November 21, 2018 / Analysis

What can investors learn from the latest carmaker scandal?

By Joe McGrath, ESG Clarity

The arrest of Nissan's chairman has again thrown the automobile sector into the spotlight

What can investors learn from the latest carmaker scandal?

Corporate governance standards in the automobile sector were again in the spotlight on Monday, when Carlos Ghosn, chairman of Nissan, Mitsubishi and Renault, was arrested for gross misconduct offences.

Ghosn’s arrest has followed a steady deterioration in the environmental, social and governance ratings of Nissan over the past three years. Most recently, in September, ratings agency MSCI downgraded the company’s ESG rating from B to CCC, citing two significant failings in the company’s corporate governance.

In the months leading up to the review, Nissan had admitted falsifying emissions data at five of its manufacturing plants and acknowledged that it failed to uphold standards in its car safety inspections. A month prior to Ghosn’s arrest, MSCI issued a warning about the standards of corporate governance at the Japanese carmaker, flagging weak management oversight and concerns over the board’s independence.

The cost of poor ESG

When Nissan acknowledged that it had falsified emissions data back in July, markets responded. Investors saw the company’s share price fall to a 14-month low, to 1,004 JPY. On Monday, the news of Ghosn’s arrest sent the share price lower still, resting at 951 JPY, its lowest point for two years and 5.5% down on the day.

The fallout from Nissan’s corporate governance shortcomings, and the subsequent impact on its share price, again underscored the importance of evaluating stocks against ESG metrics.

Back in February, the Transition Pathway Initiative – an initiative between asset owners and asset managers – looked closely at the automobile sector and concluded that carmakers were not “being sufficiently transparent” about how their businesses could be impacted by climate change.

More significant, perhaps, were the specific red flags noted about Nissan.

In its paper entitled Management Quality and Carbon Performance of Automobile Manufacturers, it found that Nissan had failed to assign explicit responsibility for the oversight of climate change policy and recognised that the company had failed to reduce its total operational “Scope 1” and “Scope 2” greenhouse gas emissions over the past three years.

Sector-wide implications

Initial indications of how severe investor losses could be from poor governance in the sector were highlighted in 2015, when the world’s second largest carmaker VW was issued with a regulatory intervention notice by the US Environmental Protection Agency.

The EPA found that VW had deliberately manipulated its diesel engines to give a false reading during laboratory emissions testing and saw the company’s share price more than half from its 2015 high of 253.20 EUR (10 April 2015) to 92.36 EUR (2 October 2015).

More recently asset managers have warned that the repercussions from the 2015 scandal may still be playing out. On Monday, fund management group Schroders explained that new rules to more closely scrutinise carmakers emissions levels had led to a dip in sales across Europe, since September.

The fund manager explained that the worldwide harmonised light duty vehicles test procedure (WLTP), introduced in 2017 after several manufacturers were found to have cheated emissions tests, had inadvertently led to a dip in sales in September.

“These new tougher standards were introduced for all new models from 1 September 2017, but also applied to all newly-registered vehicles from 1 September 2018,” explained Azad Zangana, senior European economist at Schroders.

“In anticipation of this, retailers heavily discounted non-compliant models to clear stock before the deadline, causing a surge in new registrations in August, but then came the inevitable collapse in September mentioned above.”

The role of governance

While analysts agree that the temptation to cheat emissions tests may not have been entirely overcome with stronger independent oversight at board level, they acknowledge that this would have been a stronger deterrent.

MSCI’s head of Corporate Governance Research, Alan Brett, told ESG Clarity that oversight would have been strengthened with a greater number of independent board members at Nissan and VW, and this could have led to the issue being resolved at a far earlier stage.

“We may have found out about the issues sooner, and there may have been less of a willingness to turn a blind eye to these issues if the board oversight had been more robust and there was more of a challenge between the independent board members and the executive,” he said.

“There haven’t been enough independent directors at board level. Based on governance principles and what governance arrangements try to prevent, you could make the case that this could have helped, although it is an interesting area for further study and explanation.”