Introduction
There are various definitions of the concept corporate governance. Talaulicar (232) provides a conventional definition of this aspect of business management. Talaulicar refers to it as the wide range of policies used by boards of directors, executive managers, and stockholders in running an organisation.
The identified parties use the policies to manage themselves and to meet the expectations of the investors and other stakeholders. On their part, Chau (7) postulates that corporate governance involves the design of institutions. Such a model is tasked with the responsibility of forcing or inducing managers to internalise the activities specified by stakeholders.
The current paper involves an analysis of corporate governance in relation to Royal Dutch Shell. The author reviews some of the factors informing the formulation of these governance policies and their impacts on the operations of the company. Some issues revolving around this concept in the company will also be reviewed. Recommendations will be made to improve the operations of Royal Dutch Shell with regards to corporate governance.
Corporate Governance and Changing Times
Over the last few decades, the concept of governance in the corporate world has attracted a lot of attention from scholars and other parties. Various initiatives to influence the conduct of boards of governors have been executed.
Such undertakings involve filing shareholder resolutions and the creation of governance standards. Issues highlighted include, among others, compensation, board diversity, and accountability. Other areas addressed under the auspices of governance involve the formulation and implementation of environmental policies, establishment of employment ethics, and involvement of community members in company operations.
Royal Dutch Shell: Company Background
The Shell Group of Companies was formed in 1907. It resulted from an amalgamation between Shell Transport and Trading Company and Royal Dutch. In the new firm, the former had a stake of 40%, while the latter had a majority share of 60%. The organisation operates from The Hague, Netherlands. It has operations in more than 70 countries around the world (Crowley 36).
Shell is engaged in a wide range of operations. It has interests in the exploration and production of gas. It is also involved in the marketing and transportation of natural gas and electricity. In addition, the company has invested in the shipping and marketing of chemicals and oil products (Crowley 45). It is also important to note that Shell has invested heavily in the renewable energy sector. It is involved in the exploration of alternative sources of energy.
Corporate Governance Issues at Shell
One of the major factors behind governance among corporations is the misconduct of management and the failure of many companies. Consequently, it has emerged that the inadequacies associated with corporate surveillance has led to major concerns in the industry. That is the reason why shareholders, employees, and potential investors have taken interest in the way companies are managed.
Shell has emerged as one of the biggest and most influential multinational corporations in the world. Like majority of other companies, Royal Dutch has been negatively affected by shortcomings in its governance structures. For example, the company has been accused of violating the rules and regulations guiding the accounting process among firms.
The violations led to an overstatement of the company’s oil and gas reserves (“Royal Dutch/Shell: Another Enron?: Assessing the Seriousness of Shell’s Crisis” 13). On January 2004, the multinational reduced the statement of proven oil reserves and gas by one-fifth. The reduction amounted to an estimated four billion barrels of oil. The figure was a massive misrepresentation of the company’s worth.
In spite of the disclosures, the company’s chairman, Sir Philip Watt, denied any incompetence or wrongdoing on the part of the management in relation to the overstatement. However, the board sacked him following the incident. Prior to his dismissal, it was established that the chairman was aware of the misrepresentation since 2002 (“Royal Dutch/Shell: Another Enron?: Assessing the Seriousness of Shell’s Crisis” 13). The facts were established through an internal investigation launched by the company.
The incident highlighted above had far reaching implications on the company and other individuals associated with its operations. For example, such law firms as Berger and Montague sued the company. Some claims made in the suit included harming stakeholders through deception and overstatement of market value (“Royal Dutch/Shell: Another Enron?: Assessing the Seriousness of Shell’s Crisis” 13). Other law suits revolved around the issue of malfeasance.
In addition to the sacking of the chairman, the scandal affected Shell’s financial officer in America. The Securities and Exchange Commission (SEC) of America also initiated investigations into the operations of the company (“Royal Dutch/Shell: Another Enron?: Assessing the Seriousness of Shell’s Crisis” 13).
