Industry-wide corporate fraud: The truth behind the Volkswagen scandal
Introduction
The growing concern about the causes and consequences of climate change has impacted on business practices and consumption behaviours world-wide. To maintain long-term sustainable business developments, firms are motivated to invest heavily in research and development, in the effort to improve technological progress, and to minimize their energy consumption and greenhouse gas emissions. Consumers are more willing to buy, and pay a premium for, products whose values are anchored to environmental conservation (Gatersleben et al., 2002, Pickett-Baker and Ozaki, 2008). Thus the green marketing strategy has become a popular approach for firms in their commercial promotions. A green marketing strategy will inevitably lead to a significant positive impact on the firms’ sales revenue, profitability and market performance. Consequently, firms are encouraged to conduct their business activities by engaging in cleaner production processes.
The literature shows that technological progress plays a critical role in cleaner production activities (Li and Xue, 2016, Cheng et al., 2017). However, the notion is challenged by the uncovering of corporate fraud in environmental statistics. In 2015, Volkswagen (VW) Auto Group was found to falsify the test records of selected air pollutants by up to 40% (Reuters, 2015). Other automobile manufacturers, including Mitsubishi Motors and Suzuki Motors are also involved in test scandals in which they were found to have manipulated fuel economy data in 2016 (CNBC, 2016). This resulted in worldwide investigations of corporate fraud specifically addressing environmental data within the automotive manufacturing industry.
The originality of this study lies in its investigation of the integrity of the automobile industry in relation to environmental standards, which to date has not been investigated. This study identifies several important and under-researched issues correlated to factors affecting the decision-making, and the firms’ environmentally responsible investments (ERIs) in the automobile industry. We review a series of determining factors that affect the decision-making relating to ERIs among automobile makers. Then we extend our investigation to major car makers by empirically identifying the motives behind their deception. The US automobile market, being one of the largest reputable and mature automobile markets, is selected for our study. The research questions underpinning this study are:
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What are the key factors that affect the environmental investment decision of automobile manufacturers?
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What are the factors that underpin a deception scandal in the automobile industry?
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What are the factors that can prevent environmental related corporate deception?
Understanding these questions is important as the climate risk is an increasing concern for everyone on this planet because the effect of climate change could be irreversible and costly (Li and Xue, 2016). Consequently, many countries have introduced a series of environmental policies to transfer the current economic development model to a low carbon economic model with desirable economic growth. In theory, the business sector has no choice but to comply with the environment policies. Realistically, a business corporation needs to balance the potential cost and benefits associated with the compliance to environment policies. However, the literature in this area is scarce thus our study addresses this oversight by developing a conceptual model identifying the factors affecting the investment decision of automobile manufacturers.
Climate change research is classified into two categories: the causes and solutions of climate warming, and the effect of environmental policies on corporate performance. In recent years, climate change has attracted researchers’ attention from multiple disciplines which produces a significant amount of research outputs. For example, climate change studies can be found in Economics (Lise, 2006, Andreoni and Galmarini, 2012, Meng et al., 2013, Zhang and Tang, 2015), Finance (Daskalakis et al., 2009, Jong et al., 2014, Oestreich and Tsiakas, 2015, Griffin et al., 2015), Science (Allen et al., 2009, Meinshausen et al., 2009, McGlade and Ekins, 2015) and the Management literature (Dowell et al., 2000, Hull and Rothenberg, 2008). Empirical studies employ different methodologies, use a wide variety of samples spanning over a number of time periods. They ask different questions directly and indirectly examining the causes of climate risk, and how climate risk affects the economic and financial performance at country, region, industry and firm level (Li and Xue, 2016). However, the empirical findings of previous studies are inconsistent due to methodological issues associated with varying definitions, the choice of variables and their measurement.
In addition, many studies assume that the corporate sector should actively deal with climate risk and comply with the environment policies and regulations in an honest and truthful way. Unfortunately, it is observed that firms, such as the Volkswagen (VW) group, are strongly motivated to present themselves, or their products, to be more environmental friendly, even if they are not as good as they claim. It is precisely this aspect, which is largely overlooked in the literature. Thus this study empirically investigates the factors that underpin the deception in the automobile industry scandals. Understanding this is important to both regulators and investors as corporate performance is directly related to investors’ interest and the long term economic prosperity of the society in a boarder perspective.
The empirical findings show that corporate fraud is positively related to the variable component of the senior managers' remuneration package, implying that performance based payment design could make managers more short term focused which might deteriorate the long term performance of firms. In addition, the empirical evidence shows that firms with a high corporate governance score and leverage ratio are negatively related to corporate fraud, suggesting that a good corporate governance system and the existence of external creditors do have monitoring power on a managers’ behaviour. We find that environmental expenditure is negatively associated with environmental related corporate deception, supporting the notion that technological progress plays a critical roles in carbon emission reduction (Zhang et al., 2014, Liu et al., 2015, Li and Xue, 2016).
