CAPSULE 2.4

Corporate Governance Failures at Volkswagen

In 2015, Volkswagen admitted to installing "defeat devices" on at least 11 million vehicles with diesel engines. These devices enabled the cars to pass emission tests, even though the engines actually emitted pollutants up to 40 times above what is allowed in the United States. Current estimates are that it will cost the company at least 7 billion to cover the cost of repairs and lawsuits. Although management must have been involved in approving the use of cheating devices, the Volkswagen supervisory board has been unwilling to accept any responsibility. Some board members even questioned whether it was the board's responsibility to be aware of such problems, stating "matters of technical expertise were not for us" and "the scandal had nothing, not one iota, to do with the advisory board." Yet

governing boards do have a responsibility to be well informed, to provide oversight, and to become involved in key decisions and actions. So what caused this corporate governance failure? Why is this the third time in the past 20 years that Volkswagen has been embroiled in scandal?

The key feature of Volkswagen's board that appears to have led to these issues is a lack of independent directors. However, before explaining this in more detail it is important to understand the German governance model. German corporations operate two-tier governance structures, with a management board, and a separate supervisory board that does not contain any current executives. In addition, German law requires large companies to have at least 50 percent supervisory board representation from workers. This structure is meant to provide more oversight by independent board members and greater involvement by a wider set of stakeholders.

In Volkswagen's case, these objectives have been effectively circumvented. Although Volkswagen's supervisory board does not include any current management, the chairmanship appears to be a revolving door of former senior executives. Ferdinand Pich, the chair during the scandal, was CEO for 9 years prior to becoming chair in 2002. Martin Winterkorn, the recently ousted CEO, was expected to become supervisory board chair

prior to the scandal. The company continues to elevate management to the supervisory board even though they have presided over past scandals. Hans Dieter Poetsch, the newly appointed chair, was part of the management team that did not inform the supervisory board of the EPA investigation for two weeks. VW also has a unique ownership structure where a single family, Porsche, controls more than 50 percent of voting shares. Pich, a family member and chair until 2015, forced out CEOs and installed unqualified family members on the board, such as his former nanny and current wife. He also pushed out independent-minded board members, such as Gerhard Cromme, author of Germany's corporate governance code. The company has lost numerous independent directors over the past 10 years, leaving it with only one non-shareholder, nonlabor representative. Although Pich has now been removed, it is unclear that Volkswagen's board has solved the underlying problem. Shareholders have seen billions of dollars wiped away and the Volkswagen brand tarnished. As long as the board continues to lack independent directors, change will likely be slow.

Question: Study Illustration Capsule 2.4: Corporate Governance Failures at Volkswagen and answer the following questions:

(a) Based on the information provided, describe the ways in which Volkswagen did not fulfill the

requirements of effective corporate governance.

(b) In what ways did the Board of Directors sidestep its obligations to protect shareholder interests?

(c) How could Volkswagen better select its Board of Directors to avoid mistakes such as the emissions

scandal in 2015?