1) Executive Summary
The Volkswagen Group, headquartered in Germany, that also owns Bentley, Bugatti, Lamborghini, Audi, Porsche, SEAT, and Skoda, Ducati, had previously had a goal of becoming the world’s largest automaker by 2018, but their own action had made the company lose one third of its market cap. The scandal was a significant event not because of its presence as a global market, but because it caused lasting damage on the society and the environment that cannot fully be perceived.
In the attempt to reconcile with the public for their behavior in emission violations, the company had recalled the ‘diselgate’ engines, apologized publicly, and the CEO along with the other directors responsible had resigned. The future of the company does not look very promising as they are faced with lawsuits and criminal charges.
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To analyze how such a global company could commit fraud for so long, it is beneficial to view this case as a problem in the corporate governance involving issues with oversight and failure in their risks management. This analysis attempt to study the organization’s agency problems related to corporate governance, identify the three significant risks which are operational risks, financial risks and reputational risks in this scandal and organization’s continuity plan towards the scandal.
Finally, based on the analysis of the scandal, this report provides some recommendations on the improvement of corporate governance, agency problem and the crisis management. Volkswagen is expected to strengthen its corporate governance independence, set up reasonable management compensation, raise awareness of corporate social responsibility and understand the significant of preparing for the crisis management and/or preventing crisis. These can aid Volkswagen to navigate the difficult years ahead following the crisis. While Volkswagen may not be able to regain trust for diesel products in the near future, it can create new trust for the public by focusing on the new Electrical Vehicle technology, as there is potential to position Volkswagen for long-term growth and success.
2) Introduction and Aim
Starting off since the year 1937, Volkswagen (VW), which means “The People’s Car” in German, was originally known as “Gesellschaft zur Vorbereitung des Deutschen Volkswagens mbH”. The company was formed by the government of Germany during the Adolf Hitler’s time. Today, Volkswagen is considered as one of the top ten car companies in the world and it operates under eight different brands around the world (MBA Skool, 2017).
However, Volkswagen, despite being such a reputational brand, created a huge scandal regarding the diesel emissions on September 2015. The company was caught by the United States Environmental Protection Agency (EPA) for using a sophisticated software to cheat the mission tests. The software was created such that the cars produced during the laboratory testing was showed to emitted lesser pollution as opposed to the actual which produces 40 times more nitrogen oxide than the United States ecological standards. By 22nd September 2015, upon further investigation, Volkswagen had admitted to the public that this sophisticated software is installed in the system of total 11 million cars worldwide (Kollewe, 2015). In the end, EPA ordered Volkswagen to recall 500,000 cars back. Moreover, the company was heavily fined for their fraud and they were required to compensate their customers for misleading them. The scam combined with the fine caused the market value of Volkswagen to plummet (Zhang, 2015).
Firstly, this report will examine Volkswagen Group’s emission control cheating device scandal as a case of how corporate governance had failed as a whole. It will begin by examining the actual root cause of the case and point out the agency problems that indicated failure in the company’s corporate governance, and then go into details of how Volkswagen overlooked the operational risks, financial risks and reputational risks as they direct their focus only to make profit and gain market share in order to be the number one in the automobile industry. This report will also discuss about how Volkswagen failed to handle the processes of Augustines’ crisis management, namely – crisis prevention and preparation for crisis management. It then critiques the behaviors related to the incident as well as elaborate on the company’s business continuity plan. The report will end by bringing into discussion the alternative actions and recommendations that could help enhance Volkswagen’s position in the market.
3) Case Study
Let’s begin with what led Volkswagen to cause such scandal. It started off with hiring the wrong employees followed by the strict US regulation to control the emission and finally the impact of the financial crisis in 2007 that triggered such actions from Volkswagen.
It is believed that the root cause for this crisis goes beyond just the two engineers Ulrich Hackenberg and Wolfgang Hatz who manipulated the software. It all began a decade before the VW scandal when VW’s former CEO Verbd Pischetsrieder hired Wolfgagng Bernhard who was initially working for Daimler and Benz (Zhang, 2015). Bernhard tried to implement ‘BlueTec’, a technology that was developed by Mercedes. This technology produces a chemical called urea that help neutralize the harmful diesel pollutants; nitrogen oxide that the engine emits. While this system is remarkable, the Audi executives and the VW company felt that their own technology were better than implementing those developed by Mercedes as this urea was required to be topped up regularly and it can be quite expensive (Hakim, Kessler, and Ewing, 2018).
