Volkswagen - Conflict of Interest and Corporate Governance - Case Study Example

Abstract

This paper is aimed to assess the conflict of interest and Corporate Governance, and the case study that will be used is Volkswagen. Conflict of interest is a very serious issue that can affect the operations of a company, therefore the board of directors of accompany should declare their interest before been elected or appointed to an executive post. The paper will first give an overview of the situation that made Volkswagen appoint a chairman (Herr) that had a conflict of interest, then a comprehensive analysis of this situation will be made. Finally, recommendations will be discussed on the mechanisms that the company should take to ensure that its board of directors especially the executive don’t have any conflicting interest that may jeopardize the company’s operation.

Conflict of Interest and Corporate Governance

Introduction

Thee recent allegations that Volkswagen has installed “defeat services” on its cars so as to evade emission requirements is a case that epitomizes issues of corporate governance. Conflict of interest in corporate governance is a serious issue that should be taken serious. It can be asserted that all the board of directors are supposed to take serious action to the chairman’s case, Herr Piech. Volkswagen has a corporate culture of nominating a long-serving executive as chairman, and this is what can be described as the root cause of the diesel-emission scandal. Mr. Herr was the chairman of Volkswagen and he decided to resign due to the escalating scandal, most of the directors opted to appoint Hans-Dieter, Volkswagen Chief Financial Officer since 2003 as the new chairman. Hans-Christoph Hirt a director of Hermes Equity Ownership Services, and adviser to pension fund services to various companies including Volkswagen is what epitomizes an issue of conflict of interest in appointing Hans-Dieter as the new chairman of the company.

Culture is something that is closely related governance, it should be noted that culture and ethical tone are led from the top of the organization by the senior executives and the board members. Volkswagen supervisory board comprise, amongst others, shareholders, employees that are closely linked to employee organizations and unions. The conflict of interest at Volkswagen is enormous and it seems that most parties are linked in one way or another. First the shareholders are looking to maximize profits through the dividend ad share prices, while the employees are looking for an opportunity to have a pay rise and maintain their employment. Therefore, any primary component of a given corporate governance should be aimed at the manner in which it deals with conflict of interest. A conflict of interest is inevitable especially when the director has competing interest, such the case of VW appointment of Herr who is a director of a company that offers advisory services to VW on matters relating to pension. Dealing with conflict of interest requires transparency of the highest level, it is very important if a director has a conflict of interest to disclose the matter as early as possible to the board (Zedan, Maitah, & Galalh, 2012). The culture of the company is also very important, is the company has a culture that doesn’t take into consideration the aspect of conflict of interest it should change such culture. Conflict of interest in corporate governance is a very important aspect, and if not taken seriously it can lead to an organization failure (Sayrak & Shukla, 2005).

Analysis

Control of companies and family heritage

The case of conflict of interest in corporate governance can be exemplified by the corporate government of Volkswagen and the conflict of interest by its executive. In 1974, Volkswagen was facing a major crisis related to corporate governance and sought the appointment of Ferdinand Piëch as its new chief executive manager. Given that he was the grandson of the father of Beetle, Mr. Piëch was deemed the right person to solve the market problems and corporate governance problems at Volkswagen. He had the experience of not only belonging to family with extensive knowledge of cars, but also experience in corporate governance as he was previously the chief executive at Audi. This is a case of combining control of companies and family heritage with an aim of benefiting companies with the expertise and the long term perspectives of persons who had major experience in business ownership in car dealership as well as stewards of family heritage. However, given the changing situation in the corporate world, the same mode of leadership may not be suitable for management of corporate governance due to issues of code of ethics and conflict of interest in corporate governance.

Conflict of interest and corporate governance controversy at Volkswagen

The controversy in the corporate governance in Volkswagen focuses on one primary person, Mr Piëch. He and his family are big shareholders in Porsche, the sports-car maker, a company that had already bought a 19% stake in Volkswagen. This raised a question of the type of interests Mr Piëch was representing when it came to making major decisions in the company as it would sometimes conflict with his interests in his family business. Mr Piëch was involved in many commercial arrangements between Volkswagen and Porsche as Volkswagen had a deal to supply approximately 30 percent of Porsche’s car components. Moreover, Mr Piëch’s family is also involved in Porsche Holding in Austria, a family owned company by Piëch and Porsche families, and which distributes cars from both Porsche groups and Volkswagen.

Figure 1: Ownership structure of Volkswagen AG in June 2006.

The ownership structure of Volkswagen shows that Mr Piëch enjoyed massive power and control of the company as well as personal support from the supervisory board.

According to the 2003 Germany's voluntary corporate-governance code, the provisions on corporate governance posits that “Material conflicts of interest and those which are not merely temporary” are grounds enough for termination of the mandate of the supervisory board member. However, it also provides that the affected member may leave the room when sensitive matter related to the issue under conflict of interest in being discussed (Tricker & Tricker, 2012). In this regard, Mr Piëch claimed that his issue may be managed by simply leaving the room when such commercially sensitive issues are being discussed, especially commercial arrangements between Volkswagen and Porsche. However, given the remarkable personal support he enjoys from the supervisory board, this situation seems to be very naïve as criticized by many of his opponents.

