Royal Dutch/Shell case write up

Introduction
Royal Dutch/Shell Group of Companies was formed through and alliance of Royal Dutch Petroleum company and Shell Transport Trading company in 1907. Even though the two companies remain separate, the matrix structure of Royal Dutch/Shell Group of Companies had helped the company survive the oil price collapse and some other crisis. By 1990, Royal Dutch/Shell’s revenues exceeded the industry leader Exxon’s, making it the largest oil company in the world. However, In the 1990s and early 2000s, the company’s reserve replacement ratio has dropped from above 100 percent to almost below 100 percent, which indicates that the company was having trouble with replacing the oils it produced each year with new reserves. In order to boost up its reserve placement ratio and offset other series of problems, Royal Dutch/Shell Group Companies changed its operating structures. In January 2004, the company announced that it would reduce its estimate of proved oil reserves by 4 billion barrels, or 20 percents. Six months later, by the time the restatement was completed, the company had reduced its reserves for 3 additional times. Royal Dutch/Shell’s reputation was hugely affected as it had been suited by several security boards. Shareholders were outrageous as well.

Causations of the reserve restatement
Firstly, the complex operating structure of Royal Dutch/Shell had a huge negative impact on Royal Dutch/Shell’s performances and it directly led to the downgrades of the company. Since Royal Dutch and Shell are two separate companies, the oversight of Royal Dutch/ Shell required the coordinated efforts from both sides. Directors from both companies met jointly during the years, and the meeting is called conference. The company also has its own group audit committee (GAC) and committee of managing directors (CMD) to help the company review its financial reports and to make strategic decisions. The different backgrounds of these directors might potentially prolong the decision making processes, and therefore decrease the decision making efficiency of the business. Moreover, the company reorganized its group activities by different activities rather than by geography and replaced its matrix structure with five centralized operating units. These changes decreased the autonomy of regional leaders and at the same time created a big problem for the company. As the ways to estimate oil reserves are different across regions, the regional leaders generally are more accurate in calculating oil reserves as they are more familiar with local geographic conditions. However, under the matrix structure, the calculation was carried out by one of the five groups which had little knowledge about local environments and problems automatically occurred. In addition, the complex structure also hindered the company in that the communications between the business units’ officers and top managers were rare and inefficient. The CFO of the company, Judy Boyton, was not able to react to the reserve issues simplely because none of the business units’ CFO reported to her.

Moreover, the CEO himself should be held responsible for this scandal. Firstly, Philip Watt, the chairman of CMD, was “aloof and uncommunicative” as described by some investors. He reduced the company’s expected return on sales but did not provide enough explanations to justify his decision and therefore made most investors unsatisfied. His silence negatively affected the relationships between Royal Dutch/Shell and its shareholders. Secondly, Watt did not report the reserve problems immediately but instead he refused to disclose the reserve issues. According to Davis Polk & Wardwell’s investigation results, long before Watt’s announcement of the reserve problems, Van de Vijver, the chief executive of exploration & production, had informed Watt there were issues with the company’s oil reserves. If Watt would tell the public the reserve problems at the first place, there might be less anger among publics and the reputation of the business might not be affected as badly. One critical factor that caused the misbehavers of Watt and Vijver, was the company’s Executive Compensation plan. It is stated in the plan that CEO’s salaries and other benefits (e.g. stock options) are directly linked with the performance of the company. Since the performance of the business was indicated by the reserve replacement ratio. To get higher payments, the executives would try everything to boost up the number of the ratio and even risk manipulating the numbers. During Watt’s period, the company switched from conservative accounting toward aggressive accounting and manually increased its reserve ratios.

Conclusions
The restatement of Royal/Dutch Shell’s reserves was caused by several reasons, including: the complex corporate structure, the inefficient communication systems, the company’s sole measurement of performance, the executive compensation plan, and the misbehaviors of the company senior members. In order to recover the company’s reputation and win back its investors, the company should consider changing its business structures as well as addressing the issues above.