factionalism within the board. And when board meetings become games of politics, they cease to be effective decision-making mechanisms that focus on increasing shareholder value.
On top of the labor representatives, five of the board seats were filled by controlling shareholders from the Porsche and Piëch families. They owned 31.5% of the equity, but controlled 50.7% of the voting rights through dual-class shares and a pyramidal holding structure via the Porsche holding company. Therefore the families were never fully financially exposed to the risks it voted VW to take. Moreover, it was family member Ferdinand Piëch who started the ‘growth-at-all-cost’ strategy during his reign as CEO from 1993–2002, acquiring the elaborate portfolio of brands VW owns today. However, he seemed not incentivized by creating shareholder value. He did it for power (Elson et al. 2015). Stepping down as CEO Piëch became chairman of the supervisory board. New CEO Winterkorn continued in his footsteps, leading the company into the emissions scandal without intervention from the board.
Making things even more complex, two shareholder representatives represented the state government of lower Saxony, which owned 12.4% of the equity, but controlled 20% of the voting rights. Governments tend to have political considerations (getting reelected by creating employment). Although creating jobs is great, it more often than not fails to match the long-term value goals of public equity investors.
The final three seats were filled by two representatives of Qatar’s sovereign wealth fund, with 15.4% of equity stake, and one ‘outsider’: the CEO of Swedish Bank, who also advised Scania, Volkswagen’s truck brand.
As an investor, it is crucial to know the monitoring board has independent members with objectives that align with your own. This was not the case at Volkswagen. Moreover, the unavoidable political games made the board unable to focus on doing its job. A crucial question to ask thus is: has the company changed since Dieselgate?
The company’s culture, possibly. VW has committed to building a new ‘speak-up culture’ that makes it easier for employees to bring wrong-doing to light. The company’s compliance department now yearly evaluates 2,000 ‘whistleblowing’ reports, of which 60 to 70 tend to notify ‘serious violations’ (Miller, 2020). But regardless of a possible cultural improvement, VW’s monitoring body has hardly changed at all.
VW’s supervisory board still needs half of its board to consist of workers’ unions. The distribution of voting rights has not balanced a bit. The board still lacks independent members, which will unlikely change any time soon, since members are appointed for five-year terms. And remarkably, many board members still serve after the emissions incident, without taking accountability for their lack of oversight (Blackrock, 2020).
Still in the wake of Dieselgate, VW is back with plans for industry domination, and its stock price is soaring. But there is very little reason to assume its board will do a better job at monitoring VW’s ambitious management than during Dieselgate. It may prove a challenge for Volkswagen to stay straight, on the bumpy roads that lay ahead.
References
Armstrong, R. (2017, January 13). The Volkswagen scandal shows that corporate culture matters. Financial Times. https://www.ft.com/content/263c811c-d8e4-11e6-944b-e7eb37a6aa8e
Blackrock. (2020). Voting Bulletin : Volkswagen AG. https://www.blackrock.com/corporate/literature/press-release/blk-vote-bulletin-volkswagen-oct-2020.pdf
Elson, C. M., Ferrere, C. K., & Goossen, N. J. (2015). The Bug At Volkswagen: Lessons in Co-Determination, Ownership, and Board Structure. Journal of Applied Corporate Finance, 27(4), 36–43. https://doi.org/10.1111/jacf.12144
Gordon, S. (2016, May 18). VW’s board needs to look in the mirror. Financial Times. https://ww.ft.com/content/76ba9a3e-1c42-11e6-b286-cddde55ca122
Miller, J. (2020, September 15). Dieselgate could not happen again, VW executive claims. Financial Times. https://www.ft.com/content/777cee39-f811-47d5-9841-5952f9a8bab7
Milne, R. (2015, November 4). Volkswagen: System failure. Financial Times. https://www.ft.com/content/47f233f0-816b-11e5-a01c-8650859a4767
Rauwald, C., & Strobl, L. (2021). Volkswagen Becomes Germany’s Most Valuable Stock on Electric Vehicle Enthusiasm. Bloomberg. https://www.bloomberg.com/news/articles/2021-03-17/vw-becomes-germany-s-most-valuable-stock-on-electric-enthusiasm
Reuters. (2020). Volkswagen says diesel scandal has cost it 31.3 billion euros. https://www.reuters.com/article/us-volkswagen-results-diesel-idUSKBN2141JB
Ruddick, G. (2015, December 10). VW admits emissions scandal was caused by “whole chain” of failures. The Guardian. https://www.theguardian.com/business/2015/dec/10/volkswagen-emissions-scandal-system
Segal, T. (2021). Enron Scandal: The Fall of a Wall Street Darling. Investopedia. https://www.investopedia.com/updates/enron-scandal-summary/
Sorkin, A. R. (2002, September 13). 2 Top Tyco Executives Charged With $600 Million Fraud Scheme. The New York Times. https://www.nytimes.com/2002/09/13/business/2-top-tyco-executives-charged-with-600-million-fraud-scheme.html
Surowiecki, J. (2016, April 4). Inside the Valeant Scandal.The New Yorker. https://www.newyorker.com/magazine/2016/04/04/inside-the-valeant-scandal
Volkswagen. (2020). Shareholder Structure. https://www.volkswagenag.com/en/InvestorRelations/shares/shareholder-structure.html
