CORPORATE GOVERNANCE, INNOVATION AND ECONOMIC PERFORMANCE ON VOLKSWAGEN

DIWAKAR CHUGH GAURAV SHARMA

ABSTRACT
This case relates to car manufacturing company Volkswagen. Pressure of high rates of return had led the company to change its policies. Short term profit orientation, increased dividend pay outs to investors and innovation potential of companies have to suffer. In this case, Volkswagen tried to reduced this gap.

QUESTIONS
Response of Volkswagens corporate governance to the shareholders value Role of stock market for the company Effect of incentive, target setting and controlling to shareholders value Effects of investment/disinvestments on innovation potential of the firm Effects on economic and financial performance of the company

BACKGROUND
German Car industry had a prominent role in German Economy regarding the manufacturing sectors share and growth. Car manufacturing firms are under the threat of hostile takeover. Pressure of Capital Markets - Institutional investors favoring change in the corporate governance systems.

SHAREHOLDING PATEERN OF CAR COMPANIES

Renault
0 4.90% 11.30% 28.60% 4.60% 4.90% 0 1 2 3 6.60% 8.00% 5.30% 40.00% 3.70%

PSA
0 00 1 2 3 4 5 6 7 8

4
5 6 7 8

Fiat
00 1 13% 2 3 3.30% 37.90% 2.00% 2.50% 4 5 6 7 8 51.40%

VW
0 10.20% 12.10% 3.50% 3.00% 1 2 3 4 5 6 7 8

RELATIONSHIP B/W MARKET VALUE AND VOLUME OF PRODUCTION

250 200

150

100

Market Value* Turnover

50

VW TRADITIONAL CORPORATE GOVERNANCE SYSTEM

Example of German neo-corporatism. In 1960, Volkswagen Works Limited became a stock corporation (AG) and was partially privatised. Governmental representatives remained a dominating influence on the supervisory board. In 2000, Boards composition:
3 representatives of IG Metall and 6 Representatives of Volkswagens works council (Labour Side) 4 representatives from other companies, 3 persons representing banks and a shareholder association 2 representative of Lower Saxony, among them Prime Minister of Current Social Democratic government

CONTD
High degree of Joint-ness between management policy and works councils in company policy. Union proposed general agreements on wages and salaries and working conditions which resulted with increase in the costs of production but quality improved.

BASE OF CG SYSTEM
A high degree of union membership. Top management committed to the goals of social responsibility and competivity. A priority on location and employment interests. A company-based bargaining system between IG Metall and the Executive Board of the Volkswagen.

CHANGES IN CG SYSTEM
Corporate governance of VW towards shareholder value orientation. Stock market now play a vital role in framing rules. Changes in the incentive system. Changes in target setting and controlling like were reframed to higher return on sales. Changes in investment and disinvestment policy of VW.

 Measures taken in by Volkswagen to enhance communication with shareholders:

Enhancing relationship with investors by arranging meetings to explain corporate strategy Buy Back scheme Companys commitment to support OECD principles on Corporate Governance Adoption of International Accounting standards and segmental reporting in the annual reports

CORPORATE GOVERNANCE OF VW TOWARDS SHAREHOLDER VALUE ORIENTATION

VW trying to establish the relationship between Work holder Value and Shareholder Value due to external pressure

EVENTS WHICH FOSTERED REORIENTATION

Failed attempt to increase capital in 1997. The second event was the Mannesmann case. The fear of a hostile takeover became an issue on which management and works councils were united.

ROLE OF STOCK MARKET IN COMPANYS FINANCING

At Volkswagen, recently the importance of stock markets is realized. Rare events when company goes for expanding equity base. Expanding operations to financial services requires capital. Investor relationship hasnt been good and reacted negative to issue and thus embarrassing Volkswagen which was thinking of acquiring BMW. Refinancing is one of the major concern. Mindset of company thus have changed. Stock market is the main source of providing acquisition money.

350

CASH FLOW AND CAPITAL INVESTMENTS IN TANGIBLE FIXED ASSETS

300

250

200

Cash flow as % of capital investments in tangible fixed assets VW AG automo- tive division

150

100

50

0 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000

Return on Sales of VWs Brands

20 0

-20

-40

2000 1999

-60

-80

-100

CHANGES IN THE INCENTIVE SYSTEM

Companys was aiming to improve Workholder Value.

Bonuses are also paid at the level of employees subject to collective agreements. The introduction of the 28.8 hour week and the corresponding reduction of wages.
VWs measures: Esops (Employee Stock Option Plans) Restructuring of the Pension Scheme Employment Protection Personnel Flexibility Short Term Liabilities (Overtime Pay, etc.)

TARGET SETTING AND CONTROLLING

Companys initiative to Increase profitability. Targets were set that focuses on return on sales and sales growth figures in a number of years. Introducing result oriented controlling system to deliver the commitment. Targets based on return on capital/return on investment are not differentiated according to different business units and group companies. Targets are set as peer the risk and the capital costs.

FINANCIAL TARGETS
Financial targets:
Return on capital should be within a corridor between 9% and 11%; break-even of max. 60%; return on sales should reach 4.7% and increase to 6.5% by 2005; investments should be paid out of the cash flow and have a cap of DM 6 billion.

Various performance targets were set such as material price reduction of 2%, fixed cost reduction of 3%, etc.

INVESTMENT/DISINVESTMENT POLICY OF VW
There has been general increase in the investment in tangible assets due to increase competition. Same hold true for Research and Development as well. They have also started to concentrate on Conglomerate policy as well as mergers and acquisitions. As far as disinvestment goes, there has been no indication of shift towards downsizing or distribute. From the Investment policy the real gainers are State (Taxes), Creditors (Interests) and Company (Reserves).

INVESTMENT TO SALES

CONCLUSIONS
Distinctive corporate governance system Concentrates on benefits on all the stakeholders of the company All measures related to Shareholder Value is carried out by Management and Work Councils VW relies on Cash Flows for funding the investments except few time In the view of unfavorable conditions and negative response of investors, VW has not used this instrument There can be future expansion in the equity base for mergers and acquisitions

CONTD
Incentive system has been changed in the direction of capital market oriented performance measures ESOPS being used to increase the employees ownership Fixing the targets has been there to correspond to the shareholders expectations It would signify the strong commitment of top management and thus would help in maintaining goof investors relations Investment policy is still inclined towards long term perspectives Strongly supported productionist orientation vs financialisation