Policy Operations Feb 2, 2017

What Volkswagen’s Emis­sions Scan­dal Can Teach Us about Why Com­pa­nies Cheat

Tighter stan­dards may back­fire in indus­tries with fierce competition.

Michael Meier

Based on the research of

Kejia Hu

Sunil Chopra

When news broke that Volk­swa­gen had cheat­ed on emis­sions tests, Pro­fes­sor Sunil Chopra and PhD can­di­date Kei­ja Hu imme­di­ate­ly thought about a dataset they had sit­ting on their com­put­ers. Per­haps, they thought, it could help explain why the com­pa­ny made such a seem­ing­ly reck­less decision.

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Chopra, a pro­fes­sor of oper­a­tions at Kel­logg, had been using the dataset for a dif­fer­ent project with Hu. But with the 2015 dis­cov­ery of the company’s cheat­ing, they turned their atten­tion to a more press­ing ques­tion: What would lead a firm like Volk­swa­gen to put its rep­u­ta­tion on the line by cheat­ing on nitro­gen oxides (NOx) emis­sions on 11 mil­lion vehicles?

In new research, Chopra and Hu find that fierce com­pe­ti­tion cou­pled with tight stan­dards that are expen­sive to meet can dras­ti­cal­ly increase odds of mis­con­duct among car­mak­ers. Instead, tem­porar­i­ly relax­ing the accept­able NOx stan­dard — as the Euro­pean Union has now done — will like­ly decrease the prob­a­bil­i­ty of mis­con­duct by up to 11%. 

The research also demon­strates the urgent need for gov­ern­ment auto reg­u­la­tors to improve their mon­i­tor­ing capabilities. 

If your mon­i­tor­ing sys­tem is imper­fect, just tight­en­ing stan­dards might actu­al­ly make the sit­u­a­tion worse,” Chopra says. 

The Ori­gins of an Emis­sions Scandal 

Econ­o­mists have already estab­lished that increased mar­ket com­pe­ti­tion can boost mis­con­duct. For exam­ple, one study found that hos­pi­tals exag­ger­ate their trans­plant patients’ health prob­lems if com­pe­ti­tion for organs is high. 

So it seemed per­fect­ly plau­si­ble to Chopra and Hu that Volk­swa­gen might cheat in order to stay com­pet­i­tive. After all, meet­ing NOx stan­dards is cost­ly for automak­ers who must foot the bill for engi­neers and exten­sive research. Plus, improv­ing emis­sions tends to hurt engine effi­cien­cy. Chopra and Hu the­o­rized that since it is vir­tu­al­ly impos­si­ble for car buy­ers to ver­i­fy their NOx emis­sions, automak­ers may well be will­ing to cheat on that dimen­sion in order to remain com­pet­i­tive on price and engine performance. 

But they sus­pect­ed that harsh com­pe­ti­tion was only part of the story. 

There’s no point in tight­en­ing the stan­dards if you can’t improve mon­i­tor­ing and enforcement.” 

The Euro­pean Com­mis­sion, which over­sees pol­i­cy in the EU, had tight­ened NOx emis­sions stan­dards four times between 2000 and 2014. What we want­ed to under­stand was, does the tight­en­ing of stan­dards have any­thing to do with mis­con­duct as well?” Chopra says.

The­o­ret­i­cal­ly, the authors rea­soned, stan­dard-tight­en­ing should increase mis­con­duct for two rea­sons: stricter stan­dards are more expen­sive to meet, and when the cost of meet­ing stan­dards ris­es, the penal­ty for being caught cheat­ing becomes rel­a­tive­ly cheap­er. They now have less to lose by cheat­ing,” Chopra says. 

But would real-world data bear that out? 

The Right Dataset 

Before the Volk­swa­gen scan­dal, Chopra and Hu had been inter­est­ed in how actu­al NOx emis­sions fluc­tu­at­ed with stan­dards. To that end, they had man­aged to pro­cure a huge dataset on 13 years worth of emis­sions from the Euro­pean Union. 

The data came from sen­sors installed on Euro­pean roads, which had cap­tured speed, accel­er­a­tion, vehi­cle char­ac­ter­is­tics, and NOx emis­sions data from 288,350 vehi­cles that passed by between 2000 and 2012. This was far more reli­able than data from cars that were test­ed in labs, because Volk­swa­gen had installed devices that could guess when a car was being test­ed and instruct it to behave differently. 

We nev­er even thought of link­ing the data to whether peo­ple were cheat­ing or not,” says Chopra. Until the scan­dal, that is. 