It was noted that Shell had changed the stated oil and gas reserves from ‘proven’ to ‘probable’ (“Royal Dutch/Shell: Another Enron?: Assessing the Seriousness of Shell’s Crisis” 13). The shift meant that the reserves were not eligible for commercialisation under the SEC rules.
The incident highlighted major governance shortcomings within Royal Dutch Shell. The chairman, one of the highly ranked managers of Shell, had violated rules and regulations that might have led to the collapse of the company. The company manifested a governance structure that lacked accountability. Figure one below shows the changes that resulted from the restatement of the company’s oil and natural gas reserves:
Figure 1: Changes after restatement of reserves
Source: “Royal Dutch/Shell: Another Enron?: Assessing the Seriousness of Shell’s Crisis” (13).
Royal Dutch Shell: Analysis
Insights into the Company’s Corporate Governance Issues
Corporate governance, as a concept, may seem relatively new. However, it has been around for many years. According to Chau (8), most of the issues related to this concept arise from the separation of control and ownership in large corporations. Such issues may also emanate from the control that specific shareholders have over minority stakeholders.
From an economic and legal perspective, the focus of governance in corporation illustrates the process of defending the interests of stockholders. For instance, the main issue arising from the stated scenario at Shell involved misleading the shareholders. However, the misrepresentations made in the books may have been meant to benefit other stakeholders. Alternatively, they may have been aimed at benefiting the company alone.
Governance in corporations entails the overall control of activities taking place in the organisation (Sussland 49). The management should be concerned with the formulation of plans and long-term objectives. In addition, the formulation of proper management structures, including those touching on the organisation, the people, and the systems needed in achieving the aforementioned objectives, is the responsibility of these parties.
Corporate governance also entails ensuring that these structures are functioning to uphold the reputation of the company. It is also addresses the integrity of the entity and its responsibilities to the various stakeholders (Sussland 50). The case of Royal Dutch Shell indicates a failure in this aspect. Management hid information about the ‘proven’ and ‘probable’ oil and gas reserves from the stakeholders. Ultimately, the deception harmed the integrity and reputation of Shell as a global corporation.
According to Sussland (49), one of the main objectives of governance regimes in corporations is the building a strong enterprises. The goal is achieved through the creation of value for key stakeholders. The objective brings together the senior management and board of directors.
Consequently, the two governing bodies agree on the value the corporation should and can create. In addition, they need to determine the best way to fulfil the strategic ambitions. The measurement standards in relation to performance assessment should also be established (Sussland 50).
The revelations made by Sir Philips, together with his sacking by the board of directors, revealed deep seated disagreements between the two governing bodies. It is important to note that the misrepresentation may have been disclosed in an amicable manner if the two sides were in agreement. The resulting negative publicity might also have been averted.
Based on the arguments made by Talaulicar (233), it is apparent that Royal Dutch Shell suffered from agency problems. The separation of control and ownership in corporations is bound to generate problems. Governance issues arise from diverging interests among managers, owners, and stakeholders. In the case of Shell, the developments harmed the stakeholders. There were inadequate measures put in place to deal with the shortcomings (Crowley 40).
Theories of Corporate Governance in Relation to Royal Dutch Shell
Agency Theory
The theory describes a contractual relationship between two parties. According to this theoretical framework, such a engagement is established when one party (the principal) engages another (the agent) to perform given task or services (Talaulicar 233). The relationship entails delegating the authority to make decisions to the agent. However, problems may arise when both parties become utility ‘maximisers’. Ultimately, the agent may make decisions that might not suit the interests of the principal and other constituents.
Sir Philips denied any wrongdoing following the incident in Shell (“Royal Dutch/Shell: Another Enron?: Assessing the Seriousness of Shell’s Crisis” 13). The chairman felt that he was doing what was right for the company. However, the decision by the board of directors indicated otherwise. The directors felt that their decision to fire the chairman was the best for Shell (Crowley 39).
