Risk: rogue culture killed das Fahrvergnuegen

The whistle-blower lawsuit Donovan v. Volkswagen Group of America Inc., 2016-151877-CD, Circuit Court, Oakland County, Michigan (Pontiac), filed on 8th March by a former  Volkswagen-employee, brought to light what the tone at the top can cause in terms of management of reputational and litigation risk.  Volkswagen, founded in 1937, is currently professional home to more than 600,000 employees around the globe, and a portfolio of 12 automobile brands that span the entire spectrum and include Audi, Porsche, Lamborghini and a wide range of trucks and buses.  Further, activities in engineering related to power plants, turbines, and chemical reactors and beyond make the corporation a systemically important player in Germany’s labor market and therefore a key contributor to Germany’s GDP and wider national economy.  It self-identifies as embracing an open corporate culture but has come increasingly under scrutiny for a leadership style and ownership structure (c.f. Governance issue discussion) marked by hierarchy and family dynamics.

So far, Volkswagen’s online representation only marginally touches upon the notion of whistleblowing (c.f. European Ombudsman (Draft decision on internal rules concerning whistleblowingas confined to corruption and human rights violations only, implying these are perceived as external phenomena. Following then-CEO Winterkorn’s statement in September 2015:

“We do not and will not tolerate violations of any kind of our internal rules or of the law. The trust of our customers and the public is and continues to be our most important asset.”

Volkswagen’s stance – in terms of actions – hasn’t been exactly in line with what investors and the public were hoping to see, and what should have become a governance overhaul, ideally rooted in impact assessment and supported by related relevant risk-metrics. The opposite seems to be the case, with further threatening clouds now looming large on the horizon thanks to the above-mentioned whistleblowing case which, independent of its merit, has already been making headlines and thereby increasing uncertainty for investors and stakeholders, and reputational risk.

Losses and reputational damages beyond quantifiable scars:
Increasingly it has become clear that the crisis strategy senior management at Volkswagen has been resorting to is proving inadequate and not suited to reestablish its fragile but most vital asset. Customers’ and the public’s trust have taken a severe and sustained blow as Volkswagen’s share value.  More than 6 months after the peak of emission fraud -related news, it still keeps hovering well below the 50% worth of its 52-weeks’ high Volkswagen currently faces a solid two-digit amount worth billions of Euros in fines, criminal charges, lawsuits and class actions, anticipated and resulting from filed claims in the US, Canada, the UK and beyond.  This is going to add to the losses already incurred and priced in by the market:

  1. the cost of recalling affected cars and
  2. installing the required software update.

In addition Future Losses encompassing:

  • long-term profit decline resulting from reputational damage to the corporate brand, the wider industry and the nation’s quality standard “Made in Germany”,
  • a weighing down of Germany’s share performance index DAX,
  • staff retention issues, hiring and related costs, and
  • further expansion of internal controls and compliance efforts,
  • less apparent knock-on effects such as not yet known potential further revelations which may need to be added in and will most likely be revised upward.

Risk resulting from ineffective crisis management:
The lack of clear, firm, concise and concerted, as well as forthcoming and truthful communication, by top management, has been particularly painful and adding scorn to the scandal.

  1. Senior leaders chose to provide piecemeal allocations of blame and engaged in accountability rhetoric of very limited substantiation.
  2. They focused initially on blaming a single-digit figure of “rogue engineers”.
  3. In addition, they had very little to say about the lack of decisive action upon notification in the past,
  4. and failed to provide clarity on missing or dysfunctional internal controls, thereby only further damaging the demolished brand.

Volkswagen’s social media engagement continued to be highly selective: VW Group’s Twitter channel follows less than a mere 10% of its followers and engages predominantly in glossy self-promotion. An advanced search demonstrates Volkswagen’s complete absence of engagement with critical consumers, clients, and the wider public.

This silence on the particular matter has proven counterproductive to the restoration of trust and confidence.  Even if the default tone at the top in such moments of public and widespread embarrassment may have been silencing critical voices, waiting it out and hoping that time will encourage regulators and the public to forget, might not be a reasonable strategy, in particular as Volkswagen had committed similar fraud in the past (discussed and referenced further below in more detail).

Volkswagen Financial Services AG (VW FS, and Volkswagen Bank GmbH) 2015 report strikes a tone that appears overly confident, given the ongoing debacle, the audience is assured of the Group’s strength to “master the impact of the emissions issue and to emerge stronger in the future”.  The report was compiled at a time when the full scale of what Volkswagen calls euphemistically the “emission issue” was neither clear nor the internal investigation, commenced in October 2015, concluded.

With no consideration or reference to factual data and underpinning evidence, the bold promise made to the audience represents an assessment that is potentially misleading shareholders and the public alike:  VW FS’ credit rating downgrade in November 2015, to long-term investment grade BBB+ (S&P via Reuters; downgraded also by Moody’s with negative outlook by either rating agency, also applied to Volkswagen Group which maintains a higher credit rating though) reflects this  view.

Volkswagen, however, argues that the rating agencies focused mainly on the emissions fraud and resorts to a defensive tone in respect to their communication with the agencies. Overall, the report remains very tight-lipped on the tone at the top, in fact leadership issues are mentioned only a handful of times within the 184-pages strong report, with a brief and vague note on one training opportunity which was held to “promote the corporate and management culture”, leaving the reader guessing as to whether the problematic existing culture was indeed further promoted or if any rethinking and remodeling was considered.

Communication as to the consideration of adoption of best practice from outside the firm, industry or nation has not been provided at all so far.

