Governance risks

VW's mega-profit hides risky governance weak spot

Volkswagen is defying gravity. Even though the European car market has been in terrible shape for two years, VW's 25.5 billion euros of 2012 pre-tax profit was the highest ever for a listed German company.

While half of that profit was a one-off, thanks to a revaluation of financial derivatives related to the Porsche takeover, the actual business is performing nicely. Operating profit increased by 2.1 percent to 11.5 billion euros. But the industrial strength comes with a serious weakness - in corporate governance.

Volkswagen's supervisory board is highly politicised and lacks real external control. Of the 20 members, 17 are local politicians, German trade unionists or belong to two related and occasionally feuding family lines, Piëch and Porsche. Ferdinand Piëch, the 75-year-old chairman and former chief executive, is an autocratic patriarch who still dominates the company. He intends to stay for another five years. His brother has been on the board for years. Piëch's wife, a childcare worker by training, recently joined.

On top of that comes heavy state influence. The regional government of Lower Saxony holds 20 percent of the shares and enjoys a veto on all important decisions.

Management theory and the history of other companies show that this structure is a recipe for disaster. VW's own story supports the case. In the early 1990s, it plunged into an existential crisis. A decade later, the company was rocked by a compliance scandal, involving prostitutes and luxury trips for members of the workers' council.

True, Volkswagen has avoided such blunders in recent years. Right now, it is steaming ahead. It has 12 well-positioned brands. It has globalised, and become less vulnerable to regional economic cycles. It is pushing costs down with a new production concept that standardises parts across different models. That could boost annual pre-tax profit by 14 billion euros.

However, the lack of external checks and balances should not be taken lightly. Strong governance protects companies from overconfident managers, vanity projects and internal sleaze. VW's good record of the last few years provides no guarantee that it will always remain immune from these dangers.