How was this allowed to happen? A clear answer has been elusive but competition for market share seems to have driven some within the automaker to bend, and in many cases break, the rules. Governance practices then in place failed to catch or deter them. Bad actors were, apparently, unconstrained by cultural norms within the company, and that proved to be costly. As the Financial Times wrote in 2017, “The Volkswagen Scandal Shows that Corporate Culture Matters.”

There are other examples. Facebook, for one, has been targeted by activists over its privacy policies and, recently, for not more aggressively policing the content on its platform, weeding out misleading or more malevolent posts. Advertisers like Starbucks and Patagonia have stopped doing business with the company, at least temporarily. While others, like Coca-Cola and Verizon have considered pulling social media ads across the board. So far, the company has remained mostly resistant to change, but as more advertisers leave or pause their efforts on the platform, Facebook may have no choice but to make major changes to its governance approaches.

Another example, Wirecard, a German financial technology firm, announced recently that it could no longer find about $2 billion thought to be held in a bank account. Shortly thereafter it said that the missing cash probably “didn’t exist”—a governance issue if there ever was one. Once valued at more than $26 billion (market capitalization), Wirecard filed for insolvency last month.

Poor governance hits companies in many ways. Sometimes it’s share price, other times it’s reputational. (Many times it’s both.) In this era of social activism and the ability to quickly mobilize opinion, a misstep in the public sphere can very quickly translate into headlines and a major business problem.

Evaluating companies in an ESG world that is no longer focused on the exclusionary is complex. It’s easy to identify cigarette producers or gun manufacturers; it’s harder to identify the companies whose governance policies will lead to improved market performance. But uncovering this can clearly add value. In the past, these issues were far down on the list of shareholder concerns. But times change. Today, investors increasingly recognize that good governance matters, and that poor governance policies can be costly.

Poor governance hits companies in many ways. Sometimes it’s share price, other times it’s reputational.

In our last two blogs we discussed the impact environmental and social concerns can have on portfolio performance, so today it only makes sense that we delve into the “G” part of ESG—governance.

Governance issues are ones that often percolate behind the scenes, but they can easily spill out into public view and create very real and very lasting damage. The VW emissiona crisis—nicknamed “Dieselgate”—may be the poster child for this.

The company was accused by the U.S. Environmental Protection Agency of violating the Clean Air Act by falsifying emissions tests for its diesel vehicles back in 2015. People who thought they were buying clean running diesel cars discovered the cars weren’t nearly as clean as they thought.

As the world’s largest carmaker, VW had legal exposure around the globe. As of June 2020, the scandal had cost VW around $33.3 billion in fines, penalties, financial settlements and buyback costs. The intangible damage to the brand is harder to calculate, but also substantial. The company’s stock took a hit, too, falling from around $26/share in March 2015 to a little over $10/share in October of that year, wiping out billions of dollars in value.

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