Effect of leaving the room during discussion of commercially sensitive matters

The board of director’s action of permitting Mr. Piëch’s claim of leaving the room when important commercially sensitive matters were being discussed was a way of ensuring that he did not influence the board’s decision to vote in favor of decisions that would benefit him and his family company. Since he was a supervisory board of director and a major shareholder in Porsche, they did not deem it necessary to termination of the mandate of the supervisory board member if a simple expedient as leaving the room would solve the problem. Mr. Piëch was also required to leave the room when important matters related to Porsche were being discussed by the board of directors. This served to give enough space and opportunity to the directors to discuss issues related to him and his relationship with the decisions made in the company.

Based on the analysis of the power that Mr. Piëch had on the other company’s directors and the support from the all ten employee’s representatives on the supervisory board, it would be prudent to conclude that the board was naïve in approving his action of leaving the room. The best strategy to solution of the issue of conflict of interest would have been to terminate his mandate as a supervisory board member in order to take away his power and influence over the other members. Moreover, his continued stay in the board was deemed to have negative consequences on the reputation of the company and would evoke negative reactions from the company’s investors, thereby hurting the profitability of the company in the long run.

The decision to retain Mr. Piëch as a supervisory board member also exposed the board members as very unprofessional since their action served to portray him as a major policy maker in the company. The board should have challenged his action to protect the interests of the shareholders in Volkswagen as Mr. Piëch also protected his interests in both Porsche and in Volkswagen. Given that Mr. Piëch is not a single decision maker in the company, he should not have been allowed to influence the decision of Volkswagen.

Effects of conflict of interest on Shareholder’s value

The conflict of interest in Volkswagen has a negative effect on Shareholder’s value as the decline in the reputation of the company and the loss of investment has a direct impact of lowering the profitability of the company and consequently the overall value of the shareholders (Clarke, 2007). In such case, there is a conflict of interest between the management and the shareholders as the decision of the directors to retain Mr. Piëch in the board served to neglect their interests in the company. To examine the extent to which the shareholder’s value is compromised, it is prudent to look at the structure of the supervisory board members.

In the supervisory board, there are ten representatives appointed by the trade union organization to represent the employees while the other ten are appointed to represent the interests of the shareholders. It is also worth noting that Mr. Piëch had personal support by all the ten representatives of the employees, hence his position in the board was very strong. Despite the fact that the ten shareholders representative had the grounds to complain and call for the removal of Mr. Piëch from the board, there are no adequate support to achieve that objective.

Moreover, all the supervisory board members as well as the chairman are appointed by the supervisory board as opposed to shareholders during the annual general meeting. This compromises the position of the shareholders’ representatives in the board when it comes to defying Mr. Piëch’s position as such members would have to step down when the term expires and would have no way of going back to the company given that there are already ten supervisory board members in support of Mr. Piëch. As such, despite their motivation to fight the conflict of interest in the company to secure the value of the shareholders, the position of the shareholders’ representatives in the board is overly compromised.

This critical analysis therefore concludes that conflict of interest in corporate governance hurts the position of a company and its shareholders and can lead to major scandals and bad reputation of the company. Individuals given the control of a company should only serve one role without conflict.

Recommendations

VW should put guidelines that with avoid conflict of interest between the personal interest and the corporate interest. The first recommendation that VW should consider is to avoid electing Herr as a chairman since he had a conflict of interest with the company, it would be prudent for Herr to resign his directorship to the company that has a conflict of interest with VW. The corporate culture should also be changed, and a more stringent corporate culture mechanism adopted in the company. The Germany Voluntary Corporate Governance Code should also be followed to the latter, and the companies that don’t observe that code should be blacklisted and the he stakeholders advised accordingly (Cromme, 2005). The code indicate that conflict of interest should result to the termination of the mandate of a supervisory member. It is highly recommended that a company should follow the guidelines that are put forth by a corporate governance body. It is also unethical for Herr to consider chairmanship of the company, he should have declined he chairmanship and cite issues of conflict of interest.

One the fact that Herr Piech was supported by the ten employees’ representative on the supervisory board, the issue of whether the shareholders representative should complain is yes. There is no doubt that the employees’ representative supported Herr because he had an interest in the company that was offering advisory services to the company, the employees’ representative had an interest in their own way by supporting Herr, since they were to benefit from issues relating to pension. Therefore, the shareholders’ representatives had the right to complain and protest angst the appointment of Herr, especially the fact that it they are main stakeholders of the company. The control of companies and family heritage should also not be the basis of appointment, the person should be appointed on the basis of merit and there should be no instances of the person to be elected to have some element of conflict of interest. Lastly, the company should ensure that it has strict measures and guidelines that relate to corporate governance. VW should formulate guidelines that are very clear on corporate governance, and that the guidelines should state clearly on the elements of conflict of interest, since conflict of can lead too organizational failure.