Chapter 1 Cases
Instructions:
Please Choose Option 1 Chapter 1 Case 1 Scenario or Option 2: Chapter 1 Case 2 Scenario.
Please answer the Critical Thinking Questions after each Scenario. Each Question under the Critical Thinking Question should be at least a 50-word response. No more than 100 words for Critical Thinking Question. Please do not write over 100 words. If the Answer for each Critical Thinking Question does not meet the 50 words you must include a justification and your answer must elaborate on the content area and give a clear response to the Question.
Option 1
Chapter 1 Case 1 Scenario: VW Cheats on Emissions Testing
Up until late 2015, Volkswagen AG (VW) was the second-largest carmaker in the world, with its 590,000 employees producing nearly 41,000 vehicles per day. At that time, the company’s prospects seemed bright, with many of its 12 subsidiaries, such as Audi, Bentley, Bugatti, Ducati, Lamborghini, Volkswagen Passenger Cars, and Volkswagen Commercial Vehicles, performing well.
However, the fortunes of VW changed significantly after a large-scale emissions-test cheating scandal became public in September 2015. VW admitted to installing special software designed to deceive emissions-testing procedures in more than 11 million of its cars, starting as far back as 2005. The software sensed when a car was being tested and then activated equipment that reduced emissions. The software deactivated the equipment during normal driving, resulting in emissions that significantly exceeded legal limits, while also reducing fuel consumption and improving the car’s torque and acceleration. The illegal software was installed in VW, Audi, and Porsche models that employed several different diesel engine designs that went through frequent updates over a 10-year period.
VW’s admissions led to investigations in Germany, the United States, and other countries, as well as dozens of lawsuits filed by customers, shareholders, and car dealerships. The U.S. Department of Justice sued VW in January 2016 on behalf of the Environmental Protection Agency, and in June, VW agreed to a $14.7 billion settlement. This represents the highest fine to date for violations under the Clean Air Act. Additional civil penalties, a criminal settlement, and further state-level fines have not been determined but could add billions more.
Since news of the emissions scandal broke, the company’s stock price has dropped 24 percent, from over $182 per share to under $137 by mid-August 2016. In addition, as a result of diminishing sales and uncertainty over future financial penalties, VW has had to relinquish its goal of surpassing Toyota to become the world’s largest automaker by 2018.
Understanding VW’s history and culture provides background necessary to understanding how this scandal could have occurred. VW was founded in 1937 by the German Labour Front, a national trade union controlled by the Nazi regime, to produce an affordable “people’s car” (eventually known as the VW Beetle) designed by Ferdinand Porsche. However, the breakout of World War II interrupted production of the car, and from 1939 to 1945, VW instead produced vehicles for the German army using laborers from nearby concentration camps.
Following the war, the VW plant was slated to be dismantled because it had been used for military production; however, British officer Major Ivan Hirst convinced his commanders of the great potential of the VW Beetle, and the plant soon began producing cars. In 1949, VW passed back to German control under manager Heinrich Nordoff, and the company became a major component of post-war West German revival.
Over the past two decades, the culture of VW has been primarily shaped by two men: Ferdinand Piëch (grandson of Ferdinand Porsche) who was chief executive from 1993 until 2002 and Martin Winterkorn who was chief executive from 2007 until his resignation in 2015 several days after the emissions testing scandal became public.
According to many employees and industry experts, a success-or-else philosophy has existed at VW at least since the time Piëch became CEO. As an example, early in his tenure, Piëch hosted a group of reporters so they could view a prototype of a new sedan intended to leapfrog all of VW’s competitors. When a reporter asked what would happen if the engineering team said that they were unable to deliver the many new features and technical innovations promised by the prototype, Piëch declared, “Then I will tell them they are all fired and I will bring in a new team. And if they tell me they can’t do it, I will fire them, too.”
Piëch turned VW into a global giant by acquiring luxury car brands such as Lamborghini and Bentley and by reviving brands such as Bugatti. One of the technologies he championed was turbocharged direct injection (TDI), which remains VW’s trademark technology for diesel engines. TDI improved fuel efficiency and acceleration and helped make diesel engines more practical for passenger cars. VW company policy required that Piëch retire in 2002 at age 65, but he remained on its supervisory board and was involved in the company’s strategic decisions until his forced resignation in April 2015.
Winterkorn rose through the ranks under Piëch’s leadership, holding significant management positions, including head of quality control, head of research and development, chief executive of the Audi division, and finally, CEO at VW. Winterkorn’s leadership style was similar to Piëch’s; both were known for publicly berating subordinates. Winterkorn would go so far as to bang car parts on tables to emphasize a point. He strongly urged European regulators not to impose excessive emission targets on the automotive industry because he felt that there was a lack of time to develop fuel-efficient technology and that such a regulation would further the economic downturn. Under his leadership, VW bought Porsche in 2012 to further its ambition to become the world’s biggest carmaker.
Many critics have argued that the autocratic leadership style of both Piëch and Winterkorn produced a corporate culture that has been described by some as confident, cutthroat, and narrow-minded. This, in turn, created an environment in which employees were apprehensive about contradicting their superiors and afraid to admit mistakes. Engineers were encouraged to compete for promotion and the approval of a management team who seemed to know only one way to manage: be aggressive at all times.
A central question of this scandal—whether VW’s top management knew of the deception—remains. However, many critics claim that the multibillion-dollar emissions cheating scandal shows that at the very least, the VW engineers who created and installed the software did not believe company management expected them to act with integrity. If they had, VW would not have cheated and would not be in this mess.
