Royal Dutch Shell Group .com

Financial Times: Shell will have to dig deep to recover its reputation


By Jane Fuller

Apr 24, 2004


Trust in company executives may have sunk to a low ebb but most of them are not born liars. So when a company that has prided itself on "honesty and integrity" blames "human failings" for the lies told to the stock market, it does not ring true.


Yet that is the story being spun by Royal Dutch/Shell. According to Lord Oxburgh, non-executive head of the UK wing of the Anglo-Dutch company, the fact that a 20 per cent shortfall in proved reserves was hidden for up to two years does not have "significance for the culture of the company as a whole".


This narrow interpretation suggests that the problem has been solved simply by ejecting the few who failed: Sir Philip Watts, chairman, and Walter van de Vijver, head of exploration and production (E&P), who knew reserves were understated; and Judy Boynton, chief financial officer, who presided over ineffectual internal controls.


There is little doubt about the lying. It is racily chronicled in a report to the audit committee from Davis Polk & Wardwell, the law firm, a summary of which was published this week.


Last November, Mr van de Vijver told Sir Philip in an e-mail that he was "sick and tired about lying about the extent of our reserves issue". This was more than 20 months after he had pointed out that "Group guidelines for booking Proved Reserves are no longer fully aligned with the SEC [US Securities and Exchange Commission] rules". Only in January this year did the company announce the shortfall. The Dutchman, who succeeded Sir Philip at E&P, repeatedly suggested that reserves had been booked aggressively or prematurely on his predecessor's watch.


But hardly anyone in business lies or breaks rules for fun. It happens when people are under extreme pressure and when support or supervision is inadequate. In other words, when there are systemic failures.


Sir Philip was chosen as Shell's top executive in late 2000, succeeding Sir Mark Moody-Stuart. It was a break with tradition for a Briton, rather than a Dutchman, to follow a Briton. But this decision - which, with hindsight, may have fuelled tensions at the top of the company - was glossed over in the general mood of self-congratulation.


Shell appeared to have pulled off a radical internal reform in response to a wave of mega-mergers in 1998-99, led by BP, Exxon and Total, as the industry sought to cope with oil prices that dipped below $10 a barrel.


Shell had striven to match the merged groups' cost-cutting and had achieved $4bn of savings. It had halved capital spending - making life difficult for Sir Philip at E&P - and replaced national baronies with more centralised control. Sir Mark's swan-song was the announcement of record net profits of $12.7bn for 2000 - a far cry from the "annus horribilis" of 1998, when Shell bore more than $4bn of writedowns and restructuring costs.


This financial turnround followed the soft reforms of the mid-1990s. Humbled by clashes with environmentalists over disposal of the Brent Spar oil platform and with human rights campaigners over Nigeria, Shell had introduced a social responsibility committee and produced soul-searching publications, such as "Profits and principles: does there have to be a choice?"


So Sir Philip was lucky. He had inherited a company that had already been purged of its ethical and financial ills. Well, not exactly. This was an organisation under severe pressure from a combination of cost cuts, capital expenditure limits and demanding targets for production growth and reserve replacement.


A company used to throwing money at problems had been asked to adopt ruthless capital discipline and to focus on shareholder value. The whole decades-old corporate culture was under stress. Such changes have execution risks not dissimilar to those that follow a big deal.


Worse, supervision was inadequate. Layers of management had been stripped out; financial officers at individual business units did not report to the group chief financial officer; and reserves were audited by a part-timer.


Old Shell hands were leaving the board, partly as a result of corporate governance changes. Replacements from outside were joining a dual-board structure that kept them and the audit committee at arm's length. "The unspoken rule within the company is that you are not supposed to go directly to individual board members or to the group audit committee," Mr van de Vijver said recently.


Faced with this combination of extreme pressure and scant supervision, Shell managers would have to have been saints not to be tempted to fudge the figures. Shell may have believed, arrogantly, that its employees were morally superior. But it should have realised that, for ordinary mortals, fudging can all too easily turn into cheating. It would have been better if Shell had systematically enforced good behaviour - SEC compliance, for instance - instead of relying on its "culture".


As it happens, Sir Philip did not have a smooth ride in the top job. He soon had to warn that the production growth target would be missed. Shell was recognised as a laggard in replacing its reserves. It is no wonder he came over as "brusque" and "defensive" when he met institutional investors.


Heads have rolled. But it will take much more than assertions about "honesty" and "integrity" to rebuild Shell's credibility.


Structural changes that deal with management accountability, the clout of the CFO and lax compliance are just as important as this week's trip to the confessional.


The writer is the FT's financial editor

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