To under­stand the impact of both emis­sion stan­dards and com­pe­ti­tion, the authors cre­at­ed a series of math­e­mat­i­cal mod­els that incor­po­rat­ed actu­al emis­sions, strict­ness of stan­dards, vehi­cle char­ac­ter­is­tics, prices, and com­pe­ti­tion intensity. 

Com­pe­ti­tion was mea­sured both at the indus­try lev­el, by cal­cu­lat­ing the por­tion of the auto mar­ket that the car­mak­er con­trolled, and at the vehi­cle lev­el, by count­ing the num­ber of sim­i­lar sub­sti­tutes that a buy­er could choose for a giv­en car model. 

Mod­el­ing Cor­po­rate Misconduct 

The mod­els con­firmed the authors’ hypoth­e­sis that fierce com­pe­ti­tion leads to more cheat­ing. But, even more inter­est­ing­ly, they found that tight­en­ing the stan­dards played a big­ger role. For every 1% the stan­dards were tight­ened, the prob­a­bil­i­ty of mis­con­duct increased by 1.72%.

Even if I were to add up mod­el-lev­el com­pe­ti­tion and mar­ket-lev­el com­pe­ti­tion, the effect of stan­dard-tight­en­ing is almost twice that,” Chopra says. 

And not all cars were cre­at­ed equal. Accord­ing to the mod­el, car­mak­ers invest­ed in meet­ing stan­dards on more expen­sive cars with prof­it mar­gins that jus­ti­fied the cost, as well as on low­er-pow­er cars, whose buy­ers were less like­ly to care about loss of horse­pow­er and acceleration. 

When­ev­er it made sense to reduce emis­sions, they were doing so,” Chopra says. But they were fail­ing to meet stan­dards when either that would result in a big loss rel­a­tive to the mar­gin, or it would upset the cus­tomer because the cus­tomer real­ly cared about power.” 

A Coun­ter­in­tu­itive Solution 

In the after­math of the Volk­swa­gen scan­dal, EU pol­i­cy­mak­ers chose to dou­ble the accept­able NOx emis­sions lim­it. It was a coun­ter­in­tu­itive move, seen by some as reg­u­la­tors kow­tow­ing to the indus­try they were sup­posed to over­see. (The U.S., whose NOx lim­its have been con­sid­er­ably stricter than those of the EU, has not rolled back its standards.) 

But Chopra and Hu do not see it as buck­ling. When they ran their mod­el again with the new lim­its, they found that car­mak­ers are like­ly to exert more effort toward actu­al­ly meet­ing the low­er lev­els, reduc­ing mis­con­duct by 9 – 11% in the short term. 

It is a tem­po­rary fix. Once reg­u­la­tors have found a way to detect cheat­ing, Chopra says, they can con­sid­er tight­en­ing stan­dards again. Which speaks to anoth­er key les­son from the paper: if reg­u­la­tors want stan­dards to work as intend­ed, they must increase the odds that an automak­er will incur a penal­ty for cheat­ing. This means improv­ing mon­i­tor­ing capa­bil­i­ties. The EU has already begun to do this, adopt­ing a new emis­sions test that will pre­vent com­pa­nies from deceiv­ing inspec­tors as Volk­swa­gen did. 

It’s a sol­id start. But Chopra empha­sizes that reg­u­la­tors must remain one step ahead of the indus­try year after year. There’s no point in tight­en­ing the stan­dards if you can’t improve mon­i­tor­ing and enforce­ment,” he says. 

Sym­pa­thy for the Defrauder? 

One could see this research as offer­ing a for­giv­ing per­spec­tive on the Volk­swa­gen scan­dal, depict­ing a ratio­nal firm respond­ing log­i­cal­ly to a set of strong incen­tives in a hyper­com­pet­i­tive and over­reg­u­lat­ed industry. 

Might any oth­er com­pa­ny in the same sit­u­a­tion — con­strained on one side by tight reg­u­la­tions and on the oth­er by the imper­a­tive to out­do the com­pe­ti­tion — also feel that cheat­ing was its only option? 

Chopra doesn’t think so. Rather than try­ing and fail­ing, what Volk­swa­gen did was rec­og­nize the form of imper­fect mon­i­tor­ing and seek to exploit it,” he argues. 

I don’t have much sym­pa­thy for Volkswagen.” 

Featured Faculty

Sunil Chopra

IBM Professor of Operations Management & Information Systems, Professor of Operations

About the Writer

Jake J. Smith is a freelance writer and radio producer in Chicago.

About the Research

Hu, Kejia, and Sunil Chopra. 2016. "How Do Tightening Standards and Competition Impact Misconduct: A Study of European Auto Emissions." Working paper.

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