poor board room

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Volkswagen:Systemfailure VW’sculturehasbeenblamedforfosteringdysfunctionbutthe
company’spoliticsmayhinderchange Share onTwitter(opensnew window) Share onFacebook
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NOVEMBER 5, 2015 Printthispage31 Industrial espionage.Prostitutionandbribery.Cheatingon
environmental standards.Onthe face of it,the three bigscandalsthat roiledVolkswagenin1993,
2005 and 2015 seemtohave little incommon.Butcurrentand formerexecutives,boardmembers
and investorssaythe successive crisesare unitedbyone thing:the so-calledVWsystem.A historic
and unique constructof Germany’spostwarWirtschaftswunder(economicmiracle),the systemis
builtondeepconnectionsbetweenmanagement,workersandlocal politicians — asituationmade
evenmore complex bylayersof familyownership.Forunionsandpoliticians,the systemiscrucial to
protectingjobsatthe country’sindustrial crownjewel.Forinvestorsandgovernance experts,
however,itisresponsibleforfosteringadysfunctional corporate cultureatVW — and dentingits
profitability.“Peopleare startingtoquestionthe whole VWsystemagain . . . VWisamongthe most
complicatedandquestionablygovernedcompanies,”saysHansHirt,a directorat HermesEquity
OwnershipServices,the UKactivistinvestor.“Inothercases,youhave strongfamilies.Buthere you
alsohave state ownershipandpowerful employees.Itisa veryspecial mix.”SpeedreadTopjobFor
unionsandpoliticians,the ‘VWsystem’iscrucial toprotectingjobsatthe companyLow margin
Governance expertssaythe systemhashurtprofitabilityandfosteredadysfunctionalculture Weak
handInsteadof a single boardof directors,VWhasa supervisoryboard.Butcriticssayit lacks
authorityVW’slatestscandal intensifiedthisweekasthe carmakerfacesnew allegationsof cheating
on emissionstests.USregulatorsare investigatingwhetheritfitteda“defeatdevice”in10,000 cars
— includingaPorsche model — andVWdisclosedonTuesdaythatithad understatedthe carbon
dioxide levelsonabout800,000 vehicles,includingforthe firsttime those withpetrol engines.These
findingscome afterthe initialrevelationsthat11m diesel carsworldwide useddefeatdevices.The
latestallegationshave intensifiedquestionsaboutwhethercheatingatVW wassystematic.Many
investorsandcurrentandformeremployeeshave concludedthatthe companyneedsaradical
overhaul.“The VWsystemneedsacomplete shake-up,”saysa formerVWsupervisoryboard
member.“Butdo I thinkthatwill happen?No,Idon’t — and that’swhy I’mworriedforthe future.”
Yngve Slyngstad,chief executive of Norway’s$870bn oil fund,ispushingfora revamp.“We of
course hope that thiseventcanleadto some rethinkinginthe companyaboutwhatwouldbe a
goodgovernance model,”he says.VWhasalwaysbeenanodd beast.FoundedbyHitlerin1936, it
was rescuedbythe Britisharmyafterthe secondworldwarand thenprivatisedin1960. But the
local state governmentof LowerSaxony(andfora time the federal government)were givenspecial
ownershiprightsthatgave ita blockingminorityandsupervisoryboardseats.RatingVolkswagen’s
damage limitationThesedays,VWisnolongerjusta state-controlledcompany.Followingthe 2005
scandal,the Porsche andPiëchfamilies — andlaterQatar— joinedLowerSaxonyasVW’sdominant
shareholders.Atthe same time,the carmaker’sGermanemployeesare soinfluential thatsome
criticssay it resemblesaco-operative.UnlikeUSandUK companies,VWdoesnothave a single
board of directors.Instead,ithasa supervisoryboardthatismeantto holdmanagementtoaccount.
But investorsandgovernance expertssaythe emissionsscandal showsthatitlacks the
independenceandauthoritytodothis.Under the Germanprinciple of co-determination,half of the
board seatsare reservedforworkers.InVW’scase,the headof the IG Metall unionhaslonghelda

2. board seatand evenservedasinterimchairmanwhen the diesel scandal firstbroke inSeptember.