Critical Thinking Questions
1. VW has blamed a small group of engineers for the misconduct and claims that members of its management board did not know of the decade-long deception. Within many organizations, including VW, a high value is placed on people who can deliver results and get things done. This can create a problem known as “normalization of deviance,” where something bad is done by a member of the group in order to achieve a goal but nobody says anything because everyone is expecting that someone else will instead. As a result, more and more bad behavior is tolerated. Perhaps, the VW engineers felt they had no other option when they realized that they could not deliver the combination of great performance, high gas mileage, and low emissions that had been promised. Some observers believe that normalization of deviance was perpetuated because VW kept hiring the same type of people with the same views—engineering graduates who are promotion-obsessed workaholics who have been taught not to say “no” to management’s goals. Do you accept this explanation for the emission scandal at VW? Why or why not?
2. VW must bring in a new CEO and a key board member as a result of the forced resignation of Piëch and Winterkorn. Identify three specific actions that their replacements must do to begin to change the corporate culture at VW.
3. At the time of this writing, it has been alleged that Robert Bosch GmbH, Europe’s largest supplier of auto parts, may have had a role in the VW emissions scandal. Bosch supplied the engine control unit that VW programmed to recognize when its diesel vehicles were undergoing emissions tests. However, Bosch states that it is not responsible for how its components are integrated into vehicles by customers. Do research to learn more about what role Bosch may have had in aiding VW in this deception. Do you believe that Bosch should also be sanctioned and/or fined? Why or why not?
Option 2
Chapter 1 Case 2 Scenario: Toshiba Accounting Scandal
Toshiba Corporation, a Japanese electronics and engineering conglomerate with headquarters in Tokyo, produces a wide range of products, including personal computers, semiconductors, consumer electronics, household appliances, and nuclear power plant systems. The company also provides an array of services, such as those focused on information technology, communications, and nuclear reactor construction and operation.
In May 2015, Toshiba formed an outside panel to investigate potential accounting irregularities at the company. The formation of such an outside panel is an accepted procedure for companies in Japan, where corporate boards of directors are composed primarily of company executives, with few independent outside directors. An outside panel is typically formed to investigate matters that may involve improprieties by senior managers and executives.
Toshiba’s CEO, Hisao Tanaka, resigned in July 2015 when the investigation uncovered that he was aware that Toshiba profits had been overstated by a total of $1.2 billion over a seven-year time period. (Further investigation would determine that the amount of the overstatement was closer to $1.9 billion.) Two former CEOs who held membership on the company’s board of directors were also implicated in the investigation and stepped down. Six other members of the board also eventually resigned, and Toshiba announced it would appoint several new and independent directors to its board to strengthen external oversight of its management.
The investigatory panel found that “Toshiba had a corporate culture in which management decisions could not be challenged. … Employees were pressured into inappropriate accounting by postponing low reports or moving certain costs into later years.” Managers at Toshiba set such challenging profit targets that subordinates couldn’t meet them without exaggerating the financial results of individual business units. Furthermore, the head of the investigatory panel stated that the scope of their probe had been limited by company management. The investigation of Toshiba’s U.S. nuclear business, Westinghouse Electric Co., was initially declared off limits. Months after a review of that portion of the business was completed, Toshiba took a $2.5 billion write-down on its Westinghouse business.
Following the scandal, Toshiba was removed from the JPX Nikkei Index 400, the stock index that includes the top Japanese companies based on operating income, return on equity, and market value. The move dealt yet another blow to the company’s reputation—inclusion in the stock index matters because investors, including the world’s largest pension funds, use the stock gauge as a benchmark.
In the first quarter following the revelations of the accounting scandal, Toshiba’s sales fell to their lowest level in years, and the firm lost $102 million for the quarter. The price of Toshiba stock shares dropped precipitously, reaching a 36-year low in early 2016. For the quarter ended July 2016, Toshiba reported a slight drop in revenue but generated its first quarterly profit since the accounting scandal. Cost savings generated by the cutting of bonuses and laying off of employees helped boost profits.
The rise of third-party panels is a part of a larger move in Japan to improve corporate compliance following a number of scandals at companies such as IHI Corporation, Livedoor Company, Mitsubishi, Nikko Cordial Corporation, Olympus Corporation, and others. Under Prime Minister Shinzo Abe, the government, companies, and the stock exchanges have sought to encourage foreign investors with the promise of more corporate transparency.
There are, however, several issues with the use of third-party panels to investigate potential improprieties. For instance, it is the practice in Japan for the members of such a panel to accept the scope of the investigation as defined by the company board of directors. This means that the board can pressure the panel to stay clear of sensitive areas of the business. In addition, members of the panel are not directors of the company and so do not have a fiduciary duty to shareholders. (Company directors do have such a duty, which requires them to work to advance the interests of the company, keep corporate information confidential, not use their position to further their private interests, and inform themselves of all material reasonably available before making business decisions.) Furthermore, the panel members have no power to force managers to handover documents.
Toshiba is a 140-year-old company and one of Japan’s best-known brands. The magnitude of the scandal at the company caused Japan’s Finance Minister, Taro Aso, to comment that the irregularities were “woefully regrettable” and had dealt a blow to the country’s efforts to regain the confidence of global investors. Also noted that if Japanese companies failed to implement appropriate corporate governance, they could lose the market’s trust.
Critical Thinking Questions
1. Observers have commented that a scandal of this magnitude, occurring over such a long period of time, must involve collaboration among a large number of managers—reaching from the lowest level to the highest level of an organization. Should investigation of the scandal at Toshiba continue until all involved parties are outed and punished? What are the pros and cons of such an action?
2. Do you think that the practice of appointing outside panels to perform investigations should continue, or can you develop a better solution to enforce corporate compliance with laws and generally accepted accounting principles?
3. Japan is generally considered to be struggling in areas such as transparency and board independence compared to the global standard. What measures do you think should be considered at the national level to improve transparency and gain the trust of foreign investors?