Furthermore, according to Manufacturers of Emission Controls Association (MECA), by the year 2007, EPA had set the rule that all the diesel engines are required to have Nitrogen Oxide exhaust control technology, which puts a lot of pressure on VW as they realized the trend had shifted to a more cost-efficient car (MECA, 2018). In addition, Volkswagen was experiencing a decrease in their sales due to the Global Financial Crisis that happened between the year 2007 and 2009, which caused the unemployment rate to rise, and hence decreased people’s spending power. All these reasons combined were sufficient for the company to abandon their core values and risks increasing their profits (Berlin, 2009).
Let’s begin with analyzing Corporate Governance of Volkswagen because the scandal created are closely linked to the corporate’s culture. A culture with strong ethical value would not have committed such scandal. However, at that time the company was competing against Toyota and General Motors to be the number one in the world, their hunger for growth was a reflection to their corporate governance structure. An effective corporate Governance would minimize any agency problems that can occur when shareholders’ or management’s’ interests differ. However, the ‘dieselgate’ scandal clearly showed that corporate governance failed at identifying rights and responsibilities across the departments. It lacked control system as it had failed to consider the shareholders’ interests and the company’s supervisory board lacked diversified opinions and expertise (Armstrong, 2017).
It soon came to the attention of the public that Volkswagen had agency problems when the news reported that vehicles with diesel engines produced by Volkswagen was emitting much higher nitrogen dioxide than the results shown in laboratory testing. A lot of questions were raised including how long would the company undergo this fraud, how long would they continue to be dishonest, for how many years will this system be used without being detected and would Volkswagen continued to pollute the environment had the International Council on Clean Transportation (ICCT) not thoroughly investigate Volkswagen and found this issue (Ewing, 2017).
We could look at it as a “principal-agent” problem, the principal here being the shareholders of Volkswagen, while the agents are all the company’s managers, engineers and employees who ensures that the principals’ best interests were being considered. The agents realized that by ensuring low emissions, the diesel engine might perform poorly, and it could affect the company’s profits, hence they designed software to show lower emissions under laboratory testing. Now, these agents may not have any intention to hurt the principals or act against the environment rules and regulations and perhaps they were just trying to meet the demands of the company through the incentives and bonuses provided to them. Despite Volkswagen’s strong emphasis on integrity, if they can commit such a big scandal based on the incentives provided, then clearly the company’s structure is not rigid and strong enough as a whole. And these actions certainly caused a large amount of loss to the company and the shareholders not to mention all the dealers and owners, and the society as a whole (Lotterman, 2015).
Another possible agency issues Volkswagen faced was the fast-growing technology with the potential threat of replacing employees with artificial intelligence to improve efficiency and delivered better performance. From the shareholders point of view, implementing a machine environment is very positive but from employees’ point of view, this would mean losing their job and hence this could be another reason to push the employees to commit fraud, in order to prove the company that they are able to perform well in the tasks assigned to them (Mansouri, 2016, p.212).
The fact that managers, executives and their employees overlooked the consequences of the fraud they committed, simply illustrates the company’s weak supervision and lack of evaluating risks before engaging in such actions. They had neglected to consider the future implications that could occur by not analyzing their current plan. Thus, the company had overlooked the operational risks that could incur. Volkswagen had always emphasized that their strategy is “environmentally friendly orientation and profitability” but yet they had failed to implement their strategic decisions. Originally, Volkswagen should have kept aside reserves for their research and development as their company’s structure is such that they are constantly required to be up to date with the latest technologies. But when they had to adopt the “Blue-tech”, they found it to be too costly and time consuming, and had continued to sell their cars without worrying about being caught. Volkswagen sacrificed environmental control to decrease costs and increase revenues. That is regarded as an inappropriate implementation of the expansion strategy. At this stage, the company exposed themselves to the operational risks (Walker, 2015).
The company had failed to consider the financial risks that would follow from exposing themselves to high operational risks, which is the risk of being caught and branded as fraud. The scandal that followed had caused the company to suffer immensely. Once caught, the EPA required Volkswagen to take actions and compensate their clients who suffered from this incident. Volkswagen was obligated to pay the car owners who were affected approximately $10 billion in the US. In addition to that, they were required to pay $2.7 billion plus another $2 billion for environmental cleanup and for promoting “zero-emission” vehicles. This money will be used to aid the States in replacing all the other diesel vehicles being used (Isidore ; Goldman, 2016).
