Volkswagen: Diesel Emissions - a Whiff of Scandal

Volkswagen: Diesel Emissions - A Whiff of Scandal

Section 2 Team 3

Case Summary

A goal was set by the CEO in 2005 that VW would be the world’s largest car manufacturer, which led the company to set itself on an ambitious course, cutting corners to achieve elevated results in the American market. Without the level of success required in the American car market, VW was failing to gain adequate market share to meet this goal. American regulations are stricter than those in Europe, handcuffing VW when the time to build a fuel-efficient diesel car for the U.S. market came, putting the company in a position where management felt it acceptable to commit fraud via the installation of a software Defeat Device.

Relevant Questions

1. Gross margins and EBITDA margins are down significantly from 2011. Efficiency is on the decline and the Company is barely generating cash. Why then is executive compensation up? What key performance indicators were the management team’s compensation tied to? What aspects of their contracts made it more advantageous for them to choose committing fraud over genuinely resolving emissions issues?

1. Note that the scandal was announced to the U.S. government the day after Winterkorn’s contract had been extended by 3 years
2. Three board members were surprised by the news, when their function was to ensure the company was acting in the shareholders’ best interests → how can a board of directors do their jobs if they’re being held at arm’s length?

1. What checks and balances were put in place to ensure no foul play going forward? How have internal controls changed since the discovery of fraud?

1. Per Exhibit 2 and 3, VW was in direct violation of its own corporate governance code, as well as German Corporate Governance Code and Code of Conduct → the guidelines are too fluffy. There need to be formal checks and balances instituted so that each party in the corporate chain is answerable others: there is no accountability and there was no room for an internal whistleblower
2. There is a top-down issue with compliance. If senior executives do not respect or play by the rules, why would their employees?

1. Were incentive structures adequate in ensuring key executives would act with the best interest of the Company and its shareholders in mind? Did all shareholders have aligned interests?

1. Performance-based bonus usually 5-10x base compensation
2. Egregious shareholder in-fighting during Porsche merger  

1. Were hitting the target more important even under the circumstance of cheating the market? After the exposure, were it worth to keep trying to buy some time and take chances to sell more cars?

1. To be able to take down the U.S market and become the number one global car manufacturer, Piech and the CEO of VW decided to use the illegal software, which may potentially cause a huge loss to the company if it got exposed. Was it a wise thing to do especially for the interests of shareholders?
2. VW is primarily owned by the Porsche-Piech family who has the absolute power in VW’s management decision making. Was it a good thing for VW’s long term development under such a central management power structure?  

Recommendations

1. Restructure management incentive structure (to better align with shareholders’) and performance/KPI measures
2. Overhaul compliance structure, have real, specific rules that are enforced
3. Improve corporate governance standards to provide more checks and balance
4. Resolve the issues at earlier time to avoid costly impact / penalty (EUR 20mm in 2014 to fix the US diesel issue vs. EUR 26bn market cap loss after scandal was publicly revealed)