Volkswagen's Perfect Storm

Commentary | Reputation Risk

UNDER THE COSH The emissions scandal hit the automaker on all fronts

Volkswagen’s perfect storm olkswagen’s toxic mix of The Volkswagen emissions unravelled so quickly and had such a dramatic evolving and growing compliance and immediate impact on stock price, car risks (that should typically be scandal represents a resale value, stakeholder value and more. caught in a robust enterprise risk classic example of reputation V management and compliance Two compliance risks system) with the presence of risk gone wrong and and three strategic risks strategic risks (that the board is closes a turbulent year in It appears that Volkswagen had at least two responsible for overseeing) yielded what I serious underlying compliance risks: would call the perfect reputation risk storm reputation management of 2015, or maybe even the decade. ■ Dr. Andrea Bonime-Blanc Product fraud, misrepresentation and Embedded in this crisis were several Chief Executive Oficer and false advertising (the defeat software) underlying and neglected compliance and Founder of GEC Risk Advisory ■ Environmental (toxic emissions many strategic risks that explain why this scandal times higher than legally permitted)

Ethical Boardroom | Winter 2016 Reputation Risk | Commentary

If Volkswagen had a robust enterprise Culture risk Closely tied to leadership risk is risk management and compliance system, culture risk. Why? The leadership style of a leader A lesson for the rest of us is and had conducted rigorous analysis of the is often intimately linked to the performance, to understand and repair the downside impact on its key stakeholders, compensation, risk and reward structure of perhaps the perfect risk storm would not have an organisation. And the leader’s performance elements of organisational occurred. The stakeholder analysis (below) is in turn intimately connected to how the board resilience that might be provides a quick overview of the multitude of treats that leader from a compensation and missing or under-deployed stakeholders affected. accountability standpoint. If all the board does The two underlying compliance risks were is reward the CEO for financial metrics and not in our own organisations either allowed to develop or were actively ignored. for how those metrics are achieved there is likely With the passage of time and addition of the to be culture risk – a serious strategic risk. that the underlying environmental violation and following three strategic risks, it was only a product fraud risks were covered up or suppressed matter of time before the perfect strategic risk Reputation risk Reputation risk as it relates to over a period of time (instead of addressed and storm would gather. an organisation is almost always a strategic risk repaired) explains why the reputation risk because of its very nature. attached to these underlying risks grew over time. Leadership risk It appears from the facts “Reputation risk is an amplifier risk that In the case of the other two strategic risks – we know that the leadership style of the layers on or attaches to other risks – especially leadership and culture risk – reputation risk is previous CEO Martin Winterkorn was Environmental Social and Governance (ESG) tailor-made to amplify and worsen the impact authoritarian, single-mindedly driven to create risks – adding negative or positive implications of these risks: it has been claimed that leadership the number one auto company in the world, to the materiality, duration or expansion of encouraged (tacitly or openly) risk-taking and whatever it took, tolerating little or no dissent the other risks on the affected organisation, rule-breaking, creating a culture where no one along the way. This could be a textbook case of person, product or service.” 1 (employees and suppliers) felt safe to speak up leadership risk, something that we have learned If one applies the reputation risk layer onto the about possible problems that might derail the from past cases (Enron, WorldCom, Lehman underlying risks at Volkswagen the picture overall strategy of the company – becoming the Brothers) can doom a company. becomes clearer and more dramatic: the fact number one global auto company.

VOLKSWAGEN: EARLY STAKEHOLDER ANALYSIS The Volkswagen case: ■ Customers – recall hassles, costs, embarrassment and anger of owning a the role of the board less shiny brand that isn’t environmentally compliant The Volkswagen case is very recent and much ■ Future customers – many will be lost to competitors remains to be known. But the severity and intensity of this scandal yields a number of important ■ Employees – dealing with investigations and embarrassment, lessons even at this early stage. There are important many to lose jobs, others may vote with their feet reputation and strategic risk lessons, for the highest ■ Future employees – many lost to competitors or other industries echelons of an entity – specifically the board. ■ The works councils – loss of prestige, power, ability to influence future outcomes As Volkswagen scrambles to deal with the ■ The Town of Wolfsburg (Germany) – a company town, Wolfsburg and its economic immediate crisis by deploying its crisis eco-system have been built around Volkswagen management, there are a number of critical ■ The government of Lower Saxony – a Volkswagen shareholder and medium- to long-term activities that the member of its supervisory board company, its supervisory board and executive ■ Dealers – recalls and embarrassed to carry the brand, likely to lose substantial future sales management must undertake to address their ■ Audi, Seat, Skoda – the ‘brother’ auto companies under the Volkswagen long-term survival and to restore the trust of its umbrella may suffer collateral damage stakeholders including:z2 ■ Other automakers – the microscope will be trained on other global automakers ■ to find out whether similar deceitful practices abound Deep SWOT (strengths, weaknesses, ■ opportunities, threats) analysis Germany, the brand – much discussion is already underway on whether the ■ stellar German brand for quality and engineering has been damaged Corporate governance and culture overhaul ■ Establishment of an effective global ethics ■ Shareholders – already suffering devastating, probably unrecoverable equity losses, and compliance programme preparing for multiple types of law suits in multiple jurisdictions ■ Understand and deploy reputation ■ Banking and investment community – already burned, some may stay away, risk within ERM others may play financial games that may not benefit Volkswagen ■ Undertake stakeholder impact ■ Environment – the diesel toxic emissions are 40 times greater than permitted analysis and repair plan under US law and arguably much worse for the health of living beings anywhere ■ Build organisational resilience and ■ Executives and management (plus former executives and management) long-term stakeholder trust – under the gun and under the microscope of public opinion, governments, regulators and prosecutors for a long time to come The rest of us must take advantage of ■ The supervisory board – under pressure to ramp up more proactive corporate this dark time to understand and repair the governance and/or engage in more wholesale corporate governance reform elements of organisational resilience that might ■ Multinational regulators – likely to ramp up investigations and be engaged in long-term be missing or under-deployed in our own investigations, prosecutions, settlements and compliance monitor arrangements organisations to build long-term resilience, trust and organisational strength for the longer term ■ Lawyers and consultants – arguably the only ones who will benefit and to the benefit of our stakeholders. greatly from this reputational cataclysm ■ The media and social media – will continue to have a party discussing 1Andrea Bonime-Blanc, The Reputation Risk every possible angle of this scandal, fanning the fires with information Handbook: Surviving and Thriving in the Age of Hyper-Transparency, 2014. 2The Reputation Risk that may be accurate, inaccurate or downright malicious Handbook Chapter 5.