According to Chau (8), the standard definition of governance in corporations involves safeguarding the interests of the shareholders. The management team is accountable to the owners of the company, especially the shareholders. However, focusing on the shareholders and leaving other parties out gives rise to problems.
Exaggeration of the oil and gas reserves figures initially favoured the shareholders, especially in the stock market. However, in spite of this favour, shareholders stood to lose more from the revelations. The realisation informed the argument by Berger & Montague law firm to the effect that Shell had deceived the shareholders by overstating the firm’s market value (“Royal Dutch/Shell: Another Enron?: Assessing the Seriousness of Shell’s Crisis” 13).
Some financial economists are of the opinion that maximising the value of shareholders by governing regimes may eventually benefit other stakeholders. However, according to Chau (9), the gains made by the shareholders may be realised at the expense of the welfare of the other parties. The scandal at Shell reflects this imbalance between shareholders’ value and stakeholders’ interests.
The chairman placed a lot of emphasis on shareholder value. It is one of the reasons why he pressurised the executive to engage in the unethical activities. A case of conflict of interests is made apparent at Royal Dutch Shell. The shortcomings reveal inherent flaws associated with the conventional definition of corporate governance (Chau 9).
According to Sussland (50), the notion of shareholder’s value has forced the management and the board of directors to focus on one stakeholder only. The stakeholder’s value focused on in this case is that of the shareholder, as made apparent in Shell’s scenario. The management, through the chairman, made stock price the focal point of their strategy.
The shortcomings in stock price or stock market value do not reflect the actual worth of the enterprise. They are prone to unfounded speculations and manipulation (Sussland 50). The governing regimes fail to realise that focusing on shareholders disregards the fact that stakeholders are interdependent. Effective functioning of the corporation relies on the effective cooperation between the parties in optimising their interests.
The book value of Shell should have acknowledged the real situation. Simply put, book value provides an inventory of the financial assets and the market value of a corporation (Talaulicar 35). The figures neglected other aspects relating to the worth of the business. Royal Dutch Shell’s management could have succumbed to stiff competition.
It is perhaps one of the reasons behind the shortcomings associated with the governance regime. Stiff competition, coupled with short time cycle, may force managers to focus on results and how to get them fast (Sussland 50). Shell’s management focused on evaluation of the company performance through financial indicators only.
Financial indicators are advantageous as they merge the various performance aspects under one common denominator (Chau 9). However, they fail to explain how the performance was obtained. The management focused on this element of the business value, leading to the witnessed manipulation of real corporate earnings.
Different authors argue for or against corporate governance in relation to the agency theory. The theory can be used to explain the scenario presented by Royal Dutch Shell’s governing regime. Donaldson (265) highlights the weaknesses of the agency theory with regards to corporate governance. The theory fails to take into consideration the moral obligations of the governing regime towards their agents and other external groups.
The management is expected to serve the interests of the agents. However, in the case of Shell, the team failed to define the appropriate course of action in case of conflicts of interests. The chairman and his team may have been obliged to lie in order to attain specific shareholders’ marginal benefits.
Based on the agency theory, one may question the appropriateness of the manager’s actions. For instance, it may not be clear how a manager should behave when operating in countries that have inadequate environmental laws. Such weaknesses as far as theories on corporate governance are concerned might have facilitated the scandal.
According to Talaulicar (233), the agency problems witnessed in Shell can be pinned down to a number of factors. The agents managing the firm might access information that they use to their advantage. However, most problems emanate from discrepancies between the interests of the owners and those of the managers (Talaulicar 233). The issues may persist when the owner fails to reduce the information asymmetries. Such factors as costs might make it difficult for the owner to verify the actual activities of the managers.
The major problem behind the scandal at Royal Dutch Shell involves the agency’s concept of corporate governance. The failure of the board of directors and the shareholders to determine the actions of the management team led to the scandal. The problem might have been averted if the managers were under the control of external and internal oversight systems.
