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The Volkswagen Emissions Scandal case study tells the story of the admission of Volkswagen on deliberately installing a device on its cars to pass the tests imposed by the government. Stakeholders are wondering how such a scandal could have happened at Volkswagen.
Luann J. Lynch; Cameron Cutro; Elizabeth Bird
Harvard Business Review (UV7245-PDF-ENG)
July 21, 2016
Case questions answered:
- Identify the relevant corporate governance issues and practices and problems at Volkswagen.
- Apply corporate governance theory relevant to that industry/profession and the identified issues and problems.
- Provide recommendations for improving the corporate governance practices of Volkswagen in order to resolve the identified problems.
- Evaluate the business ethics focusing on the Volkswagen Emissions Scandal.
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Case answers for The Volkswagen Emissions Scandal
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EXECUTIVE SUMMARY – The Volkswagen Emissions Scandal
This report examines the corporate governance practices of the German automotive multinational, Volkswagen AG, in relation to the revelation of the diesel-engine emissions scandal by the U.S Environmental Protection Agency (EPA) in 2015. The Analysis focuses on how a monetary mindset and negligence towards other elements of 3P’s (People, Planet, and Profit), that are embedded in corporate structure, ownership composition, Supervisory Board (SB) and Corporate culture leads to decisions that serve the interest of power-hungry shareholders at the expense of other stakeholders.
This paper presents identified issues and impacts that contributed to the firm’s choice to move forward with a decision that led to Volkswagen Emissions Scandal, a disastrous scandal for the corporation.
The finding reveals power imbalance and abuse-of-power from dominant shareholders; Porsche-Piëch family, the intrusion of Lower Saxony (German Government) to ensure national employment, risk of labor inclusion on SB under the Co-Determination Act and company culture focusing only on profit led to unethical conduct of ‘implanting cheating device’, hence displaying the firm’s poor Corporate Governance procedures.
Furthermore, analytical research has been done using two prominent theories in this field – Agency Theory and Stakeholder Theory. Using Agency Theory, it is found that the presence of the controlling shareholder in Volkswagen induces principal-principal problem by exploiting opportunities catered to their interest at minority shareholders’ cost. In addition, Germany’s two-tier board system that ideally separates job is not effective for Volkswagen due to the dominance and abuse of power from major Shareholders in regards to controlling the direction of management activity.
On the other hand, Principal-Agent Problem also exists due to the presence of Government as the second-largest shareholder of the firm ever since World War II. This intrusion is negative to Volkswagen due to conflict of interest between Government and Shareholders – focus on welfare or increase shareholder returns. Furthermore, the inclusion of labor representatives in SB is also risky due to the possibility of these representatives exercising decisions based on their personal interest; maintaining their job.
In view of Stakeholder Theory, it is found that Volkswagen’s intention to save profits by carrying out activities that are unethical backfired, causing the firm to incur a massive loss and damage its brand image. Therefore, the company’s long-term sustainability can only be achieved if the company aligns its profit intentions with ethical intentions of serving People and Planet.
To improve good corporate governance practice in Volkswagen, this report provides various recommendations to modify internal governance procedures.
Firstly, setting a contract that specifies clear expectations and roles. Following this, the firm will benefit greatly by having regular evaluations and instilling a whistle-blower protection system managed by the third party.
Secondly, in order to increase performance, reformation on the structure of SB needs to be conducted by having more independent members, professional-hired as a government representative, and allowing other representatives on the nominee committee to limit majority shareholders’ power.
Lastly, to restore its brand image and gain stakeholders’ trust, Volkswagen must rebrand and plan on fulfilling corporate social initiatives that will gear the firm into strategic success and sustainability in the long-run.
1. Company Overview
Business cannot be successful when society around them fails
A business can only succeed if its environment is feasible enough to promote growth and sustainability. Both external and internal stakeholders play an important role in ensuring success. To achieve this, interests should be aligned ideally, which is not the case in Volkswagen due to the difference in ideas, leading to conflicts.
1.2. Volkswagen History
Volkswagen is a German automotive multinational corporation, thriving on global fame. This brand is managed by vital players ensuring the firm’s success from its humble beginnings. The “Deutsche Arbeitsfront” (the German Labor Front), the British Military Government, and Porsche played an important role in the history of Volkswagen’s development in its early days, starting with the design of Volkswagen’s car by Ferdinand Porsche on June 22, 1934. The establishment of the company was supported by the German Labor Front on May 28, 1937 (Volkswagen, 2008).
During World War II, Volkswagen was intended to be the main vehicle producer for the German Army, however, as time went, the German Government began privatizing the firm in the 1960s, leading to the company’s rapid growth afterward.
1.2.1 Two-Tier Board and Co-Determination Act 1976
As a German Public Listed Company (Aktiengesellschaft or AG), Volkswagen has a two-tiered board structure: an Executive Board (EB) headed by a CEO and a Supervisory Board (SB) headed by the Chairman. The EB is, inter alia, responsible for managing day-to-day operations, proposing a business strategy and dividends to the SB, whereas the SB is responsible for appointing, supervising, and firing the SB, as well as setting dividend, and votes on major decisions.
The German system of corporate governance is very unique due to the Co-Determination Act of 1976. This law stipulates that companies must allow their stakeholders, including employees, to share their interests and considerations in making company decisions and the composition of the SB must be in the same number between shareholder representatives and employee representatives. (Fauver, 2006).
Furthermore, in terms of the election mechanism, the shareholder representatives are chosen at the shareholders’ general meeting while the employee representative is elected either in the direct ballot or through delegates.
In the case of Volkswagen’s SB composition, which employs more than 20,000 people, the law requires Volkswagen to have 20 seats: 10 seats for shareholders and 10 seats for employees. As for the employee representatives, the seats are allocated into three factions: labor unions, workers, and managerial employees’ representatives (Mertens, 1979).
Once the SB are formed, all of the members choose the chairman and vice chairman at the first meeting. The first vote requires a candidate to have a two-thirds majority to be elected, and if no candidate succeeds then the shareholder representative will elect the chairman and the employee representative will elect the vice-chairman.
An illustration of the election process of the SB and EB is depicted below in Figure 1:
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