It’s Grimm for Volkswagen

Schadenfreude is an emotion that many non-Germans are indulging in at the news that Volkswagen is not the squeaky clean corporation that everyone believed it was.

While we need time to get over the sense of [hidden] glee we feel at such a ‘holier than thou’ company getting its ‘comeuppance [1]’, the tale of Volkswagen really is Grimm and the Brothers had, as usual, a Tale on hand to cover the situation.

In the tale ‘The Bright Sun Brings It to Light’ a penniless tailor murders a Jew for a paltry sum but the dying man warns him that he will get found out eventually by the ’bright sun’. And so it was. Many years later, the now family man remembered what he had done when one day the sun glinted on his coffee, and he unburdened himself to his wife, urging her not to tell anyone. But his wife told a friend and before long it was all over town and the tailor was tried and condemned to death as the dying man had predicted.

The tragic tale of Volkswagen (and it is a tragedy that impacts real people’s lives) has followed and is following a now-familiar pattern. We are currently in the ‘new broom’ phase [2], having turfed out the CEO and desperately looking for scapegoats  – the traditional bad apples. As we go forward, lower level managers will get sacked and the company will pay billions of dollars in fines and compensation. It will take a long time for Volkswagen to regain its previous glory – the brand has arguably been irreparably damaged. It’s not inconceivable that some time down the road the company will be broken up and re-branded.

It’s all so predictable!

But let’s delve into why the scandal happened?

At its core, the Volkswagen debacle began with a really bad decision – to add a bit of software to make it easier to nudge the results of emission tests in the ’right’ direction. Now we already know that all car companies make adjustments to their test vehicles, such as inflating tires and switching off air conditioning, to ‘pass’ emissions tests [2]. It is only a small step to putting a few lines of code into the on-board computer to make the adjustments automatically.

Somebody, somewhere came up with the bright idea, some manager thought it was a great idea and further up the line no-one questioned the fact that tested emissions appeared to be improving without anyone actually doing anything. No one thought about the ethics, – it was just pushing the envelope a little bit further and, by the way, ‘everyone is doing it’!

This is not an engineering design problem, such as cars losing power at high speed, but People doing the wrong thing, albeit with the belief that it was for the good of the company.

The Volkswagen case is an example of People Risk, or the risk that people make bad decisions that can cause large losses to a company. And there are numerous examples, such as LIBOR manipulation in the banking industry and money laundering by HSBC [3]

But why do such disasters keep happening?

Leon Festinger, the father of the concept of Cognitive Dissonance argued that “humans are not a rational animal, but a rationalizing one!”

In other words, people make a decision and then justify it to themselves and others. In real life most people could not live with themselves if they consciously did something wrong – they would be constantly afraid of the ‘bright sun’ catching them up. Of course some people (such as psychopaths) are not worried by such niceties but most of us are and we ‘kid’ ourselves that we always do the right thing for our firms.
So what are the rationalizations in this case; see [4 and 5] for other examples.

The first is ‘Ubiquity’ – everyone’s doing it so it must be OK? This was true of scandals such as the GFC where ‘everyone’ was creating toxic securities based on dodgy mortgages. This is a form of ‘Groupthink’ across an industry.

The second is ‘Victim-less Crime’ – no one is getting hurt and lots of people benefit, not least my firm. Of course, someone somewhere might get hurt but we don’t know who? We tend to only feel empathy with ‘real pictures’ not abstract groups. This rationalization is everywhere, such as in the PPI scandal in the UK banking system.

The third is so-called ‘Distrust of Law’ – the emissions rules are silly and don’t work, so no need to obey them. This was the underlying rationale for example for manipulating the FX benchmark.

The combination of Ubiquity, Victim-less Crime and Distrust of Law are everywhere in scandals from the GFC to the manipulation of the LIBOR markets.

What does this mean for business decision making?

When a business decision is made it is important to be able to distinguish the reasons given for a decision from the post-hoc rationalizations. And if any of the reasons/rationalizations smell like, ‘everyone else is breaking the rules, because the rules are wrong’ then alarm bells should go off. While such a reason/rationalization may be at least partially true, it won’t help much when the rule breaking gets found out.

In particular, the Board of a corporation should work to be the ’bright sun’ that brings in the light and should demand that proposals clearly distinguish between reasons and rationalizations. That alone might prevent a Volkswagen happening to their shareholders.

People Risk Management

The risk that an employee or group makes bad decisions is a People Risk as it can lead to significant losses even the bankruptcy of the firm. In this case decisions to proactively work to game emissions tests has resulted in significant damage to the reputations of Volkswagen and the whole car industry.

This blog is one of a planned series that will discuss facets of People Risk in general and bad Decision-Making in particular [4]. It is obvious that managers and assurance functions, such as Risk Management, Audit, Compliance and Human Resources, must understand the concept of People Risk, particularly the influence of individual and group biases on decision-making, because badly-made decisions may result in significant damage to the firm.

References
[1] See news report
http://www.forbes.com/sites/greatspeculations/2015/09/24/dieselgate-scandal-could-cost-volkswagen-up-to-35-billion/
[2] See http://www.theguardian.com/business/2015/sep/25/volkswagen-appoints-matthias-muller-chief-executive-porsche-vw
[3] See https://peopleriskmanagement.com/2015/02/26/hsbc-board-level-people-risk/
[4] See Blacker and McConnell, 2015, ‘People Risk Management’, Kogan Page, London http://www.koganpage.com/product/people-risk-management-9780749471354
[5] See McConnell, 2015, ‘Systemic Operational Risk: Theory, Case Studies and Regulation’, Risk Books, London
http://riskbooks.com/systemic-operational-risk-theory-case-studies-and-regulation

Disclosure: the author owns a Volkswagen of the type that may have the rogue software but considers the deception more in sorrow than anger.

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