Taking stock of the VW settlement agreement

On June 28, more than 9 months after the “Dieselgate” story broke, Volkswagen agreed to a $14.7 billion partial settlement designed to do three things: compensate consumers for advertising fraud; promote electric vehicles; and clean up excess air pollution from the nearly half a million deliberately defective diesel cars sold into the US market for 7 years. While the settlement is incomplete—it does not include civil and possible criminal penalties, nor does it address the 85,000 3-liter diesels outfitted with defeat devices that VW sold in the U.S.—we know enough at the moment to step back and assess the results as they currently stand.

We now know that VW underestimated the risk of deliberately misleading regulators and the public. This massive error in risk assessment stemmed from the belief that its chances of getting caught were slim, and that even if it was caught, the size of the penalty would be manageable. A decade ago, VW’s management board, led by then-chief executive Martin Winterkorn repeatedly rejected staff proposals to upgrade emissions control equipment due to cost concerns, according to internal documents and company sources cited by the New York Times. As late as April of this year, VW’s annual report reaffirmed the company’s belief that penalties would be modest.

Prior to Dieselgate, the general practice at EPA and the California Air Resources Board (CARB) was to selectively spot check, in their own laboratories, the emissions test results that manufacturers reported to regulators. The regulators would also perform additional lab testing when a manufacturer proposed to install a novel emissions control technology, such as VW’s proposed lean NOx trap in 2009. Except for the collaboration that started between the ICCT and CARB in 2013, agencies did not test passenger vehicles under normal driving conditions. As a result, the diesel Jetta easily passed the EPA lab tests in 2009.

Much has changed in response to VW’s misconduct. The EPA and the California Air Resources Board now conduct defeat device screening tests under real-world drive cycles. In fact, it was these screening tests that uncovered defeat devices on the 2016 Audi A6 3-liter diesel vehicles.

Historically, EPA and the Justice Department have imposed financial penalties for Clean Air Act violations that were well below the legal maximum, which is currently $37,500 per vehicle. My review of the six major defeat device cases involving light-duty and heavy-duty vehicles over the 20 years prior to the VW settlement reveals that penalties ranged from $96 and $292 per vehicle, averaging just under $160 per vehicle. If this amount were applied to VW, the total settlement would be just under $80 million, a tiny sum to a company with annual operating profits of more than 11 billion Euros from 2011 to 2014.

The current proposed settlement—a whopping $29,000 per vehicle, or 185 times the historic average—brings the average financial assessment per vehicle far closer to the legal limit. And it’s likely to go higher once civil penalties are assessed, along with a full settlement for the 3-liter diesel cars.

There are a number of factors that likely played a role in pumping up the size of the settlement. They include:

• The inability to repair the vehicles resulted in the first vehicle buy back in history for an emissions violation at an estimated $10 billion.
• The magnitude of excess emissions up was to 40 times the legal limit, resulting in real-world emissions significantly higher than a modern tractor-trailer truck.
• The Federal Trade Commission issued a separate complaint fuelled by popular anger at VW’s false advertising.
• VW’s attempt to cover up its use of defeat devices for more than a year—first in discussions with California, then with EPA – left the company with little credibility entering into the settlement negotiations.

It seems clear that past settlements have not deterred continued misconduct, and it’s plausible that modest financial settlements may have inadvertently influenced VW’s illegal behavior.

In addition to government penalties, the private market has extracted a high cost, erasing 14 billion Euros in shareholder value after VW stock dropped 22%. While market reaction and government penalties are substantial, the company appears capable of weathering them. Bloomberg reports that most analysts believe that VW’s 24.5 billion Euros in liquidity will cover the Dieselgate costs. The scandal has had little impact on global sales, which fell only two percent in 2015. It was telling that share prices rose more than 3 percent on June 28, the day the settlement was announced.

There are some genuine signs that VW has learned some important lessons from the global scandal. It’s getting its own house in order in Europe: Real world emissions data published by Germany’s type approval agency show that the 2016 Audi A3, VW Passat and Touran are the cleanest diesel cars tested. And it’s looking towards the future. Last month, VW announced “Strategy 2025,” which includes more than 30 new electric vehicle models by 2025, and annual sales of two to three million. That’s the equivalent of 20% to 25% of VW total vehicles sales.

Only time will tell whether the size of this settlement is sufficient to deter future use of defeat devices. But considering how much the likelihood of discovery and the magnitude of the consequences have increased in just nine months, it’s clear that the odds in favor of a genuinely cleaner transportation sector have changed dramatically for the better.

Related Content