Question

Read the overview below and complete the activities that follow.

Every corporation should have a strong independent board of directors that are well informed about the company’s performance, guides and judges the CEO and other top executives, has the courage to curb management actions the board believes to be inappropriate or risky, certifies to shareholders that the CEO is doing what the board expects, provides insight and advice to management, and debates the pros and cons of key decisions and actions. Illustration Capsule 2.4 discusses how weak governance at Volkswagen contributed to the 2015 emissions cheating scandal, which cost the company billions of dollars and the trust of its stakeholders.

Although senior managers have lead responsibility for crafting and executing a company's strategy, it is the duty of a company's board of directors to the shareholders to play a vigilant role in overseeing management's handling of a company's strategy-making, strategy-executing process. A company's board is obligated to (1) ensure that the company issues accurate financial reports and has adequate financial controls, (2) critically appraise and ultimately approve strategic action plans, (3) evaluate the strategic leadership skills of the CEO, and (4) institute a compensation plan for top executives that rewards them for actions and results that serve stakeholder interests, most especially those of shareholders.

Answer the assignment questions for this exercise after reading Chapter 2 and Illustration Capsule 2.4. The mini case is also provided below.

Case:

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 Piëch, the chair during the scandal, was CEO for nine 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. Piëch, 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, non-labor representative. Although Piëch 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.

Note: Developed with Jacob M. Crandall.

Sources: “Piëch under Fire,” The Economist, December 8, 2005; Chris Bryant and Richard Milne, “Boardroom Politics at Heart of VW Scandal,” Financial Times, October 4, 2015; Andreas Cremer and Jan Schwartz, “Volkswagen Mired in Crisis as Board Members Criticize Piech,” Reuters, April 24, 2015; Richard Milne, “Volkswagen: System Failure,” Financial Times, November 4, 2015.

What caused the governance failure at Volkswagen? Multiple Choice Directors evaluating the senior executive's leadership skills and performance Directors becoming involved in the company's strategic direction The two-tiered governance structure imposed by the German government The wo seres som Directors becoming involved in the manufacturing process Lack of independent directors

Answer 1

Answer: Lack of independent directors

Explanation:

Every corporation should have a strong independent board of directors who have good knowledge on the company’s performance, guides and judges the CEO and top executives, have the ability to stop inappropriate or risky management actions, certifies to shareholders regarding CEO performance, provide insight and advice to management and debates the pros and cons of key decisions and actions. But in the given case study, when Volkswagen involved in the scandal of installing defeat devices to pass the emission test, the supervisory board was not ready to accept any responsibility. They were of the opinion that the matters of technical expertise is not for them and hence it is clear that they were not involved in the manufacturing process. The two tier governance structures in German corporations require that the supervisory board should not contain any current executives and at least 50 percent supervisory board representation from workers. But the chair in Volkswagen used to appoint former senior executives as chairman and this has prevented the board from acting independently as these chairs were previously involved in the management operations. They have also pushed out independent members using voting share and installed unqualified family members on the board. This made the board dependant and led to the scandal. Hence the reason for governance failure in Volkswagen is lack of independent directors. Directors becoming involved in the company’s strategic direction, the two-tiered governance structure imposed by the German government and director’s evaluating the senior executive’s leadership skills and performance were the actions to be followed by the board to ensure proper governance and these are not the reason for governance failure.