Analysis: VW’s diesel emissions scandal is the latest in a string of governance failures

Investors should realise how current crisis fits in with German giant’s recent history

The rotten governance at Volkswagen has been an embarrassment for corporate Germany for years. The current diesel emissions scam is just the latest in a series of scandals that have engulfed the auto giant and, at other German companies, would have led to the dismissal of top executives and better governance. But not at VW.

One thing is sure, as class actions and regulatory action starts to stack up, investors should not claim to be surprised at the latest governance failings given a litany of poor oversight at the German giant.

In 1996, Ferdinand Piëch, then Chief Executive and still part owner of VW, was forced to fire José Ignacio López after the Spanish executive was found to have stolen industrial secrets from his former employer General Motors (GM). As part of a settlement, VW paid GM $100m in damages and agreed to buy $1bn in auto parts from its US rival. The scandal didn’t touch Piëch.

Eleven years later, it emerged that VW management attempted to win the support of employee representatives on its board by flying them to Brazil for sex parties. The lewd business led to the departures of VW’s top employee representative and top personnel executive, but again Piëch remain unscathed. Instead, Piëch, who is said to have “petrol in his blood,” became Chairman of VW in 2007 and ensured that Martin Winterkorn succeeded him as CEO.

At the firm’s annual meeting in 2012, Piëch embarrassed VW yet again by managing to get his wife, a former nanny to his children, appointed to the board. Last April, though, the VW patriarch met his end when he was forced out as Chairman after openly criticising Winterkorn’s management, especially as regards its weakness in the US market.

How was all this possible at VW and why were Piëch or Winterkorn not held accountable?

The reason has partly to do with Piëch’s perceived brilliance – under his watch, VW became one of the world’s biggest and most profitable automakers. But it also has to do with the simple fact that his family, together with the related Porsche family, own just over 50% of VW.

“Yes Volkswagen is a listed company and, until the diesel emissions scam, one of the best performers in the Dax (the German blue-chip index),” says Hans-Martin Buhlmann, Chief Executive of German Association of Institutional Shareholders (VIP), which holds shares in the company. “But ultimately Volkswagen has to be seen as a family firm where the same ethical standards that apply to other listed German firms do not apply.”As powerful as the Piëchs and the Porsches are, they are not omnipotent. VW’s board also contains nine employee representatives/union officials (including Chairman Berthold Huber) as well as two politicians who represent VW’s home state of Lower Saxony, which has a 20% blocking minority. Therein lies another governance problem, say analysts. The employee representatives are chiefly concerned with maintaining and creating jobs and Lower Saxony shares that concern and also relies on VW, as one of its biggest taxpayers.

So as long as the automaker remained successful under Piëch and Winterkorn, the 11 directors (from 20) representing the employees and Lower Saxony basically gave VW management carte blanche. Qatar also holds 12% of VW, but its two directors have invariably voted to support Piëch and Winterkorn. That leaves a free-float of under 20%, meaning that other shareholders have had precious little influence.

A huge governance problem, certainly, but VW’s past scandals did not tarnish its reputation for well-engineered automobiles. Until the diesel emissions scam erupted, the Wolfsburg-based giant was presenting itself as a supplier of clean and efficient vehicles and a generally sustainable firm.

It signed the United Nations’ Global Compact, reported on its emissions to the CDP, an investor-backed initiative, and filed a sustainability report along with its annual business report.

It led to it being selected for the Dow Jones Sustainability Index (DJSI), which is run jointly by Swiss sustainable asset manager RobecoSAM and Standard & Poor’s. In 2013, the automaker was even lauded by the them as the most sustainable company in its sector.

The London-based CDP, meanwhile, gave VW a grade of ‘A’ for the quality of the environmental data it published.
In hindsight, it’s clear that outsiders may have misread VW. A glance at VW’s sustainability report for 2014 is instructive.

The report has plenty of good news in it, including an announcement that VW would seek to be the first European automaker to meet EU emissions requirements.

Under the requirements, new cars sold from 2020 must emit 95 grams of carbon dioxide (CO2) per km against 126 grams currently. VW also said that during 2014, its worldwide operations had cut CO2 emissions, energy consumption and waste by around one-fifth. And while the claim has now been proven false, VW said its emissions of nitrous oxide (NOx) in its cars and trucks had dropped by 45% since 2010.

Now that the diesel emissions rigging in the US has come to light, RobecoSAM says VW’s membership in the DJSI is under review, adding that a decision on its fate could be made soon.

But it should be pointed out that the German automaker has not scored well everywhere. Just before the scam emerged, the NGO InfluenceMap gave VW a score of ‘D-‘ due to what it said was its opposition to tighter emissions standards in the EU. “Despite stating support in 2013 for EU emissions standards, media reports and statements by their CEO suggest Volkswagen were actively opposing the strengthening of these standards in 2014,” said InfluenceMap.

The scandal has in any case rendered VW’s green offensive moot for the time being, and the company is struggling to limit the damage done to its reputation and brand.The damage to its share price and bottom line is already immense. Since the scam broke last Friday, VW shares have lost 30% of their value. And on Tuesday (September 23), the automaker said it was setting aside €6.5bn in reserves to deal with the recall of 11m diesel engines equipped with the cheating software. The move should greatly erode its profits for this year.

Analysts say that before there can be any talk of improving VW’s governance, the automaker must get over its current crisis. Winterkorn has already publicly apologised for the scam and insisted that the company will find out – and learn from – what happened. This probably means that VW’s board will not replace him in the short term, says VIP’s Buhlmann. But he adds that VW desperately needs new leadership. “In order for VW’s governance to improve, there has to be fresh blood. And I can’t imagine that they have not already groomed some middle managers to take over some time.”