3 Lessons from the VW Emissions Scandal

Volkswagen is in trouble. Independent testing revealed last fall that VW had cheated diesel emissions tests in the United States. This news precipitated a dramatic decline in the company’s stock price, investigations by the EPA and Congress, and threats of lawsuits from VW owners.

The facts of the scandal seem pretty clear – the auto manufacturer learned in 2005 that its diesel vehicles could not meet U.S. emissions standards, so in order meet these standards, they deployed a software “fix” that reported dramatically lower emissions levels during testing than were possible on the road. The fraudulent test results met emission requirements, but allowed the vehicles to spew up to 40 times more pollutants on the road than allowed by regulation. The software was installed on at least 11 million vehicles worldwide before a team from West Virginia University discovered the deception and reported it.

In the wake of these revelations, sales of VW vehicles in the U.S. plummeted, and the scandal could cost the company in excess of $17 billion in fines from the Environmental Protection Agency alone. VW owners are threatening lawsuits to recover the value of their vehicles and Congress has taken steps to investigate the issue.

While the basic facts may be clear, it is unclear what specific role senior management or supervisory boards may have had. During his testimony in a Congressional hearing, Volkswagen Group America President and CEO Michael Horn blamed the scandal on a “couple” of rogue engineers who acted without proper authority. Congressman Chris Collins, a former engineer, said of the claims: “Either your entire organization is incompetent when it comes to intellectual property, and I don’t buy that, or they are complicit at the highest levels in a massive cover-up that continues today.”

The scandal has already cost a number of top VW executives their jobs, not the least of which is former CEO Martin Winterkorn, but the crisis raises much larger questions about corporate governance at VW. The company’s governance structure has been criticized for years. The German newspaper Süddeutsche Zeitung recently compared Volkswagen’s governance to that of North Korea – autocratic and non-functioning. Decision-making has been highly centralized and junior managers have been afraid to voice their opinions.

Besides being a cautionary tale, what can VW’s woes teach other companies the importance in developing a governance structure to avoid such scandal?

Lesson #1 – Create Diversity of Thought and Expertise on Governing Boards

Volkswagen’s governance structure includes a 20-member council of directors that is responsible for hiring and firing executives, providing advice to management and monitoring their actions. Yet the board has only one truly independent voice – Annika Falkengren, chief executive of Swedish bank SEB. Many of the remaining directors are representatives of the three largest shareholders, the Porsche and Piëch families, the State of Lower Saxony and Qatar. Critics assert the board lacks diversity of opinion and expertise, citing the 2012 election of Ursula Piëch, former kindergarten teacher and the chairman’s wife, as a prime example. As a result, the board was particularly isolated from outside opinion concerning environmental guidelines and lacked the experience to question management decisions.

Ensure that your board of directors is diverse in more than just age and gender. Consider diversity in expertise and thought. Create guidelines for the qualifications and experience board members should have.

Lesson #2 – Increase Transparency by Eliminating Conflicts of Interest

Shortly after the scandal broke, the VW board appointed the former head of Porsche, a VW division, as its new CEO. The company also appointed the former VW finance director as the new chairman. While inside knowledge of the company may allow both men to respond to the crisis immediately, they may also have conflicts of interest that keep them from investigating the current scandal thoroughly. VW’s unwillingness to control apparent conflicts of interest throughout its history is seen by many as a potentially fatal flaw. In one of the best recent examples, Ferdinand Piëch served as the company’s CFO before being named chairman. As chairman, he could not properly investigate improprieties that occurred during the years he was CFO without incriminating himself. The new CEO and chairman may find similar problems investigating the current crisis.

Develop comprehensive ethics and conflict-of-interest guidelines. Require disclosures from your board for any actual or perceived conflicts. Act on those conflicts, recusing board members from discussions and votes on issues as required.

Lesson #3 – Ensure Corporate Social Responsibility

In the early 1990s, then VW Chairman Ferdinand Piëch challenged the company to become the largest automaker by sales in the world. VW achieved that goal last year, but at what cost? Engineers knew the company wanted to increase diesel sales in the U.S. They also knew that VW diesels would not pass emissions testing. The message was from the top was apparently clear – achieve the sales goal at all costs. Deceiving consumers who wanted cleaner burning cars, VW provided a product that was the antithesis of clean burning. VW now must contend with customers who feel betrayed by the company morally and financially. Although the company is still doing well in China, its reputation in the U.S. market has been badly damaged. Some commentators expect the company will rely on a bailout from the German government to survive.

Corporations must recognize their social responsibility in the markets they serve. Those who do the right thing and are responsible in both their messaging and actions will maintain the approbation of their customers. Those who ignore their corporate social responsibility risk alienating large portions of their customer base and damaging their brand. Nothing guarantees that a market will stay loyal when a company behaves badly.

The HORNE PMM team has experience helping our clients establish good governance practices. Contact us if we can be of help to your organization.

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