Volkswagen Scandal: The Undoing of a Corporate Icon

My first car was a used 1967 Volkswagen Beetle. It was a great little “starter” car, but only a couple of months after I bought it, the car was stolen. Last week, I relived that loss when Volkswagen was stolen from all of us.

The venerable automaker’s shocking admission that it developed and installed software designed to circumvent U.S. emissions rules will forever change how the company is perceived by the public. The phrase “German engineering,” once synonymous with quality, will now be the butt of jokes on late-night talk shows.

What’s more, the scandal once again raises serious questions about the inner workings, and possibly ethical practices, of a respected corporation. As with FIFA, Hertz, and Toshiba, we can expect details of this debacle to trickle out in a painful and public unveiling of failure in corporate culture.

It remains to be seen how pervasive the scheme was to make Volkswagen’s diesel vehicles appear to run cleaner in emissions tests than they do on the road. But one thing is perfectly and immediately clear: This is an extraordinary example of how a company’s reputation, particularly one built over many decades, can be severely damaged — if not decimated — in mere days.

Already, Volkswagen has seen the resignation of its CEO against the backdrop of criminal and U.S. Environmental Protection Agency investigations, which could lead conservatively to fines of as much as US $18 billion. The company already announced it would take a charge to earnings topping US $7 billion. Not surprisingly, Volkswagen’s stock price has plummeted.

On the horizon, one can expect to see lawsuits from car owners, shareholders, and others directly and indirectly affected by Volkswagen’s actions. And one thing is certain, the impact won’t be limited to Volkswagen. Like a devastating tsunami after an earthquake, the scandal’s ripple effect already is striking stock prices of other automakers and parts suppliers.

The fallout conceivably could spread to other consumer sectors, where claims about product performance or quality will understandably be viewed more cynically. Is gluten-free really free of glutens?

Ultimately, the consequences of this misdeed might topple the world’s second largest car company, according to some analysts. Whether Volkswagen can survive the storm, from an internal audit perspective, the scandal must be placed at the catastrophic end of the risk spectrum.

It remains to be seen if Volkswagen’s top managers knew about the scheme or contemplated the risk of its discovery. But the lesson for internal audit is that virtually all risk carries a component of potential reputational damage to the organization. In the case of Volkswagen and many other failures of iconic companies, it would seem unimaginable that management or the internal audit function would condone potentially criminal behavior in support of boosting the company’s value. The risks associated with such behavior — reputational, share value, corruption, fraud, corporate culture — are unacceptable to me, and presumably unacceptable to most shareholders and consumers.

This brings up another lesson to be drawn from the Volkswagen episode: Internal auditors must be keenly aware of the pressures associated with performance within their organizations. In a nutshell, they must understand that what gets measured/rewarded also can get manipulated.

Whether it’s about profits, bonuses, or reducing the emission of nitrogen dioxide, internal audit must be attuned to pressures that management, regulators, or stakeholders place on measurable metrics. Typically, this is where an organization is most vulnerable to bending or breaking the rules.

I am encouraged by the comments of new Volkswagen CEO Matthias Müller upon his being named to the top post. Müller, who worked his way up the corporate ladder over a 38-year-career that began with Audi, a unit of Volkswagen, said winning back trust is his most urgent task. He promised to accomplish this, “by leaving no stone unturned and with maximum transparency, as well as drawing the right conclusions from the current situation.”

It will be a good first test for Müller to see if he can truly determine whether creation of the emissions “defeat device” was an isolated instance of overzealous engineers succumbing to compliance pressures — or a product of a broader corporate culture willing to do anything to achieve results.