The Consequences of the Volkswagen Scandal
By Stephen Silvia

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"Sed quis custodiet ipsos custodies?" wrote Juvenal in his satires many centuries ago, "Who will guard the guardians?" This is the question confronting employees and shareholders at Volkswagen and other German firms in the wake of the Volkswagen scandal, which broke a little over a month ago. The scandal itself is both stereotypical and sensational. The financial side includes dummy companies, kickbacks, and padded expense accounts. Reports of sex tours to Brazil for works councilors ensured that the scandal received attention not only on the financial pages, but also in the tabloid press. The Volkswagen scandal touches three spheres: politics, codetermination, and the "system VW" of collective decision making. This brief essay will discuss the impact of the VW scandal on each.

Volkswagen is a unique company. While some have described it as the "last relic of Deutschland AG," it has always been sui generous, even within "Modell Deutschland" during its heyday from the 1960s to the 1980s. First, unlike BMW and DaimlerChrysler, which are private companies, the state of Lower Saxony currently owns close to twenty percent of Volkswagen. Second, the so-called "lex Volkswagen" effectively insulates the firm from hostile takeovers. This law states that no single shareholder may cast more than twenty percent of the votes at a shareholders' meeting, regardless of the number of shares owned. The law has suppressed VW's share price, since it restricts the capacity of shareholders to profit from ownership and insulates management from paying the price for bad decisions. The European Commission has challenged the Volkswagen law as a restriction on the free flow of capital that is incompatible with the Treaty of Rome; the Volkswagen law is currently under review at the European Court of Justice. Finally, Volkswagen is famous for its "system VW," as officials from the Industriegewerkschaft Metall (IG Metall, industrial union of metalworkers) like to call it. System VW is the extremely tight relationship among management, Lower Saxony public officials, and the firms' works councilors that mark the governance of the firm. This includes a "house" collective bargaining agreement that has made VW workers the highest paid in the German automobile industry and the penchant of the union to launch pilot programs at VW - such as shortened weekly working time to stave off layoffs - that IG Metall wishes to spread throughout the metalworking sector.

The VW scandal applies a heavy coat of tarnish on the recent labor market reforms of the Schröder government, but it is unlikely that it will cost the Sozialdemokratische Partei Deutschlands (SPD, Social Democratic Party of Germany) a significant number of votes. This is by no means the first scandal at Volkswagen; the political damage had already been done. A year earlier it came to light that Volkswagen had scores of SPD Bundestag members on its payroll who had no responsibilities within the firm. The current scandal does add one new political twist, but it provides little more than Schadenfreude for the critics of Federal Chancellor Gerhard Schröder. In wake of the scandal, Peter Hartz chose to resign as personnel director at Volkswagen because of, namely, expense account padding in his division. Hartz had previously headed the commission that in 2002 issued a package of proposals to reform the German labor market. The series of labor market reforms passed starting in late 2002 have all borne his name, despite the fact that he distanced himself from the content of much of the actual legislation. Critics of the entire reform agenda see the Hartz resignation amidst scandal as simply proof of the underlying illegitimacy of the Hartz proposals. Proponents of the reforms concede no linkage between the reforms and the current scandal. The VW scandal also does not have political legs because the Christian Democrats are vulnerable to it as well. Lower Saxony minister president Christian Wulff was a VW board member when the alleged improprieties took place, but did nothing. Christian Democrats at the federal level have also advocated labor market reforms that call for decentralizing wage determination. The proposed reforms would expand the role of works councils, yet the VW scandal heavily implicates some works councilors.

The VW scandal has also prompted criticism of Germany's system of codetermination. The original purpose of codetermination was to integrate both labor and management into the new democratic and capitalist regime. Some proponents of codetermination have also argued that the additional oversight that it provides should provide greater accountability and economic efficiency. In recent years, elements of codetermination have been criticized. There is a mismatch however between the criticisms and the details of the VW scandal. Codetermination has two components: employee representation on corporate supervisory boards (Aufsichtsräte), and works councils comprised of elected employee representatives. Works councils have far greater support among German employers than employee representation on corporate boards, yet it was works councilors rather than employee board members who were implicated in the VW scandal. The incompatibility of the contents of the scandal and the focus of the critics of codetermination make the scandal a poor instrument to promote the critics' desired changes. As a result, the VW scandal will not result in the repeal of codetermination.

This does not mean the VW scandal will have no effect whatsoever on VW or on the institution of codetermination. The scandal is likely to unravel much of the System VW and, ironically, accelerate restructuring at VW. The tight interweave of corporate leaders, politicians and union officials at Volkswagen has badly compromised oversight and immobilized decision-making within the firm. Were the company efficient and profitable, this could be overlooked; however, Volkswagen finds itself at the lowest end of the league table in terms of quality and productivity. It no longer has the luxury to engage in social experimentation, such as thirty-hour workweeks. It is far less likely that VW will be roped into these sorts of union campaigns in the future. Wolfgang Bernhard, the new head of the VW car division, comes to the firm from DaimlerChrysler. Bernhard has a no-nonsense reputation. The scandal will give him more room to act aggressively to restructure the company because many of the other players have lost credibility and shattered a "business as usual" approach. The VW scandal also reveals gaps in the oversight of works councils. Neither the metalworkers union nor the federal government engages in periodic auditing of works councils and works councilors, so tight oversight of the overseers would be a welcome reform. The scandal weakens VW's defense of the lex Volkswagen before the European Court of Justice because the law has proved detrimental to achieving best economic practice within the firm. If the ECJ were to strike down the Volkswagen law, VW would immediately become vulnerable to a hostile takeover because it is undercapitalized and its shares are undervalued. In other words, the ultimate impact of the VW scandal could be the end of Volkswagen as an independent firm.

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Stephen Silvia is a Political Scientist at American University and a former AICGS/DaimlerChrysler Fellow.
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This essay appeared in the August 11, 2005 AICGS Advisor.