All of the employees’10seatsare occupiedbyGermanworkers.Onthe shareholders’side of the
board,the problemisone of independence.Fourof the 10 are membersof the Porsche andPiëch
families;twoeachcome fromLowerSaxonyand Qatar. The new chairman,Hans DieterPötsch,was
until lastmonthVW’sfinance directorandisclose to the twofamilies.ThatleavesonlyAnnika
Falkengren,chief executive of SwedishbankSEB,as an outsider — andone corporate governance
expertdisqualifieshersince SEBisan advisertoScania,the truckmakerthat is one of VW’s12
brands.In mostGerman companies,the chairmanwoulddiscusssensitive matterswiththe
shareholderside first,agreeingacommonpositionbefore bringingitbefore the fullboard.AtVW,
particularlyunderformerchairmanFerdinandPiëch,whowasincharge from2002 until thisyear,
thingsworkedinreverse.“Piëchwouldfirsttalktothe workscouncil andagree a position.Thenhe
wouldbringitto the shareholderside,”saysaformerdirector.Sometimes,noteventhathappened.
In 2005, Mr Piëchsidedwiththe workscouncil toensure anIG Metall memberwasmade headof
personnel atVWagainstthe wishesof hisownchief executive andmostshareholderdirectors.This
createdan atmosphere where sensitivematterswere resolvedfarfromthe boardroomandwithout
managementoversight.“The boardwasreallyjustforshow,”saysa formerseniorVWexecutive.
“Theylackedthe abilitytoask anydeeptechnical questions — andyousee thatin the current
scandal.”Under Mr Piëch,whowasalso chief executivefrom1993-2002 and at the heart of the so-
calledLopezscandal involvingcorporate spyingin1993, the principle of co-determinationbecame
somethingakintoco-management,withworkersactivelyhelpingshape decisions.Togetherwiththe
presence of LowerSaxonyonthe board,it meantjoblosses — particularlyatVW’snotoriously
inefficientmainfactorynexttoitsheadquartersinWolfsburg — were all buttaboo.Criticssaw a
quidpro quo:Mr Piëchagreedtopreserve jobsif the employee blocworkedwithhimonother
initiatives.One example of the close relationshipbetweenthe formerchairmanandworkerswas
whenGunnarKilian,aspokesmanforthe works council,lefttoworkinMr Piëch’spersonal office,
onlyto returnto the workscouncil a fewyearslateras general secretary.“Itishard to exaggerate
whatkindof atmosphere thiscreated,”saysaformersupervisoryboardmember.“Itwasvery
difficulttodoanythingthathurt workersorLowerSaxony.But beyondthatitjustkilledthe boardas
a place of properdiscussion.”Questionsaboutcompetence Currentandformersupervisoryboard
memberssaytheyknewnothingof the emissionscheatingandnever discussedthe riggedengine.
“Matters of technical expertise were notforus,”saysthe formermember.A currentdirector
expressesintense irritationatVWmanagement’sfailure totell the boardof the problemfortwo
weeksinSeptember,butsaysthe supervisoryboardshouldnotbe blamed.“Thisscandal had
nothing,notone iota,to do withthe supervisoryboard,”the directorsays.IndepthVolkswagen
emissionsscandal The Germancarmakerisengulfedinthe worstscandal inits78-year historyafter
it admittedtomanipulatingemissionstestdataonitsdiesel vehiclesinthe US andEurope Read
more Othersdisagree.ChristianStrenger,aGermancorporate governance expert,says:“The control
systemof the supervisoryboardappearstohave beendeficient.” He callsforhalf of VW’s10
shareholder-appointeddirectorstobe true outsiders.“Whatisvital now isa substantial redressof
the supervisoryboard.Requiredare seasonedpersonalitiesasconvincingcounterweightstothe
families,LowerSaxonyandQatar.”Mr Hirt,the activistinvestor,issupportiveof bringingfreshblood
intothe boardroom.“The supervisoryboardappointsthe management.Itisa little bitoddtosay
that itdoesn’thave anythingtodo withthe supervisoryboard.”Manyare wary of the new role of
Mr Pötschas chairman,despite hisgoodreputationasfinance director,ashe was part of the
managementboardthroughoutthe entire periodof the scandal.“IthinkPötschwill be destroyed,”
saysone investor,addingthatanoutsiderisneededtoreformthe boardfully.‘Pursuitof perfection’
Several attemptsinthe pastdecade tofundamentallychange the wayVWisrun have foundered.
