Volkswagen Emissions Scandal: Transparency, Compliance and International Aftermath

The VW “Dieselgate” scandal broke on 3 September 2015, when the company communicated to the US Environmental Protection Agency that it had installed software devices in diesel cars to defeat emissions testing. But the roots of the scandal, which cost the company US$25 billion in fines and losses, go much deeper, into the company’s ineffective system of corporate governance. VW’s majority shareholders – including the Porsche and Piëch families, as well as the German ‘Land’ of Lower Saxony – enjoy a concentration of power that makes the two-tier board system at the company ineffective. Indeed, many experts say that the company was effectively governed by one man. The result is that internal control systems were, and still are, inadequate, according to experts. The particularly German issue of co-determination has also been a factor.

Concentration of Power in Volkswagen’s Leadership, and on Its Board

As three corporate governance experts put it in a recent paper: “One member of the controlling families, Ferdinand Piëch, was able to take leadership of the company and direct it in pursuit of his own ambitions for industrial domination. It was in the course of that pursuit that the emissions scandal occurred.”

As the controlling shareholder, with the cooperation of the labour unions and the government, which both sought greater employment, Piëch had, for years, direct effective control of all corporate activities, and he drove the company toward his goal of becoming the world’s largest car manufacturer.

Manuel Theissen, professor-emeritus at Ludwig-Maximilians-Universität München (LMU Munich), and principal expert on German corporate governance, comments: “His relentless pursuit of this goal, in which he achieved the tacit cooperation of the ‘Land’ of Lower Saxony and the workers’ representatives on the board, made the supervisory board ineffective and allowed controls over operations to lapse.”

German boards of directors are two-tiered, meaning that there is a supervisory board, which is intended for oversight, and a management board. The supervisory board is divided between members from the workers’council and shareholders.

Critics point to the overall lack of diversity and proper board composition. A report into European corporate governance by Heidrick & Struggles, a leading executive search firm, shows that German supervisory boards score the worst of 10 leading European countries in terms of their set-up and composition.

But the 20-person supervisory board at Volkswagen did not provide the appropriate counter-weight. “The board actually claimed, after the scandal erupted, that it ‘did not have an understanding’ of emissions technology in diesel cars,” notes Theissen.

Role of the ‘Land’of Lower Saxony – Politics Supersedes Economics

The role of the representatives of the ‘Land’ of Lower Saxony on the board also helped concentrate power in the hands of the Piëch family.

Volkswagen was originally a state-owned enterprise, until, in 1960, the “Volkswagen Law” was adopted by the German government and the company was privatised. Yet Lower Saxony retained a 20 per cent voting interest in the company (despite the fact that their actual equity position was 12.4 per cent), in order to maintain government influence. Additionally, the VW Law required a 4/5th vote of the shareholders to approve any corporate action by the company and mandated the appointment of two governmental board members. In this way, Lower Saxony, despite the divestment, retained considerable control over the enterprise.

But Lower Saxony did not exercise that control. A government’s drive to maintain high levels of employment is understandable. “However, when the government is a major shareholder in a company with its representatives on the board, it creates a misalignment of incentives that may not be beneficial to the overall profitability of the corporation. Indeed, in this case, it is arguable that the government in its myopic pursuit of higher employment, did not make compliance oversight a primary goal and left the company vulnerable to the lapse that it now confronts.” This may have produced the culture where there was an incentive to cut corners and falsify emission rates, in order to support growth and jobs.

The Problem of Codetermination

The concept of codetermination has existed in German law since 1918, when the liberal leader Walter Rathenau proposed the concept. On 1 March 1979, the German Federal Constitutional Court (Bundesverfassungsgericht) supported his conception, finding that the Codetermination Act of 1976 was constitutional.

The sense of this concept is that all stakeholders have an interest in common in an enterprise. According to German law, the enterprise does not have ‘its own’ interest of any kind.

“The predominant idea of the interest of the enterprise is that it is an aggregation of all the interests that are related to the actual enterprise. So this includes all corporate stakeholders, including shareholders. To use the interest of the enterprise as a goal would then mean to make the balancing of those interests (part of the) objective for management,” the recent study concludes.

All of this means, grosso modo, that workers, who are unquestionably stakeholders, should take part in the strategising and managing of an enterprise. This leads to requiring the corporations to let employees participate in a supervisory body.

What does it imply? Codetermination is a means to not only make the management consider stakeholder interests, but a rather direct way to make the worker interests felt in the decision-making process.

This led to a structural problem. Volkswagen USA, where the events causing the scandal took place, had a different governance structure, with no workers on the board. This made it difficult for the workers on the board in Germany to stay in close touch with what took place there.

Then, the board was a close-knit bunch at Volkswagen headquarters.

The head of the IG Metall union (metalworkers) has long held a board seat. All of the employees’ 10 seats are occupied by German workers. On the shareholders’ side of the board, the problem is one of independence. Four of the 10 shareholders are members of the Porsche and Piëch families; two each come from Lower Saxony and Qatar. The new chairman, Hans Dieter Pötsch, was until last month VW’s finance director and is close to both the Porsche and Piëch families.

In most German companies, the chairman would discuss sensitive matters with the shareholder side first, agreeing on a common position before bringing the issue before the full board. Instead, Piëch would first talk to the workers, agree on a position, and then open it up to the full board for discussion. In 2005, Piëch even sided with workers against shareholder wishes to ensure that an IG Metall member was named head of personnel.

“Ensuring that [he had the backing of] the workers on the board – who knew in detail what was going on at the company –  made it easy for Piëch to convince shareholders to his point of view,” Thiessen explains. “There was never any deep discussion by the shareholders of risks or control of management – they left the decisions to Piëch.”

Thiessen insists that there is still not enough debate on the VW board. “It is astonishing how quiet the shareholders overall have behaved in the VW emissions scandal so far. But there is acceptance of what the majority shareholders want – the families Porsche and Piëch, as well as the state of Lower Saxony. And they have no interest whatsoever in changing the way the board or the company operates.”

“Frogs don’t clear up the swamp in which they sit,” Thiessen concludes.

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