Home > Estructura del Consejo > The Volkswagen case and its corporate governance roots.

The Volkswagen case and its corporate governance roots.

Charles M. Elson, Craig K. Ferrere and Nicholas J. Goossen recently published a short article (1) in which they analize the corporate governance flaws that might have led to the recent Volkswagen scandal related to fraud in the polluting emissions metrics disclosed for their diesel vehicles.

 Board and even Ceo said they were unaware of the fraud, which used a complex and widespread procedure, which unveils a sever lack of oversight.

 Elson, Ferrere and Goossen wonder why this fraud appeared in a company with a strong controlling shareholder, (the two Piech and Porsche families jointly own 31.5% of shares, but Quatar Holding also owns 15.4%), that has also the government as a shareholder (12.4%) and employees sat at the board table. It was not the kind of firm with dispersed ownership where the Corporate Governance theory would have predicted a lack of oversight over the managers activities and interests.

 The causes.

 The scandal reveals bad management but also a lack of an adequate corporate culture, which allowed a complex fraudulent system to be developed and covered by several management layers. The board didn`t impose a correct oversight and corporate culture, for different reasons:

 First.- The interest conflicting nature of the dual-class share system, which allowed the two families to jointly dominate the board, probably against other shareholders` interests. In Europe the system (together with pyramidal property structures) is generally used to disproportionately allocate voting rights to the controlling shareholders. In fact, through a holding company the families own their stake but control more than 50% of the voting rights. This situation prevents outside shareholders to exert a correct control over the main shareholder and the managers.

 Problems in controlled companies arise because, although it generates a cost, private unfair allocation of results to the controlling shareholder through self-dealing still favors them. On the other hand, prestige and reputation stemming from being at the helm of the company may be more “profitable” than profits themselves for the controlling shareholder. These non-pecuniary benefits were apparently very relevant in the case of Ferdinand Piech, who used his control to reinforce his industrial domination desire. His personal ambitions, unlike the case of dispersed ownership, were not restrained by the market for corporate control.

 And perhaps his emphasis on growth implied no concern for the means used to rival Toyota as the main world car maker.

 Second.- The government as a big shareholder. A local government retained 20% of the voting rights, (more than their economic interest) and also controlled many of the corporate decisions, (that required a 4 / 5 approval). Governments have reelection and other political agendas, so that they don`t really push for the long-term value of the company, nor the economic interest necessarily, (for instance their focus on employment is outstanding). So the families could pursue their goals provided the government`s directors were also satisfied, which eventually generated a culture to round corners if necessary. Compliance and correct oversight clearly wasn`t a government`s priority.

 Third. The co-determination governance system forces companies with more than 2.000 employees to have both shareholder and employee representatives at the Supervisory board, ( a 10-10 split in our case). This generates the problem that the party that needs to be overseen by the board is also present in this one. Shirking, but also other incorrect activities have more room to emerge in this corporate structure, (corruption, illegal actions, and deceiving legal compliance in general). In general, the model has evolved into weaker and confronted boards and the emergence of informal oversight by shareholders. With Piech dominating this governance structure, but pursuing growth and labor interests together with the government, nobody actually was implementing a corporate compliance culture nor trying to assure effective regulatory compliance nor profitability.

 And the lesson on board and voting structures and government interference is clear according to Elson, Ferrere and Goossen.

 (1)  Elson, Charles M. and Ferrere, Craig K. and Goossen, Nicholas J., The Bug at Volkswagen: Lessons in Co-Determination, Ownership, and Board Structure (November 25, 2015). Journal of Applied Corporate Finance, Vol. 27, No. 4, 2015. Available at SSRN: http://ssrn.com/abstract=2737544


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