To attain long term sustainable communities requires changing current business production modes and consumption behaviours. Consequently, the cleaner production literature mainly focuses on sustainable business models (Bocken et al., 2014), technical progress (Fallde and Eklund, 2015, Cheng et al., 2017), sustainable consumption (Liu et al., 2016, Shao et al., 2017), corporate social responsibility (Barnett and Salomon, 2006Guedhami et al., 2011, Wang and Sarkis, 2017), and sustainable products and services (Chou et al., 2015, Dyllick and Rost, 2017, Hallstedt and Isaksson, 2017). Based on our study's findings, we assert that corporate governance and business ethicality greatly influence a company's operational decision and play important roles in achieving cleaner production targets. This view is overlooked in the literature. As Volkswagen Chairman Hans-Dieter Pötsch confessed on December 10, 2015 “ A group of the company's engineers decided to cheat on emissions tests in 2005 because they couldn't find a technical solution within the company's “time frame and budget” to build diesel engines that would meet U.S. emissions standards”. When the engineers did find a solution, he stated, “they chose to keep on cheating, rather than employ it” (Goodman, 2015). Therefore, we argue that policy makers need to re-examine the climate policies to ensure that they are achievable in terms of technological progress, financial budgeting and timing. Furthermore, the accountability, transparency and responsibility in current corporate governance systems need to be further improved.
This study contributes to the literature in four ways. First, a conceptual model is developed that identifies the factors affecting the firms' ERIs decision and the success of the ERIs. The conceptual model shows that legal and regulatory pressures, the firm's existing level of expertise and competency in ERIs, pressure from competitors, consumers, and owners/shareholders respectively are five key factors determining the a firm's appetite for ERIs. While the success of the ERIs will be heavily influenced by the investment size, marketing timing, technological capacity, managers' ethicality, as well as management's appetite for ERIs. Second, we empirically investigate the fundamental reasons affecting corporate deception in the automobile industry from the corporate governance perspective. The empirical findings show that corporate governance quality and the senior manager's remuneration structure have significant explanatory power on corporate deception. Third, although the cleaner production concept is well established in the literature, the effect of corporate governance and business ethicality on cleaner production has been overlooked. The empirical findings of this study assert that the importance of corporate governance and business ethicality should be taken into consideration and emphasized in the cleaner production process. Fourth and finally, we suggest that policy makers should assist firms in relaxing climate policy pressures by supporting their technological innovation as well as improving corporate governance quality so as to effectively control and monitor management behaviour.
This remainder of the paper is organised as follows. Section 2 discusses the conceptual model affecting the ERIs decision and the succession of ERIs. Then Section 3 reports the data and methodology. Section 4 presents our empirical results and Section 5 draws conclusions and areas for future research.
Section snippets
Developing an environmentally responsible investments model
One of the major causes of global warming is rapid economic growth, leading to dramatic increases in energy consumption (Li and Xue, 2016). Fortunately, countries around the world are united in sharing and expressing their deep concern on this issue, including the major greenhouse gas emitters, such as the European Union, China and the US. Due to differences in economic circumstances, the approaches to, and the formulation of environmental policies vary greatly from country to country.
Data and method
The sample used in this study consisted of 15 major global automobile makers for the period 2000–2015, and includes 240 firm-year observations. These 15 automobile makers are all publicly listed companies in United States. The list of 15 automobile makers can be observed in Appendix 1. These are the firms that have the required data from Thomson Reuters ASSET4 (for CSR score), DataStream (for firm specific information) and annual report (for execution compensation information and ownership
Empirical findings
Our empirical analyses involved t-tests of mean difference, and a probit regression. The univariate test was conducted to test the significance of differences between firms who are facing a scandal and those who are not. Table 2 shows that firms experiencing scandals have significantly higher VCR, lower LEV and lower CGS.
The regression results of model (1) are presented in Table 3. In Table 3, we found that VCR is positively related to the scandal dummy, which is statistically significant
Conclusion
This study provides a theoretical model of the many relevant factors that can have an impact on the dynamics of a firm's ERIs decision-making, and answered the following research questions addressing: ‘What are the factors that can impact on the ERI decisions?’, ‘What are the factors that cultivate a deception scandal in the automobile industry?’, and ‘How can firms prevent environmental related corporate frauds in the future?’.
Through the conceptual model, we have identified five key factors
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