Business case for rule of law

Business case for rule of law

Podcast with Rachele Cavara

In this podcast episode, the intricate interplay between the rule of law and corporate actors takes center stage. Through a discussion centered around the Volkswagen emissions scandal, insights are provided into how businesses both rely on and influence the rule of law.

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Understanding the Rule of Law and Corporate Behavior

Olena Uvarova: Hello, dear listeners, and we have a podcast on the rule of law and corporate actors. I’m happy to have today as a guest Rachele Cavara. Rachele is a PhD student in management at the University of Ca’ Foscari in Venice, and she is also part of the Rebalance project.

My first question is, what association comes to mind when you hear about the rule of law and corporate actors?

Rachele Cavara: Before starting, I just want to tell you that I’m delighted to be here and be part of this podcast series, thank you for the invitation. The short answer to your question would be that, in my research, the association between the rule of law and corporate actors manifests when corporations violate the rule of law with their behavior. But let’s work a little bit on this short answer with a longer one.

As an organizational researcher, I deal more with corporate behavior than the rule of law. Indeed, I beg your pardon if my lexicon on this second topic is not always precise or my knowledge is limited.

Well, a branch of organization studies is devoted to understanding the phenomenon of corporate wrongdoing. What is corporate wrongdoing? It is defined as organizational behavior that transgresses a line separating what is right from what is wrong under legal, ethical or social terms. Wrongdoing is a growing phenomenon in the business world, despite all efforts that have been put by public authorities in stamping it out. Some scholars even identify the will to eradicate it as one of the grand challenges of our time.

There are cases of wrongdoing that are quite simple to understand and evaluate in their functioning and control – although it’s a reductionist way to put it. Think about managers’ wrongful practice of stock options backdating: it is mainly driven by the fact that managers as organizational actors sometimes behave as an homo economicus who makes decisions based on a rational cost-benefit analysis. Studying how stock options are managed in an organization may be enough to understand the malpractice of backdating and adjust the incentives schemes of organizations to avoid it. Of course, these cases of misconduct have a limited detrimental impact on the outside of an organization.

There are instead cases of wrongdoing that are the opposite. They present giant scale ruinous consequences to the society at large. Think about the renowned examples of the Enron scandal and the Volkswagen emissions scandal. These cases are so astronomical that identifying them, prosecuting them and stopping them is never enough to stop their harmful consequences on society, not to mention to remedy them or set them off.

It is in such situations that thinking about the relationship between the rule of law and corporate actors may come into the picture as something useful and very needed. On the one hand, we have the rule of law, or a rule-based order that constitutes the prerequisite for the protection of fundamental values and principles in a given political area. This is the definition, let’s say, or the conception of the rule of law that I came up with in my studies. The values protected by the rule of law include legality, legal certainty, respect for human rights, democracy, democratic institutions and so on – the founding values of the European Union political system. On the other hand, we have corporate actors that commit to complex wrongful behaviors for their profits. They commit wrongdoing regardless of the fact that they transgress a line separating right from wrong and disrespect the rule-based status quo of their field of action. That’s why associating the two concepts came quite straightforward to me at a certain point, because corporations implementing big-scale scandals can impact the rule of law and its strength in a given institutional area and erode the trust that citizens place in it.

This association is currently underexplored in management studies. I myself have many questions and little answers right now. My point is just that this may be something worth exploring to hold companies accountable for their wrongful behavior as a whole at 360 degrees.

Assessing Compliance with Rule of Law: Criteria and Challenges

Olena Uvarova: Yeah, thank you for this answer. It’s very relevant and very interesting for us because we also, as lawyers, have our own lenses. And it’s common for us to talk about the rule of law as a set of principles that actually address some requirements to the State and public authorities. But now we are also in the process of rethinking this concept related to private actors because they also have power and a very strong impact on social life. So that’s why it’s not just a problem of management studies. We as lawyers also need to rethink some traditional concepts for us. But yeah, have a chance to look at them from a different perspective. And in this regard, my additional question to you: What criteria would you recommend applying to assess the compliance of corporate actors’ conduct with the rule of law requirements?

Rachele Cavara: This is a rather complex question to answer. In general, when we hear the word “compliance” in organizations we think about something that is managed through the rollout of so-called compliance management systems. These systems normally work under the risk management department in corporations and once implemented, can assess diverse kinds of compliance. For example, in the automotive industry, the kind of compliance assessed could go from environmental compliance to product compliance to HR and internal compliance. Consider that the attention to these kinds of systems as effective tools to ensure right-doing is so high that certain institutional environments discount the penalties for corporate wrongdoing if the corporation under trial has a compliance management system in place. Because it’s a kind of demonstration of good faith: “we did something wrong, but since we have a compliance management system in place, we did it in good faith, despite not having a compliance management system in place”. There’s much academic discussion about the effectiveness of these systems in assuring right-doing and about the necessity to overcome them. But the state of the art in corporate compliance nowadays is still based on them.

