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Reputability LLP are pioneers and leaders globally in the field of reputational risk and its root causes, behavioural risk and organisational risk. We help business leaders to find these widespread but hidden risks that regularly cause reputational disasters. We also teach leaders and risk teams about these risks. Here are our thoughts, and the thoughts of our guest bloggers, on some recent stories which have captured our attention. We are always interested to know what you think too.

Wednesday, 23 September 2015

First Lessons from Volkswagen

Volkswagen, scion of German industry, has fallen off its pedestal after revelations that up to 11 million of its diesel cars were fitted with software designed to deceive regulators about levels of toxic NOx emissions. 

It all began to unravel last in May 2014 when Virginia University's Center for Alternative Fuels, Engines & Emissions (CAFFE) discovered that NOx emissions from two of three diesel-powered cars it was testing produced between 5 and 35 times more than the official emissions standard, though in laboratory conditions they complied.  This was the first whiff of rat.

According to a Californian Air Resources Board (CARB) letter of 18 September, CARB took up the case and pursued investigations.  Discussions ensued with VW, who solemnly carried out tests and provided fixes, which did not work when CARB tested them.

As CARB relates in its letter, on 3 September, after a year's prevarication, VW confessed.  As the world now knows, large numbers of VW's diesel-powered motor cars were "designed and manufactured with a defeat device to bypass, defeat or render inoperative elements of the vehicle's emission control system" whilst meeting official testing procedures.

When the news became public, on 18 September, it was met with a mixture of incredulity and a drop in the VW share price of about 25%.  After defending an almost indefensible position for almost five days, VW's Chief Executive Martin Winterkornstood resigned.   Some began asking whether VW would survive.

Beyond VW there was collateral damage.  The share prices of other car makers dropped, though less than VW's.  A discussion began as to whether diesel technology, held responsible for large scale health problems, was a wrong turning that should be abandoned.  And questions were asked whether, after a long string of governance failures in Germany, German industry was really the paragon represented by its good reputation

But the intriguing question is: why did this happen?

We do not yet know what happened but it is not unknown for major corporate scandals to have their genesis in the board room.  Think of the Olympus and Toshiba scandals.  That said there is no evidence of active boardroom involvement and Mr Winterkornstood's protestations of surprise imply that he first learned of the problem very late in the day.  But the composition of the supervisory board, which does not seem to have been chosen with skill sets as its primary concern, has echos of the boards at Airbus at the time of the A380 crisis and at the UK's Co-operative Group when it almost collapsed.

If that is so, he must have been in the dark, unaware of what seems to have been a piece of deliberate skulduggery going on under his nose - but without his knowledge.

This sadly is a very common state of affairs.  We call it the Unknown Knowns problem.  There are things that leaders would dearly love to know - but they cannot find out until it is too late.  In our research, 85% of leaders were taken by surprise when a serious crisis engulfed their company. Yet most of these crises were caused by systemic failures that had lain unrecognised for years, sometime decades.

The most telling example is that there have been at least 14 rogue traders, averaging one every eighteen months, since Nick Leeson broke Barings in 1995: most recently the London Whale, who breached in 2012.  JP Morgan sustained losses of $6 billion on positions said to amount to about $160 billion.  All the rogue traders operated in an environment where risk teams are huge: JP Morgan's risk team ran to thousands but they didn't spot the Whale; nor did the astute Jamie Dimon - until an even more astute hedge fund spotted his problem from the outside and began to trade on his misfortunes.

What seems to happen is that some combination of character, culture, leadership, targets, incentives, corner-cutting, complexity, groupthink - and the slippery slope from gently bending rules to breaking them - leads an individual or team to start doing something that, as Warren Buffett put it, you "wouldn't be happy to have written about on the front page of a national newspaper in an article written by an unfriendly but intelligent reporter."  It doesn't help if regulators are not robustly independent.

Once the wrongdoing has begun, it is very hard for participants to confess - doing so will probably lead to unpleasant sanctions - so it continues.  The hole gets deeper.

The wrongdoing is rarely known just to the participants.  Others usually know, but are unwilling to rock the boat.  This may be because the wrongdoer has higher status; or it may be because they are in the same 'tribe', but as time passes unwillingness becomes tacit complicity.  Many may know things are wrong but they won't tell anyone above them.  Often the root causes are visible to the thoughtful, perceptive outside observer, such as a hedge fund or professional investor.  We call these companies 'predictably vulnerable'.

There may be a potential whistle blower; but anyone who researches whistle blowing as an activity will discover that it is commonly terminal if not merely frustrating.  It takes courage and determination to blow the whistle; and it takes an exceptional leader to listen and understand what a whistle blower is alleging with an open mind.

This is one of the ways in which leaders find themselves in the dark.  Breaking this silence is difficult.  It takes an insider-outsider, as anthropologists term it, armed with trustworthiness, skill and understanding of human behaviour to learn what insiders think and know but won't tell.   A sensitive investigation should uncover the root cause behavioural and organisational risks that lead to Unknown Knowns so that leaders can fix at least the root causes before they can cause more harm.  And as our research also shows, they usually do have some time.

An investigation may uncover things you wouldn't be happy to have written about on the front page of a national newspaper.  If so, you should listen and learn; and be grateful for the opportunity to deal with them before they blow up and destroy your personal reputation as well as that of your organisation.

Anthony Fitzsimmons
Reputabilty LLP
London
www.reputability.co.uk












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