VW Diesel 'Defeat Device' Scandal Will Test Winterkorn's Leadership

VW faces fines of up to $18 billion and a backlash from consumers in the U.S. after the company admitted that software that it designed for VW brand and Audi diesel cars gave false emissions data.

Arndt Ellinghorst, a London-based analyst for Evercore ISI, called the move "worthy of a back-street garage looking to get a used car through a mandated vehicle inspection." The issue may help to catalyze further management changes at VW, he said.

Winterkorn, whose contract renewal is scheduled for a supervisory board vote on Friday, now faces a serious challenge to his leadership, Ellinghorst said in an investors note today.

Analysts at Bernstein said the issue is a serious setback for VW. "This is not your usual recall issue, an error in calibration or even a serious safety flaw. There is no way to put an optimistic spin on this - this is really serious."

Trying to pin the blame on rogue engineers probably will not appease U.S. regulators, said Bernstein analyst Max Warburton. The best-case scenario is a multi-billion-dollar fine, damage to its diesel market share and "pariah status in the U.S. with government, and possibly consumers," he said.

Ferdinand Dudenhoeffer, director of the Center for Automotive Research at the University of Duisburg-Essen, said Winterkorn should resign. Winterkorn should have known about the manipulation in his role of head of VW's r&d or, if he didn't, it shows that he does not have the automaker under control, Dudenhoeffer told a German newspaper. Either way, Winterkorn's role as CEO is no longer tenable, the academic said.

VW said on Sunday that the company is cooperating with an investigation by the U.S. Environmental Protection Agency (EPA) and has ordered its own external investigation. In a statement Winterkorn said: "I personally am deeply sorry that we have broken the trust of our customers. He said VW would do “everything necessary in order to reverse the damage this has caused.”

U.S. backlash

Earlier this year, Winterkorn won a power struggle with his former mentor and chairman, Ferdinand Piech, forcing Piech's ouster from the automaker. As investigators seek to establish complicity within the company, Winterkorn will need to walk a fine line to shield himself and VW from a backlash in the U.S., a market where VW, despite being the world's biggest carmaker, has struggled for decades.

The VW brand's struggle to compete in the U.S. was one issue Piech cited in his failed attempt to oust Winterkorn earlier this year. Clean, powerful diesel vehicles were supposed to be VW's ticket to growth, and the company has big plans for the U.S. It spent $1 billion on a factory in Tennessee in 2011, then said it would invest an additional $7 billion in North America by 2018.

VW brand and Audi sold about 482,000 diesel vehicles in the U.S. with illegal emissions control software designed to make their cars appear cleaner in testing than they are in the real world, according to the the EPA.

The software, included on VW and Audi vehicles from the 2009-15 model years with 2.0-liter turbodiesel engines, detects when a car is undergoing EPA emissions testing and turns on the vehicle’s full emissions controls.

The software then switched off the full emissions controls during real-world driving, the EPA said. Officials called the software a “defeat device” that allowed VW and Audi vehicles to fulfill emissions standards in lab testing, but emit nitrogen oxides at up to 40 times allowable levels in real-world driving.

VW said it has told U.S. dealers to halt sales of some of its diesel cars. Diesel models can account for 20 to 25 percent of the VW brand's U.S. sales each month. The ban is expected to put a major dent in the company's volume and slow its turnaround efforts in coming months.

The vehicles affected include the VW Passat, Jetta, Beetle and Golf, and Audi A3.