A possible way to assess compliance with the rule of law in organizations could be (this is just an idea, of course) to leverage these existing compliance management systems and roll out a similar system for the rule of law compliance. This would be quite easy and not costly for organizations because corporations could leverage existing internal knowledge, existing cultures of compliance, and also existing structures and infrastructures for compliance. This last point, in particular, is important. Big multinationals such as automakers necessarily massively deploy IT infrastructures to align their compliance between headquarters and different divisions and regions, for example. Developing such IT platforms is quite costly in financial and development terms. But if, in this case, existing IT infrastructures for compliance can be leveraged, corporations may even want to scale the resource. And rolling out a rule of law compliance management system would be quicker than in the case of not having an infrastructure in place.

However, I have the feeling that the sole rollout of a management system would not be enough; while a focus, for example, on the improvements in the rule of law compliance as a result of the implementation of the compliance management system would provide a more concrete picture of how corporations implement rule of law compliance. This point, differently from that on IT infrastructures, is not always the focus of already existing compliance management systems. Sometimes compliance is indeed assessed with a checklist or procedural mindset more than a substantial one. So, normally corporations and their auditors ensure and control that everything that is supposed to be there in terms of compliance is actually there and sound. In the case of rule of law compliance, however, requesting organizations to stress the substance of compliance would be, in my view, of utmost importance because of the social cost and consequences of failing to comply. An idea here would be to request organizations to display the milestones of improvements on the topic of rule of law compliance in corporate reports year after year.

The Volkswagen Emissions Scandal: A Case Study

Olena Uvarova: It’s a very good point. It’s an interesting view as well to see how, from the management perspective, it could be considered because we don’t have the relevant experience, how it could be managed on the corporate level. So it’s very interesting. And you mentioned already the Volkswagen case. Could you tell us a little bit more why this example was mentioned by you and what is the case about?

Rachele Cavara: Yeah, sure. Absolutely. I’ve been working on the Volkswagen emissions scandal during my PhD for some years. Right now, I’m at the point in which the reflections about it brought me to connect it with the concept of the rule of law. It’s a very well-known case of corporate wrongdoing, and it’s considered one of the most outrageous cases of wrongdoing in history. It is comparable to the Enron accounting scandal or the BP Deepwater Horizon disaster in terms of the harm that these cases of wrongdoing all caused to society, human health, and the environment.

What is the scandal about then? A quick recap: we all know that it broke in September 2015 when the EPA, that is the federal Agency of the United States for Environmental Protection, issued a public notice of violation of the Clean Air Act to Volkswagen. Basically, the EPA alleged that the automaker installed illegal defeat devices on the diesel vehicles that it sold in the US from 2009 to 2015. As a result of being equipped with defeat devices, those vehicles were able to first, cheat on federal emissions tests by faking to be compliant with the U.S. emissions standards; then, to obtain the certificate of conformity to be marketed in the U.S.; and in the end, to pollute the environment by a factor that was up to 40 times the allowed limit for certain pollutants.

In terms of scale of the wrongdoing, 11 million polluting vehicles were sold globally between 2009 and 2015. Of those, 600,000 were sold in the U.S., 9 million in Europe, with a spike of 2.6 million just in Germany and the rest around the world (mainly in China and South America). The biggest concerns around excessive emissions were around nitrogen oxides that are very harmful pollutants for human health. There are many studies that estimate the consequences on human life of nitrogen oxide excess emissions. I will just give you some numbers. There’s a study by Barrett and others from 2015 that estimates 59 premature deaths and 65 morbidity cases per year in the U.S. as negative externality of vehicles sold between 2009 and 2015. Then, we have to consider the total life cycle of passenger cars as a product: the negative consumption externalities are higher and measured in 140 early deaths and 173 casualties per year. Just imagine that these numbers refer to the 600,000 vehicles sold in the U.S., while in the EU the cars sold are 9 million. There is a study by the MIT stating that the amount of life years lost in Europe as a consequence of the emissions scandal is 29,000.

Let’s come to the elements that may have to do with the rule of law principles. The 2016 European legal system did not allow Volkswagen’s wrongdoing to be prosecuted centrally in Europe. This meant that, differently from the Multidistrict Litigation against Volkswagen defendants put in place in the U.S., the European Union had no legal competence in prosecuting Volkswagen. Each EU member state had to prosecute it singularly according to its own legal provisions. In this case, this principle resulted in much fragmentation, overall scarce legal action, and a certain difficulty in seeing consumer rights enforced or enforced equally throughout the EU or in a timely manner in terms of compensation.

This may have to do with the EU rule of law system in a two-way direction. On one side, such legal uncertainty comes unexpected in an institutional environment with a strong rule of law like Europe, and may actually open a window of opportunity for corporations to get away with their unethical behavior. On the other hand, cases such as the Volkswagen emissions scandal, by going unpunished under certain respects violate the principle of the European institutional environment protecting fundamental rights because Volkswagen, with its behavior, violated human rights to life, to health, and also environmental rights. To recap: on one side, the rule of law setup permitted Volkswagen to get away in the EU with its wrongdoing and on the other hand, in a kind of reinforcing mechanism, Volkswagen wrongdoing eroded somehow the strength or at least the perception among European constituents of the strength and power of the rule of law principle in Europe. This is a first reflection about the European rule of law and corporate wrongdoing.

