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Corporate Financial Management Question 1 : Explain what is meant by the term “corporate governance”. In...

Corporate Financial Management

Question 1 :

Explain what is meant by the term “corporate governance”. In 2015, an emissions scandal involving Volkswagen unfolded. Based on your knowledge of corporate finance, critically assess what has happened to the value and performance of Volkswagen since the emissions scandal was uncovered. Why do you believe the value has changed and what impact this might have on the corporate governance policies of Volkswagen going forward? How can Volkswagen mitigate the risk of events such as this one occurring in the future?

  • Explanation of Corporate Governance
  • Clear understanding of corporate governance and why it is crucial that companies have high quality corporate governance in place.
  • The depth and quality of company analysis:
    • Good understanding of the business background based on the available data
    • Clear identification and outline of the events
    • Comprehensive outline and discussion of ways to mitigate risk going forward

Solutions

Expert Solution

Corporate governance is the system of rules, practices, and processes by which a firm is directed and controlled. It essentially involves balancing the interests of a company's stakeholders, such as shareholders, senior management executives, customers, suppliers, financiers, the government, and the community. Since corporate governance also provides the framework for attaining a company's objectives, it encompasses practically every sphere of management, from action plans and internal controls to performance measurement and corporate disclosure. In short, it refers to the set of rules, controls, policies, and resolutions put in place to dictate corporate behavior.

Corporate governance is important as it increases the accountability of a company and avoid massive disasters before they occur. A high corporate governance structure in place can help in increasing transparency, preventing market shocks, reduction in conflict of interest and at times can also help avoid possible shareholder activism.

The Volkswagen emissions scandal began in September 2015, when the United States Environmental Protection Agency (EPA) issued a notice of violation of the Clean Air Act to German automaker Volkswagen Group. The agency had found that Volkswagen had intentionally programmed turbocharged direct injection (TDI) diesel engines to activate their emissions controls only during laboratory emissions testing which caused the vehicles Nitrogen Oxides (NOx) output to meet US standards during regulatory testing, but emit up to 40 times more NOx in real-world driving.

On 21 September 2015, the first day of trading after the EPA's Notice of Violation to Volkswagen became public, share prices of Volkswagen AG fell 20% on the Frankfurt Stock Exchange. The next day, the stock fell another 12%, while on the third there was a further fall of 10.5%, thus dropping below €100 to a record 4-year low before regaining some lost ground. A year later VW stock was down by 30%.

The emission scandal also had an impact on its financial results. Volkswagen had to set aside €6.7 billion to pay for recalling and fixing affected vehicles and received a lawsuit from the US Department of Justice for up to $46 billion under the Clean Air act. In February 2016, The New York Times reported that Volkswagen “would delay reporting its annual earnings and move back the date of its annual shareholders’ meeting because of uncertainty about the cost of its diesel emissions scandal.”

The scandal did highlight some of the corporate governance issues that existed in Volkswagen. Primarily it is reported that one member of the controlling families, Ferdinand Piëch, was able to take leadership of the company and direct it in pursuit of his own ambitions for industrial domination. It was in the course of that pursuit that the emissions scandal occurred. As the controlling shareholder, with the cooperation of the labour unions and the government, which both sought greater employment, Piëch had, for years, direct effective control of all corporate activities, and he drove the company toward his goal of becoming the world’s largest car manufacturer. Further, the board of directors were mostly non-independent, and the company has seated several family members, including two nieces of the former Chairman, without providing substantial disclosure about their credentials.

The company also had labour representatives on the board. Unusually, the Board Chair was a labour representative, which also created a perceived conflict of interest regarding alignment with shareholders. The audit committee was not independent, and the company lacked a compensation committee. These factors not only failed their corporate governance policy but also lead to this scandal.


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