Internal controls – wherefore art thou?
At the time of writing, neither Volkswagen’s online staff magazine nor its corporate website offers much transparency as to recently implemented hotlines (via external Ombudsmen). Questions which arise are for instance:

  • what protection and/or incentives are offered other than (discouraged) anonymity,
  • whether whistle-blowing is valued or perceived as the operation of last resort.
  • in the case of the latter, what alternative routes exist in order to tackle misconduct, fraud, corruption, or other ethical concern.
  • How many, if any, instances have been handled so far and
  • how long it took to investigate them and/or
  • what losses and damage have subsequently or potentially been prevented.

Clarity and insight into soundness, effectiveness and acceptance rate of the mechanism would benefit investor relations but also impact positively on retention rates. It could prevent whistleblowers from going public.  It could in the wider sense positively shape the restoration of trust and support behavioral change if Volkswagen’s leadership committed to more transparency of their whistleblowing policies and related procedures.

A progress report of 2010 (dated 2008) can be found that summarizes progress on whistle-blowing protection but only in the narrowly defined context of conflicts of interest and corruption:

“Der Volkswagen-Konzern zeichnet sich durch eine offene und transparente Unternehmenskultur aus.

Das Ombudsmann-System garantiert allen Mitarbeitern bei Verdacht auf Verstöße das Whistle-Blowing, ohne dass sich jemand vor Repressalien fürchten müsste. “

Volkswagen prides itself on an “open and transparent corporate culture” and guarantees employees [the right] to whistle-blow with subsequent protection from retaliation. Further details cannot be found, this hasn’t changed post-scandal.

VW Group Sustainability Report 2014 further demonstrates very limited progress on group-wide compliance efforts: less than 1/3 of all staff had received class-based or online Compliance training. Whistle-blowing is not mentioned anywhere in the report. Further questions arise:

  • No explanation is provided as to the newly introduced – quite airy and generic – Code of Conduct (PDF, 24p), mandatory per online training for all new employees has been introduced.  However, with respect to those who have been with the firm for years or decades, no clarity is offered as to training records.

While the variable bonus pay (performance-based element of compensation) has now been linked to compliance with the Code of Conduct:

  • Yet, it remains entirely unclear how/to what degree compliance with the Code is measured and taken into account;
  • how the Code is enforced,
  • what measures are taken when breaches occur and
  • what consequences, in particular with respect to those employees who haven’t been recently recruited, can be expected, and
  • what metrics and qualitative data underpin the wider implementation and monitoring of compliance with the Code and when communication to shareholders and stakeholders about progress or lack of such can be expected.

The Group’s online subsite on Compliance and Governance is boldly talking of “successful Governance”, not clarifying, though, how it measures the success, what parameters feed the model and not permitting the audience to reverse-engineer that statement.

Trust assumed, when trust has just been severely damaged does not underpin the notion of an introspective, reflective, open and learning corporate culture.

The notion of a flat, open and dynamic corporate culture, capable of incorporating critique for the wider good and at an early stage as means of effective (preventive) risk management appears like a nostalgic advertisement of the glorious past.

The glorious past – and the history of breaches:
Volkswagen had come under intense scrutiny by US EPA (Environmental Protection Agency) back in 1973 for a not dissimilar issue: emission-defeat devices had been installed in more than 20,000 cars and also buses.  This consequently resulted in fines and a costly recall for removal imposed by the US authority, c.f. VW DefeatDevice EPA Prosecution 7-23-73 (PDF, 6p).

The failure to disclose the inbuilt switches and seek prior permission and certification was paralleled by a lack of swift and forthcoming correspondence with the US Agency.  The settlement meant that Volkswagen did not admit any wrongdoing, but committed shortly after, in 1974, yet another breach WSJ, 1974 [PDF].

Switching heads:
Various individuals have stepped down or have been suspended, most prominently CEO Winterkorn who was offered a much criticized golden handshake. Furthermore, heads of development and research respectively at Audi and Porsche as well as Volkswagen U.S. CEO Horn were dismissed.

While the internal probe, launched on 1st October 2015, continues, the reshuffle brought various new heads in.  Previously ordinary board member Poetsch (since 2003) is now heading a newly set up 20-member controlling panel and is chairman of the Supervisory Board.

As mentioned at the onset, Volkswagen is systemically important to the Germany national economy and a look at the newly placed Board members and their affiliations raises further questions as to independent decision-making and conflicts of interest at the helm of the giant:

  • While the federal state Lower Saxony holds 12.4% of subscribed capital and 20% of voting rights, 2 of the Supervisory Board members are ministers of Lower Saxony,
  • 3 hold professorships at German universities,
  • 5 of the Supervisory Board Members received basic compensation of nearly EUR 6.5 mn p.a. in the past fiscal year, with the lowest of the 32 receiving only around 6% Supervisory Board’s Chairman’s compensation, amounting to EUR 398,500.

Switching gears – or not:
In total 5 key Committees of the Supervisory Board are headed by 2 individuals who act as chairmen, i.e.:

  • Chairman of the Supervisory Board Poetsch – heads 3 committees, including ExCo and Nomination, and
  • 2 family members of the Porsche family (uncle and nephew) are heading the Audit Committee and a Special Committee of Diesel Engines.

The lack of independent decision-making at the top level and related impressions of conflict of interest are unfortunately not being dispersed by the newly set-up Ombudsmen system. Neither is specialized in whistleblowing protection, but both have extensive expertise in employer interest representation and their legal defense.

The segregation of functions, independent examination of internal controls and compliance with regulatory requirements remain a major challenge for Volkswagen Group.  Also, perhaps most importantly, mechanisms that offer effective means in the prevention and early detection of compliance breaches continue to present a pressing issue to the organisation.

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