Followingascandal in2005 whenexecutiveshiredprostitutesandboughtViagraformembersof the

3. workscouncil,the managementtriedtodismantlethe system.Theyendeda29-hour,four-day
workingweekandWolfgangBernhard,acost-cutterwhowasheadof the VW brand,lookedat
closingsome of the leastprofitable operations.Butthe systemendured,asMr Piëchinstalledthe
newheadof personnel andthenoustedthe chief executive,leavingMrBernhardto resign.A few
yearslater,WendelinWiedeking,thenchiefexecutive of Porsche,whichhadbecome VW’sbiggest
shareholder,declaredthere shouldbe “nosacred cows”at VW. Workerstookthisas code thatjobs
wouldbe threatened,butwhenPorsche ranintofinancialproblemsin2009 Mr Piëchpouncedand
VW boughtthe sportscar maker.Some are hopeful thatthe emissionsscandal mightforce VWto
change.For the firsttime intwodecades,Mr Piëchhas noformal leadershiprole atVW.Andthere is
freshbloodbothinthe chairman’srole andin MatthiasMüller,the formerPorsche executive who
was appointedchiefexecutive afterthe emissionsscandal claimedhispredecessor,Martin
Winterkorn.UnderMr Winterkorn,VWbecame known — inthe wordsof one formerdirector — as
a “dictatorship”.“There wasno dissentallowed.Everyonewasparanoid,andeveryone wasafraidof
beingtoldoff fromabove,”the formerboardmembersays.Mr Müllerhas pledgedtochange VW’s
culture,buthe is alreadyfacingquestionsoverhisownrole inthe scandal.US regulatorssaya
Porsche model waspotentiallycaughtupinthe affair,whichcouldthreatenhiscredibilityasthe
personto cleanupthe company.He says he wantsto keepthe bestpartsof the VW wayof doing
thingsincluding“the pursuitof perfection”.Andhe hashelpedinstall along-plannednewstructure
of the VWgroup underwhichits12 brandsare to be givenmore responsibility.“The keypointisthat
groupmanagementwill be decentralisedtoa greaterextentinthe future,”he saidlastmonth.That
ismost crucial at its mainVW brand,whose problemsinthe USlaybehindthe emissionsscandal.
The VW brand alsohas a newhead,HerbertDiess,aformerBMW executive,whoinheritsaslew of
problemsfromweakprofitabilitytopoorsalesinthe US. VW managementculture facesscrutinyA
seniorVWexecutivesaysMr Diesswasshockedthe firsttime he walkedaroundthe Wolfsburg
factory.“He was justso upset,shakinghishead.Itlookssoinefficient.”VWmakesaboutthe same
numberof cars as Toyota— 10m in2014 to 9m bythe Japanese — but hasalmostdouble the
numberof workers — 593,000 to 344,000. Analystspinthe blame predominantlyonVW’sGerman
factoriesandsuggestchange isdifficultbecausebothunionsandLowerSaxonyare resistanttojob
cuts. “Our role isto protectjobs,”saysa personclose toLowerSaxony’srulingSocial Democrats.VW
executivesare alsoclearaboutwhatis possible andwhatisnot.Mr Müller’spronouncementshave
beensimilartothose fromBerndOsterlohandStephanWeil,respectivelythe headof the works
council andminister-presidentof LowerSaxony.The triorecentlytouredthe Wolfsburgfactoryina
displaydesignedtoreassure workers.“We needanew culture,thatmuch istrue,”says a senior
manager.“But to change the VW system, tomake the workersor LowerSaxonyupset,Idon’tthink
we have the time or the energyforthat. That isjust the constraintsyouhave to acceptwhen
runningVW.”Troublesonthe factory floor:scandalsThe LopezAffair(1993):FerdinandPiëch,then
the newchief executive atVolkswagen,unleashedone of the biggestfightsinthe carindustrywhen
he poachedJosé IgnacioLopezfromGeneral Motors in1993. A torrentof insults,law suitsand
criminal investigationsfollowedamidclaimsof espionage,stolendocuments,andpatent
infringement.MrLopezhada reputationforsqueezingmoneyoutof suppliersbyscrappinglong-
termcontracts and pushingdowncostsrelentlessly.MrPiëchwantedhimtohelpliftVWoutof its
early1990s torpor.The acrimonyonlyendedwhenMr Lopezwasforcedto leave the German
carmaker.Prostitute andbriberyscandal (2005): VW’scosy relationshipwithitsworkscouncil layat
the heart of twinscandalsthat broke in2005. KlausVolkert,thenheadof the workscouncil,was
foundguiltyof breachof trust for illegallyreceivingabonusof almost€2m fromPeterHartz,a VW
managementboardmember.A secondaspectinvolvedtripsabroadformembersof the works
council involvingprostitutes,shoppingexcursionsforwives,andevenViagrapaidforbyVW.Mr
Piëch,bythenVWchairman,tolda court the scandalswere “irregularities”of whichhe had known

4. nothing.Emissionsscandal (2015):The mostseriousscandal of the three broke inmid-September
whenUS environmental regulatorsrevealedVWhadadmittedcheatingonemissionstestsfordiesel
engines.Intotal,11m cars worldwide were involved.Analystsestimatethatlaw suits,fines,and
recallscouldcostVW up to $30bn. The carmaker hasalso revealedproblemswiththe statedcarbon
dioxide levelsof about800,000 cars inEurope.