Moreover, Volkswagen was required to recall around 500,000 ‘diselgate engines’ and was fined by various organizations around the world of approximately $18 billion. The company’s share price dropped by 30% from 30 billion Euros upon the leakage of the news of the fraud (Snyder, 2016). For the first time in a decade, the company encountered a net loss of approximately 5.5 billion Euros in the year of their scandal. The company’s credit rating in S;P also dropped, and to make matters worse they were also faced with a lot of difficulties in borrowing from banks or in raising their capitals (Volkswagen, 2016). The loss however, extended beyond only financial loss. They lost confidence, opportunities and above all, they lost their customers’ trust, the most important thing in any industries (Snyder, 2016).
Being an extremely large, multinational business with global recognition, companies must consider how their actions can impact their reputation. Public expects such companies to take corporate social responsibility very seriously and once a company exhibit an act of social irresponsibility, it will not only destroy the consumer’s trust but also the organizational identity and reputation, and that is what Volkswagen is experiencing. In this digital era, companies must look beyond just operational and financial risks, they must evaluate risks associated with the social, environmental and ethical issues. These risks are difficult to manage and measure or even identify as they usually lie outside the areas of expertise. A lesson for Volkswagen is that all the reputational threats should be taken into account and all managers should look closely and assess any threats that could affect the balance sheet of the company. By claiming themselves, as “ecological leader” but are not actually conforming to it puts the company at reputation risk crisis (Adam, 2015).
From the case above, let’s look at the six stages of crisis management. This is the process where a company or an organization encounters an unexpected situation that poses a threat to their company, their shareholders or the public as a whole. The six stages are avoiding the crisis, preparing for the crisis, recognizing the crisis, containing the crisis, resolving the crisis and lastly profiting from the crisis. On the whole, it is evident that Volkswagen had failed at avoiding the crisis. They had acted recklessly without considering the after events that would follow. Had Volkswagen been able to avoid the crisis (first stage of risk management), or at least recognize the crisis (second stage of risk management), they would have been able to avoid such scandal by not implementing this fraud device. Had they considered resolving the crisis before the outbreak of the news, they would have been able to minimize their losses. As for the company recognizing their crisis and containing it, once the scandal broke, they instantly knew they had problem with their corporate governance, and that their strategy and culture were not as strong as they presumed it to be and the company immediately showed responsibilities by paying for their losses, while the CEO, Martin Winterkorn, stepped down from his position (Parloff, 2018).
Initially, after the news of the scandal broke, Volkswagen denied all charges imposed on the falsified device. They finally admitted to fraud in September 2015 but employees of the company continued destroying the evidences from their computer even after they admitted. There were six supervisors in Detroit who were accused of lying or destroying the evidences and they were charged with fraud and clean-air violation and also for giving false statements to the public and to the environmental regulators.
Adding to the scandal was the fact that Volkswagen was aware of the study, which the University of West Virginia had conducted in 2014, a year before the scandal, and this study showed emission discrepancies for Volkswagen vehicles. However, the supervisors and employees of Volkswagen had chosen not to disclose this information or make any attempts to clean up their act and had instead kept quiet. This was enough evidence to indicate that Volkswagen had no backup plan or any risk management plans (ABC News, 2017). This scandal provides a good example of bad risks management, and other companies could benefit by learning from it. It showed how an underestimation of risks had led to a huge loss and undesirable consequences to the company as their actions backfired (Parloff, 2018).
Moving on to Volkswagen’s business continuity plan in the industry, the CEO came out to apologize to the public and showed deep regrets to what had happened, stating he was unaware that this forgery had been going on. He then showed responsibility on the behalf of the company by stepping down from his post. In the absence of crisis management, the company faced with severe criminal laws and in the span of nine months they had to pay about $25 billion USD for criminal fines and penalties (Parloff, 2018). It is believed that instead of the CEO stepping down from his position, a better option would be for all the board of directors of Volkswagen to get together to try to resolve or find another alternative way to deal with the scandal. This would also potentially reduce the cost incurred. On the other hand, this huge payment by the organization can be a benefit to the company as it may aid the company to gain customers’ trust and help bring up the reputation and image of Volkswagen. The company chose spokespersons to represent them during the crisis and helped to clear all the controversies that occurred. They provided a very good customer service and gave upgrades, along with US$1000 vouchers to all the customers affected by this incident. They also removed themselves from being part of the emission certificate for their 2016 diesel engines. Apart from that, the company abolished all the sales of EA 189 in Europe. Matthias Muller, the CEO who replaced Winterkorn, saw this crisis as an opportunity to make their organization stronger and bring about the changes that were long overdue. They set new priorities and announced that by 2025 they would invest billions to create more than 30 fully electrical vehicles and would conduct the emission test on each vehicle individually. Muller assured the public that he, along with the company, would do anything to gain their customers’ trust back (Ruddick, 2016)
4) Conclusion and Recommendations
After extensive research on this case, it can be concluded that Volkswagen’s scandal was not only caused by a failure of risk management but also a failure of corporate governance as they depicted a lack of control from the top, lack of diversity on the Board and in the management team and inappropriate incentives to their employees. First thing that Volkswagen needs to change is the structure of their corporate governance as the company’s foundation is built on it. Corporate governance help minimize the gap between the interests of the principals and the agents so that they are aligned together. Traditional risk management practices and a solid grounding for it are also vital for managing downside risk events, preventing unnecessary losses and enable businesses to recover from risky events, and gain market confidence. Hence with a strong corporate governance and knowledge on managing risks, Volkswagen will be able to avoid similar crisis in the future (Wennekers, 2016).
