Will Volkswagen Shake-up Traditional Governance?
“The chronic productivity problem in VW cars is a consequence of its legal form”
Volkswagen, particularly its core brand, needs to attain healthy profitability to restore investor confidence, but this is unlikely to happen while strategy remains in the hands of the union and local politicians.
And whatever protestations Volkswagen’s leadership makes that a shakeup is coming, this is unlikely to change.
That’s the view of investment banks and analysts, reacting to the stinging attack on VW from shareholder TCI Fund Management which said in a letter that top executives had been paying themselves too much money in return for protecting jobs and wages.
The engineering workers union controls half the votes on the ruling 20-seat supervisory board. The German state of Lower Saxony has two seats on the board too.
Volkswagen is still reeling from the effect of the dieselgate scandal after it admitted cheating to defeat U.S. environmental rules which limited noxious emissions from diesel engines. This concerned around 500,000 diesel engines in the U.S. The scandal then moved on to the rest of the world with 11 million engines involved in cheating not only diesel emissions, but also fuel economy claims.
Investment researcher Evercore ISI, although conceding that the union is often more constructive than given credit for, said the power of veto held by Lower Saxony is holding back Volkswagen from transforming itself and staying on top of the global industry.
“With (the) Porsche (Piech and Porsche family shareholding), and (the state of) Qatar, VW today has two anchor shareholders. The arguments for special privileges just don’t exist anymore,” Evercore ISI analyst Arndt Ellinghorst said.
“Obviously, it hasn’t made the VW brand a more efficient business,” he said.
Chronic low profitability
The VW brand accounts for more than 55 per cent of the automotive division sales, and suffers from chronic low profitability compared with world-class companies like Toyota, said Professor Ferdinand Dudenhoeffer, director of the Center for Automotive Research (CAR) at the University of Duisburg-Essen.
In 2015, Toyota’s auto division profit margin before interest and tax (EBIT) was 9.7 per cent.
“This is almost a factor of three higher than at VW brand cars for the first nine months of 2015,” Dudenhoeffer said.
VW Group also includes premium brands like Audi and Porsche, luxury brands Bentley and Lamborghini, and workaday SEAT and Skoda.
VW looks bad compared with GM too, which produced 46 cars per employee in 2015 compared with 17 at Volkswagen. GM, with 215,000 employees, produced almost as many cars as VW with 600,000 employees, Dudenhoeffer said.
VW brand’s costs have been out of line with its competitors for a long time, and it persists because of the intransigence of the governing structure.
“The chronic productivity problem in VW cars is a consequence of its legal form,” Dudenhoeffer said.
The engineering workers union with 50 per cent of the Supervisory Board votes, plus the politicians from Lower Saxony, can dominate decision making, he said.
The letter to VW from TCI Fund Management made a similar point.
“Clearly the company has a major corporate governance problem. The fact that huge management bonuses have been approved by the labour-dominated Supervisory Board suggest the old executive management team knew they would be paid a lot of money simply for protecting jobs and increasing wages. We are concerned this improper arrangement is continuing today. That is no way to run one of the biggest companies in the world and it is no longer acceptable to minority shareholders. It also brings into serious question the judgement of the controlling Porsche and Piech families as to why they are happy to see management enrich themselves whilst the value of their shareholder collapses,” the letter said.
Investment bank Morgan Stanley doesn’t see much hope for VW increasing its profitability.
“VW’s premium pricing strategy to offset VW’s high cost base has clearly not been successful. Without a sharply lower cost base likely involving lower cost manufacturing outside of Germany, it is not clear to us that VW’s position is easy to improve,” said Morgan Stanley analyst Harald Hendrikse.
VW’s structure limits potential for change, Hendrikse said.
Evercore ISI’s Ellinghorst said VW needs a more contemporary structure with Lower Saxony’s so-called special blocking minority, and guaranteed seats on the board eliminated.
“Granting the Government (of Lower Saxony) two seats on VW’s board materially distorts the balance of power between shareholders and workers. Effective decision making on the Supervisory Board is questionable. Lower Saxony and the labour side dominate the board, which hasn’t proved to be effective in the past and will unlikely be helpful in the future,” he said.