According to Chau (12), governance in corporations is not an end in itself. On the contrary, transparency is paramount. Accountability promotes public confidence in corporations. Dialogue can also enhance understanding of the interdependent and dynamic aspects of corporate environment.
Following the restatement of Shell’s reserves, the company’s shares dropped by 8%. Such a drop was a reflection of the impacts of poor governance (“Royal Dutch/Shell: Another Enron?: Assessing the Seriousness of Shell’s Crisis” 13). The faith that shareholders had in Shell’s governance was put to test.
The scenario was evident in spite of the value the stakeholders initially derived from the misrepresentation of the company’s value. Arguably, the management might have sought to match their competitors in the market. Such players include BP and Exxon Mobil.
Transaction Cost Economics Theory
The other framework that can explain governance issues at Royal Dutch Shell is the transaction cost economics (TCE) theory (Donaldson 265). The theory holds that firms are established with the intent of avoiding some transaction costs in price mechanisms. Under TCE, corporations are created by the market forces. They also originate from the attempts made by market actors to avoid the transaction costs (Donaldson 266).
One of the major differences between TCE and agency theory is the former’s assumption of the opportunistic nature of humans (Donaldson 265). On its part, the latter emphasises on the agency costs and associated moral hazards. TCE takes into consideration the economics of governance driven by workable arrangements and “good order” (Donaldson 269).
Good order in TCE entails spontaneous market arrangements. It also involves deliberate, conscious, and purposeful economic engagements (Talaulicar 240). As such, the theory is founded on the transaction cost that involves economising on outcomes. It can be predicted using the interactions between market actors and forces. In essence, the moral aspect of corporate governance does not feature in the TCE theory.
The concepts found in TCE theory are applicable to the governance scenario that affected Royal Dutch Shell. In spite of the errors committed by Sir Philip, the incentive to cheat through manipulation of books did not come out strongly (“Royal Dutch/Shell: Another Enron?: Assessing the Seriousness of Shell’s Crisis” 13).
The compensation given to the chairman was lower than that of his peers at Exxon Mobil and BP (“Royal Dutch/Shell: Another Enron?: Assessing the Seriousness of Shell’s Crisis” 13). In addition, only a small fraction of Shell’s managers’ relied on oil and gas reserves bookings.
The managers lacked motivation to manipulate the booking of oil and gas reserves. In light of this, TCE theory might be used to effectively explain the scandal. The external and internal market economic factors might have facilitated the deception. Based on the data presented in figure 1, it is likely that the management may have been compelled to keep up with the competitors, mainly Exxon Mobil and BP. The executive at Shell sought to govern by creating workable arrangements and good order in the company.
TCE has a number of weaknesses. For example, it is inadequate in the determination of the appropriate and workable arrangements. Establishing good order raises the issues of the probable beneficiary. In addition, the issue of workability of arrangements becomes a problem in corporate governance.
Recommendations
Addressing the weaknesses associated with Shell’s corporate governance requires responding to all the issues highlighted in this report. The corporate decisions need to serve the interests of the enterprise and facilitate sustainable value creation. The bottom line is the creation of a principle that strikes a balance between the interests of the various stakeholders.
The weaknesses of agency theory in relation to Shell can be addressed through a combination of approaches. It is important to note that the compensation problem may not be the major cause of the scandal. However, the issue should be reviewed. Effective compensation systems require the introduction and review of equity ownership. As equity owners, the managers might embrace transparency in their activities.
Alternative corporate governance systems can also be introduced. Such arrangements might include structural recommendations like representation of stakeholders in the board. Alternatively, special units of governance can be established to deal with the affairs of the stakeholders. Stakeholders can be represented through non-shareholder appointments. The parties can also be appointed to the supervisory board, leading to a two-tier corporate governance system.
The recommendation is based on the assumption that the interests of the stakeholders will be catered for if these agents are involved in decision making. In addition, their representatives might bring with them expertise, skills, and experience in the boardroom. The added advantage would enhance corporate value in general.