Volkswagen is still trying their best to restore the customers’ trust, and while large payments made to the public is seen as one method of risk management, there are various experts who have aided the organization with other possible ways to manage their crisis.
First and foremost, the most basic is to avoid the crisis and also make preparations to deal with it. It is very important that the company understand the importance of day-to-day operations and how some fault in it can cause the company to be exposed with unpredictable and unavoidable operational risks. Managers must, therefore, be prepared to deal with any crisis that can occur, and this can be done only if they are aware of all the risky scenarios that they could encounter and how it will impact the company, then the managers must also be prepared to take into account how much expense would incur to either prevent such an incident or response to it (Business.gov.au, 2018).
Volkswagen knew they had agency problem, so for this reason a good way to avoid agency problem is to draft a clear contract with details specifying the roles and responsibilities of the agent and a clear code of conduct expected by the agent, and the penalty imposed upon failure of act. The company can also conduct screening and background check on each employee before hiring as it is proven to be less expensive as it can be done ex-ante. By taking such precautions, Volkswagen might have been able to avoid the crisis, as they would only be hiring trusted employees. Once the employees are hired, there could be random monitoring and reporting of how each individual is performing but it can be quite inefficient and the downside side of this is that some employees may get influenced by the agents.
Third way could be rebranding their organization and ensure that they practice a better corporate social responsibility by being more green as customers’ decisions are normally based upon the reputation of the company. Volkswagen could work together with suppliers, or other research department that conducts good corporate social responsibility. Moreover, they could shift their focus to reducing energy consumption and ensure that less carbon is being emitted into the air, as this will show the public that they do value sustainability and care about the environment. At this point it is vital for the company to turn to social marketing for their strategy as this will help improve the company’s image.
Alternatively, Volkswagen might consider developing a catalyst or neutralizer into the car’s exhaust system that can help minimize the emission of nitrogen oxide. This can, however, be very expensive, as they need extensive research on how to develop such a device. Alongside with this, the company must take initiative to show the public that they are taking all the necessary actions to repair the damage, and this can be done through extensive advertisements or campaigns. Hiring international experts is another good option for the company as they might have better insights to more practical solutions to such scandal.
Issuing a bond can be another way to regain the consumer’s trust and assure them this kind of fraud will not occur again. The company can enter an agreement that if they commit a fraud again, they will pay out bonds to European Commission automotive industry as this will motivate the European Commissions regulators to conduct a strict and detailed inspection. The funds raised from this can be directed towards the research and development of green engines and also to improve the technology infrastructures and decarbonizes the traditional engine. These bonds can be set at the highest price to reflect that Volkswagen are fully aware of their actions and regret creating such frauds. Being a huge company with various well known brands and large assets, Volkswagen might be able to obtain loan from second-tier banks or raise funds from the security market to finance such bonds and if not, the last resort for Volkswagen is to sell one of their brands or technologies to obtain the funds (Zhou, 2016).
With all the considerations mentioned above, Volkswagen’s priority is to regain the customers’ trust and restore the company’s image. Rebranding might be an option that Volkswagen chooses, though it is quite unlikely. Another more expensive option would be selling one of its brands to issue bonds in order to obtain the loans. Many customers are considering buying Volkswagen stocks as its prices are low and they believe that the company is taking measures to resolve the scandal and eventually the company’s stock price would increase. It is, however, uncertain that the stock price will be as high as before anytime soon but if Volkswagen continues to show responsibility and continues to improve their social corporate responsibility then they will be able to recover their position in the automobile industry.
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