20th June 2004

The business scandal that rocked Shell earlier this year is still creating tremors. Here Ian Jones and Michael Pollitt, two CBR researchers who have written and edited several working papers and books on business ethics and corporate governance, assess the impacts of Shell shock.

Shell admitted in January this year that it had overstated its proven reserves of crude oil by 20 per cent. This was followed by an internal report showing that Shell executives had hidden the company's oil and gas shortfalls as far back as 2001. As a result, Shell is now under investigation by the US Securities and Exchange Commission, the US Department of Justice and the UK's Financial Services Authority. And investor confidence has been dented.

What is surprising to us is not the scale of the scandal, but the fact that it should have happened to Shell. The company has, after all, been here before. After two major crises in the mid-1990s, it instituted a thorough review of its corporate governance structures that should have helped it avoid the current scandal. So what has gone wrong?

Root and branch reform
At a CBR conference in Cambridge in December 2001, the former Chairman of Shell, Sir Mark Moody-Stuart, gave an admirably candid talk. Under his leadership, he said, Shell had performed a root and branch reform of its approach to external issues - including the environment, political engagement and human rights - after the public outcries over the disposal of the Brent Spar oil platform and the execution of Ken Saro-Wiwa.

However, Shell appears not to have taken full account of two fundamental and related shifts in its business environment that have taken place since 2001. Firstly, the US Securities and Exchange Commission has been steadily increasing its requirement for information on proven oil and gas reserves (paralleled by Britain's Statement of Recommended Practice). Secondly, businesses' accountability to shareholders for policy and accuracy of reporting has increased enormously since the Enron and WorldCom disasters.

What has further compounded Shell's error, in the eyes of some shareholders, is the fact that the company treated the downgrading of the reserves as a technical matter, and reported it to shareholders through its head of exploration and production, Walter van de Vijver. Shareholders felt that the then chairman, Sir Philip Watts, should either have announced the downgrading of the reserves himself, or made himself available to shareholders immediately afterwards.

An ethical issue
Shell gave the appearance of not having learned the lessons from previous occasions when they ignored external events. Senior executives involved did not seem to recognise that accurate reporting is an ethical issue, as much as it is a legal or technical one, and hence that Shell's own principles (outlined by Sir Mark) - of 'consultation', 'telling it as it is', 'looking people in the eye' and 'developing a management system to track the issue' - applied.

There also appears to have been a failure at board level. The hallmark professionalism of Shell, with its emphasis on team-working, bringing in expert advice and analytical problem-solving, did not seem to operate at board level. It is very surprising that one of the most significant long-term strategic factors - the reserves on which the company could call for its future business, and the policy for increasing these reserves - was not fully discussed by the board.

Shell is not another Enron. In fact, the contrast between the two companies could not be stronger. There was no exceptional greed (!!) that was driving policy-making in Shell. It was more that there was, as the internal report shows, a lack of transparency about the reporting of reserves. Iraq=Exxon+Shell+gov.nl=G a s u n i e !

'Trust is like a mirror...'
Management guru Charles Handy (who, ironically, began his career with Shell) has a phrase: 'Trust is like a mirror. Once it is shattered, it becomes useless.'

Is trust in Shell shattered or just cracked? Our research would indicate that the company's professional response to previous crises helped build its reputation. Shell is now embarked on 'an accelerated review of its corporate governance and structure', and though we have every confidence that it will do an excellent job in this, it will be some time before it can regain the confidence of shareholders, employees and government.

The latest CBR publication by Ian Jones and Michael Pollitt is CBR Working Paper 285, "Multinationals in Developing Communities".

This article first appeared in the Summer 2004 issue of the CBR Newsletter, Top Floor.