The $50 Million Agency Problem

All opinions expressed are my own and do not necessarily reflect the views of Chiasma Inc.

Image by bengt-re from Sweden (Halloween-raceUploaded by Josve05a) [CC BY 2.0] via Wikimedia Commons

Image by bengt-re from Sweden (Halloween-raceUploaded by Josve05a) [CC BY 2.0] via Wikimedia Commons

If you haven’t already heard; Volkswagen are emission cheats. (Full story here)

When I heard the story my first thought was: agency problem - employees are acting in their own best interest. Why? The now ex CEO, Martin Winterkorn, says he knew nothing but I think this is unlikely. With 11 million vehicles currently known to be affected, he and others have no doubt been benefiting from the advantages of this for years. The deception will have helped them to meet sales targets, emission targets, cost targets etc. all while picking up bonuses for this (non-existent) effort.

But now the game is up. Heads have rolled.

Martin Winterkorn walks away from the great mess with a further 28.6 million euro ($51 million NZD) - enough to ease a guilty conscience?

Martin Winterkorn By Volkswagen AG [CC BY 3.0], via Wikimedia Commons

Martin Winterkorn By Volkswagen AG [CC BY 3.0], via Wikimedia Commons

Agency problem is one that is faced by all large companies. The usual solution is to tip the scales by including company shares in the compensation package. The idea is that this will incentive the managers to operate in the best interest of the shareholders. But when top managers are paid in the millions, how much is enough?

The second way that a company tries to minimize agency problem is the board of directors. In theory, the board should remove a CEO that is not acting in the best interest of the company. This relies however on the board identifying the corruption before the problem rises. This is not an easy task.

In the case of VW the board continue to back the ex CEO, supporting his story that he knew nothing. This is another conflict, as the board is unlikely to admit they believe he is responsible, even if they know he is. Doing so would not only be bad for the company but would also reflect badly on their own judgement.

As in previous cases of corruption we will never know for sure who knew what. Understanding agency problem however, can give us an insight into the deeper story.