Other elements of corporate governance in Shell should also be addressed. For instance, the roles of the chief executive officer and the board chairman should be separated. Managers must be granted the autonomy necessary to drive the corporation forward. However, their freedom must be exercised on a framework of accountability. Such an objective can be achieved through efficient decision making processes by executives. Power distribution must also be based on a clearly defined scope of responsibilities and rights.
Shell’s corporate structure should clearly define the legal entitlements and legitimate roles of stakeholders. Various external and internal control mechanisms should be designed and implemented to avoid repetition of such incidents. The governance structure should uphold transparency and integrity. Furthermore, responsibility, stewardship, and accountability should feature in Shell’s governance framework.
Care should be taken not to stifle the productivity of Shell’s corporate governance. The proposed structure should not entail excessive bureaucracy and surveillance. The main role of governance should be to foster quality care through the creation of value for the stakeholders and the enterprise.
The benefits of an effective corporate governance framework are many. By supporting socially accountable behaviour, Shell would gain the trust of investors. Well governed organisations are also likely to generate high equity returns. Shell would increase its market value and improve its performance.
The future of corporate governance is characterised by numerous challenges. Most of these issues are related to globalisation. Such challenges are significant considering the evolving nature of global enterprises. A holistic model of corporate governance may help to overcome such issues. Changes in economic relationships and market structures influence corporate governance.
The process is also affected by the nature of interactions between the community, the stakeholders, and the business forces. As such, administrative systems require regular reviews to help corporations cope with the changing environmental needs. Good corporate governance is a function of a number of factors. They include legal, social, economic, and personal elements. Such corporations as Shell should invest in mechanisms meant to check the operations of corporate governance.
Conclusion
An analysis of Royal Dutch Shell’s corporate governance from the perspective of the various theories of governance reveals several shortcomings. The major issue affecting the company is lack of transparency. The problem is common in the oil industry since these companies rarely reveal their books in detail (“Royal Dutch/Shell: Another Enron?: Assessing the Seriousness of Shell’s Crisis” 13).
Transparency with regards to honest disclosure of a company’s information is vital for effective corporate governance. Shell’s management exhibited lack of transparency in restating oil and gas reserves. It is not possible to point out to the beneficiaries of this practice. Some people may argue that the company did nothing wrong. However, it is obvious that the reputation of the organisation was negatively affected.
It is clear that the governance structure at Royal Dutch Shell needs to be restructured immediately. For instance, the structure of the two arms of the company (Shell and Royal Dutch Shell) facilitates lack of accountability (“Royal Dutch/Shell: Another Enron?: Assessing the Seriousness of Shell’s Crisis” 13). Such a scenario arises from the weakened position of the chief executive officer.
The company is also characterised by lack of a balanced corporate structure. Such a structure is needed for efficient corporate governance. The firm’s governance model fails to address the varying interests of stakeholders. The management seems to focus more on the creation of value for shareholders than on other aspects of the organisation. The skewed focus led to deceptions in relation to the actual value of the company.
Works Cited
“Royal Dutch/Shell: Another Enron?: Assessing the Seriousness of Shell’s Crisis.” The Economist 11 Mar. 2004: 13. Print.
Chau, Soling. “An Anatomy of Corporate Governance.” The IUP Journal of Corporate Governance 10.1 (2011): 7-21. Print.
Crowley, Michael. “Corporate Governance- Royal Dutch Shell, Terrorism and Reputational Risk.” Legal Issues in Business 11 (2009): 35-47. Print.
Donaldson, Thomas. “The Epistemic Fault Line in Corporate Governance.” Academy of Management Review 37.2 (2012): 256-271. Print.
Sussland, Willy. “Business Value and Corporate Governance: A New Approach.” Journal of Business Strategy 25.1 (2004): 49-56. Print.
Talaulicar, Till. “The Concept of the Balanced Company and its Implications for Corporate Governance.” Society and Business Review 5.3 (2010): 232-244. Print.