Another one is connected to the fact that at the time (we are in 2015 – 2016 – 2017) only the EU member state that had type approved a vehicle could impose penalties for a breach of its type approval procedure. What does this mean, briefly? Automakers need to undergo a lengthy type approval process for the vehicles they want to sell in a certain market. Do automakers want to sell this car model in the U.S.? You have to undergo the U.S. type approval process, basically. In the EU there exists the principle of mutual recognition for which automakers can see the vehicle models they wish to sell in the EU internal market type approved by a specific member state and be recognized as approved by all other member states. The problem was that the member states that had type approved Volkswagen’s vehicles involved in the scandal could not prosecute Volkswagen for the reason that they did not set up appropriate sanctions for infringements of their type approval provisions in connection to the disclosure of defeat devices. Even if and when such penalties were established, their effective, proportionate, and dissuasive character was at least questionable – this last sentence is not mine, but it’s taken from the report of the Committee of Inquiry that the European Parliament established in 2016 to investigate the role of the European institutional and legal system in permitting the scandal. Of course, in such a situation, we need to respect the fundamental principle of “no law, no punishment”. Volkswagen couldn’t be punished if punishment provisions were not in place. But this means that the issue that we have with the rule of law is quite remarkable. Indeed, as a consequence of the scandal, the European Commission launched formal infringement procedures against multiple member states on the grounds that they have failed to fulfill their obligations under EU vehicle type approval legislation and the EU principle of effectively applying European-level law at the national level.

What does this second point have to do with the rule of law and corporate actors? I have the feeling that the scandal showed that the EU has not full power in seeing its legislation always transposed effectively at the national level; and that, as a consequence, it has no surveillance or enforcement power on private actors, if not through member states. This rule of law setup is thus sometimes not enough to prevent corporate wrongdoing from happening or, alternatively, to act against it. This is a little bit of a breach of some points of the Treaty on the EU according to which the European Union infrastructure should ensure effective legal protection in the fields covered by the EU law, such as the human rights right to life, to health.

Business Interest in the Rule of Law: A Multifaceted Perspective

Olena Uvarova: It’s a very concrete example. And this concrete example shows this important correlation between the state’s duty to protect and how it correlates with the rule of law principle and corporate responsibility to respect human rights. It’s one system; it’s not different parts that are independent from each other. It’s one system, and we also have these different levels of law regulations here. We have the national level, we have the European Union level, and we have global standards. So, it’s essential for it to work effectively in protecting human rights and being based on the rule of law. This very concrete example shows all these perspectives. It’s very interesting. And probably my very last question to you… from this perspective, could we say that businesses are interested in the rule of law? Because it seems that it’s probably much easier for them to operate in a business environment where the rule of law is not so effective and strong?

Rachele Cavara: I would say that the business world is definitely interested in the rule of law. In very general terms, the interest of the business world in the rule of law derives from the fact that operating in an environment with legal certainty is always beneficial under many points of view. Think about high-level strategizing; in strong rule of law environments corporations can strategize without bearing the cost or the risk of uncertainty and ambiguity about how to reach planned goals. Instead, where weak rule of law environments create institutional voids, corporations may even decide to avoid entering those environments. There’s literature on this. The same would also comes with competition. Strong rule of law contexts assure equal treatment of competitors and fair competitive practices, while weaker rule of law contexts may prompt competition as played no more on rule-based mechanisms, but through, for example, political connection, not to mention political corruption. That, as a result, decreases competitiveness as a whole in a market.

Apart from this general consideration, I also think that the business world is interested in the rule of law in order to deliberately use it to its benefit. I’m sorry to provide a disenchanted view on the business interest in the rule of law, but the fact that corporations may use the rule of law to their benefit is maybe the strongest argument to stress the importance of talking about the rule of law and corporate actors, as you’re doing with this podcast series. I know we are running out of time for the podcast: briefly, as recipients of the rule of law, corporations are deep experts of the rule-based order governing their field of action, because sometimes what they want to do is to meet the minimum requirements to be considered law-abiding. There is no moral judgment in my words, because these words are just perfectly in line with the vision of an efficient use of resources. Since resources are scarce, why should corporations deploy more resources to do more than what is actually required of them?

More importantly, corporations may also be interested in the rule of law as creators of the rule of law, as they may want to shape the legal environment of their field of action. In order to do that, they have to know the organization and the functioning principles of the legal environment they want to shape. Corporate political activity, for example, is a growing strategy that companies use to reach their goals. This is particularly true in strong rule of law environments such as Europe, the US.

Olena Uvarova: It’s an excellent concluding remark. The idea of the title “business case for rule of law” came to me. It’s very, very relevant for us. Thank you. It was very valuable and interesting for us to hear these concrete examples and to know your view on this question. Thank you very much. It was a great pleasure to have you today.

Rachele Cavara: Thank you, Olena. It was a pleasure to talk.