Darden Professor Luann Lynch peeked under Volkswagen’s hood to determine just how Germany’s premier car maker managed to destroy its once sterling reputation.

Her case study titled The Volkswagen Emissions Scandal, co-authored with former Darden students Elizabeth Bird and Cameron Cutro (both MBA ’16), suggests that a combination of autocratic leadership and lack of both controls and consequences led to a corporate culture that proved fertile ground for bad decisions.

Her study shows the company’s goal was both ambitious and simple. Martin Winterkorn, who took over as Volkswagen’s CEO in 2007, planned to transform his company into the world’s largest automaker by selling over 10 million cars a year, relieving Toyota of the crown. Besides bolstering the bottom line, the strategy would also help Germany ameliorate the effects of the 2008 global financial crisis by exporting more cars. Winterkorn saw the neglected U.S. market as a target to success, though the company would need to triple its car sales in the U.S. to meet its goal. Upping sales meant its engineers had to conjure up a near miracle — powerful, fuel efficient diesel cars whose emissions passed the test of America’s increasingly stringent pollution regulations. And the engineers — who had made German engineering a world renowned brand — had to make the miracle happen quickly.

The company had dismissed the idea of competing in the hybrid market, instead electing to build diesel cars, which held just 5 percent of the U.S. auto market in 2007. Winterkorn believed that diesel promised high fuel efficiency without sacrificing power. However, diesel cars generate significantly more pollutants than gas powered cars. VW engineers faced a huge challenge.

The company had known success under the autocratic leadership of Winterkorn and his mentor, Ferdinand Piëch, both of whom kept VW under tight control. The company’s leadership set aggressive goals, and senior executives involved themselves in even minor decisions. Former employees described a workplace in which subordinates were afraid to admit failure or contradict superiors. Company leaders bullied employees. Piëch bragged that he forced superior performance by “terrifying his engineers” and at times fired engineers or executives who displeased him. Winterkorn didn’t like bad news. “Before anyone reports to him, they make sure they have good news,” said one industry analyst.

After Winterkorn took charge, he tossed the idea of teaming with Daimler, a competitor whose BlueTec invention used a substance called urea (essentially cat urine) to neutralize nitrogen oxide, a major pollutant in car emissions. So VW engineers were starting from scratch and under deadline to meet a tough goal set by demanding company leaders who insisted on success.

VW engineers solved the daunting challenge by installing cheating software in cars exported to the U.S. The software recognized when a car was being tested for emissions in a lab because only two of its four wheels were used, at which point it activated emissions-controlling devices that would have inhibited performance in on-road conditions. In lab testing, the cars met U.S. emission standards. On the road, where the defeat device automatically turned off, testing in some cases showed emissions 35 times higher than allowed.

The discovery of the defeat devices was made in 2014 by researchers curious about why diesel technologies appeared cleaner in the U.S. than in Europe. The fallout was fierce. Regulators across the world opened investigations and VW halted sales of its 2015 models. Winterkorn resigned. Senior managers were suspended or put on leave. VW stock plunged.

Lynch says the presence of three factors contributed to the catastrophic decision made by the VW engineers — pressure, opportunity and rationalization. When those three factors (known by some as a “dangerous triad” or a “fraud triangle”) are present simultaneously, we often see employees act unethically.

  1. Pressure: The pressure from the top was intense. VW’s 25-page Code of Conduct, on which every employee was ostensibly trained in ethics, seemed irrelevant when contrasted with management’s autocratic leadership style and single-minded goal to succeed at any cost. What’s more, the company’s engineering reputation was at stake, and the consequence of failure for the German economy and reputation around design and manufacturing would be substantial
  2. Opportunity: The opportunity to cheat was present, too. Coinciding with the directive the engineers received to come up with a new solution, Bosch sold VW the diesel-engine-management software that could detect when a vehicle was being tested and turn on emission-controlling devices — on the understanding that it would be used for internal testing, as use was illegal in vehicles sold to the public. And modern cars operate with about 100 million lines of software code, making it easy to hide cheating software code amidst the complexity
  3. Rationalization: The engineers knew that in the 1970s, VW engineers had installed in Volkswagens “defeat devices” that allowed the company to cheat on newly enacted emission standards. The consequence then was minimal — a mere $120,000 fine. Even if they cheated, the punishment would be light, they may have rationalized. How else might they have rationalized such a feat?  Perhaps they thought it was in the best interest of the company and, as a result, management would approve.

“When all three parts of this dangerous triad are present, you have a situation in which employees can begin to engage in unethical behavior,” says Lynch.

Changing corporate culture can be difficult, she says, but not impossible. Outside leaders with new ideas and new leadership styles can be brought in, internal oversight can be put in place and consequences for unethical behavior can be clearly stated and acted on when the situation warrants.

Companies should have a clearly articulated values statement that spells out the fundamental core beliefs that should guide all behavior in the organization. And top management must live those values every day.  “Those values statements and stated core beliefs are worthless if top management doesn’t walk the walk,” says Lynch. “Those in the senior positions need to be living those core values in addition to having put them on paper, or these statements of core values are valueless.”

This article is based on the case The Volkswagen Emissions Scandal (Darden Business Publishing), by Darden Professor Luann J. Lynch, Elizabeth Bird and Cameron Cutro.

A summary of the case also appears in the article “Volkswagen’s Lax Ethical and Emissions Standards” in the Darden School of Business/Washington Post “Case in Point” series.

About the Expert

Luann J. Lynch

Almand R. Coleman Professor of Business Administration

Lynch’s expertise and research interests are primarily in how to best pay or otherwise give incentives to bosses that will make their companies succeed. The focus of her work can be broadly characterized as an exploration of how incentives and compensation systems are structured to encourage the desired behavior by the individuals or organizations. Her work has examined incentive issues such as stock options, compensation in post-merger integration efforts and the effect of financial reporting, accounting and regulation on incentive compensation.

Before joining the Darden faculty, Lynch was assistant vice president at Roche Biomedical Laboratories Inc. and held positions in finance and accounting at Roche, Northern Telecom (NorTel) and Procter & Gamble.

Lynch is author and co-author of several articles published in leading accounting and finance journals.

B.S., Meredith College; MBA, Duke University; Ph.D., University of North Carolina