Case Study on "Cases in Corporate Governance"

Case Study 6 pages (2084 words) Sources: 6

[EXCERPT] . . . .

Corporate Governance

Shell

What occurred in Shell case?

In what became known as the Royal Dutch case, Shell, in 2004, overstated its oil reserves. This resulted in a loss of confidence in the group, a $17 million fine by the Financial Services Authority and the retirement of both its chairman Sir Phillip Watts and its exploration director, Walter van der Vijver. Expostulating that he was sick and tired of lying, van der Vijver, the firm's head of exploration and production, told Sir Phillip Watts in November 2003 that he had enough of covering up for shortfalls in the firm's reserves and that he wished to do this no longer. Watts, accordingly, replaced him.

Van der Vifver's outburst was over the overly aggressive and inaccurately optimistic recordings that he had been stimulated to record in the financial statements. . However, Watt's zealous overbooking caught up with him when, in January of that year, questions compelled Shell to reclassify a huge fifth of its 'proved' reserves. This suspicious action caused investigations to be carried out that unrobed the corruption and both men were forced out of the company.

Inquiries also showed that, despite strict accounting laws that may easily intimidate companies form deception, Shell's ambition proved too much for them. Deflated profits made them inflate reserves in order to retain the services of their investors and to attract further shareholders.

A consequent lawsuit in 2007 resulted in Shell having to pay $450 million to non-American shareholders (Treanor, 2009). Shell briefly suffered for its errors, but, once again, managed to climb out of its mess to regain some of its original reputation.

1. To what extent the event facing Shell in 2004 caused by human failings or structural (organizational) failings?

The Shell scandal seems to have occurred more due to human failings than to internal structural weaknesses. Apparently, Shell had deliberately misled its investors for years according to one of its internal reports that were published in 2004. It admitted to having overestimated the quantity of its oil and gas reserves by more than 25% and, moreover, both its chairman, Sir Phillip Watts and its exploration director, Walter van der Vijver, had been aware of this fact for at least 2 years and had advised destruction of at least one internal e-mail that indicated facts that pointed to reverse circumstances in Shell. Other employees acquiesced in hiding misstatement for fear that they would lose their jobs

2. Discuss the potential facing the members of the parent companies in attempting to monitor and control the activities of management.

Governmental procedures instituted since the Shell scandal as both prevention and control to further similar occurrences have gone a long way in enabling parent companies to monitor and control the activities of management.

These controls are largely dual and both internal and external. Internal controls involve postings such as that on Shell's website where Shell has pledged allegiance to integrity, transparency, and honesty, and they have established an online facility for whistleblowers to report Shell activities, both on larger or on internal scale (as, for example, from management) that contradicts these ethical resolves. ("Reporting and addressing suspected violations of the law or the Shell General Business Principles (SGBP) is of critical importance in protecting our reputation and the value of the Shell brand.") Whistleblowers are encouraged to focus on both internal and external occurrences and anonymity of respondents to accepted (Environment and Society, 2007)

On a national scale, the Sarbanes-Oxley Act (SOX) was established to control similar corporate scandals from occurring. The SOX contains 11 sections, or prerogatives, that include stress on additional corporate responsibilities, and penalties for their transgression and involves the intervention of the Securities and Exchange Commission (SEC) as well as the creation and involvemnt of the Public Company Accounting Oversight Board (PCAOB) to monitor implementation of and obedience to the SOX.

Part of the provisions of the SOX is that:

1. A set of internal procedures that mandate accurate financial disclosure certified as such by the signing officers (Section 302)

2. Disclosure of all material off-balance sheet items (Section 401).

3. Each corporation has to produce an internal control report where management and an external auditor has to assess and report on the level of the company's internal control over their financial reporting. This also involves the company having to implement and monitor an effective internal control structures (Section 404).

4. Deliberate falsification of records or statements involves a fine and/or imprisonment for at least 20 years (Section 802). Other criminal retaliations include deliberately and fraudulently interfering in the livelihood or employment of another person. Punishment for this offense consists of fine / and/or imprisonment of at least 10 years (Section 1107).

Research such as that by Arping & Sautner (2010) and the Institute of Internal Auditions (2005) found that corporate companies have not only become more transparent as a result of this Act, but that financial statements have become more reliable and accurate.

In Europe, too, corporate control was tightened with: (a.) call of greater infusion of ethics in corporate cultures; (b) appointment of a 'Chief Ethics Officer' and (c) push for adoption of stricter ethical codes of conduct (Fombrun & Foss, 2004).

3. Why might the senior management of a large quoted company be sensitive to the concerns of large institutional investors such as Calpers? Organizations depend on investors for putting money into their organization. This especially helps them with difficult times. The larger and more prominent the investor -- such as Calpers in Shell's case -- the more Shell would want to retain such an investor and seek to retain their trust and confidence.

Private investors provide the funds to put into a business in order to propel it forward, to give it a solid foundation (if it needs one), and to help it expand by accomplishing its desired projects. The money is also useful for buying equipment, machinery, or land.

2. Enron Scandal

The Enron scandal, revealed in 2001, resulted in bankruptcy of the Enron firm. And the dissolution of Arthur Andersons that was one of the five largest audit and accountancy partnerships in the world. Enron was not only the largest bankruptcy case at the time, but also the largest audit failure.

Enron was an American energy company based in Texas. Through use of special purpose entities, accounting loopholes, and fraudulent accounting strategies, Enron was able to hide billions of dollars in debts from failed deals from its investors and unsuspecting public. The internal company including executive and managers was misled by it Chief Financial Officer Andrew Fastow and others of similar rank on high-risk accounting practices and they pressured Arthur Andersons to ignore issues.

Investigation began when shareholders lost nearly $1 billion in 2001 when Enron's stock price plummeted to less than $1 by the end of November of that year. Many of its executives were jailed and Arthur Andersons was found guilty in a UN states district court (the ruling was later overturned by the U.S. Supreme court). The firm lost most of its customers and was forced to close. Shareholders and employees received limited compensation, and the SOX emerged as one piece of legislation that was formed to prevent and control such, and similar, scandals from occurring (Healy & Krishna, 2003).

3. Discuss the relative risks of companies with substantial physical assets compared with companies which have substantial intangible assets.

It seems as thoguh companies with substantial intangible assets may have more involved than companies with substantial physical assets. This is because intangible assets help the company innovate and differentiate themselves and, therefore, potentially accrue a larger load of physical assets than those that hold the physical assets alone. Companies with the intangible assets hold the helm in competition.

The UK government has, for instance, recognized this dilemma in trying to prevent and control corporate corruption from occurring. Financial statements typically reveal tangible assets alone and regulations have been created to ensure that integrity and correctness holds. The UK government, in its 'Accounting for People' initiative, set out the premise that employees are also a form of capital and that, therefore, employers should include information on their people management activities in their financial statements. Later this changed, however, when UK companies were only required to include information about their employees in their operating and financial reviews. Even now, there are constant difficulties with implementing this, primarily due to finding a methodology that would be able to develop non-financial metrics. Nonetheless, changes have developed with three new terms of intellectual capital coming into circulation (i.e. human capital; customer or relational capital; and organizational or structural capital).

Another government that recognized the crucial importance of tangible assets and the need to control for this too was the Danish government that tried to experiment with introducing intellectual capital into its capital reporting. There are constraints to incorporating intellectual capital into the accounting system, but observers believe that a way to do so may yet be found, particularly since accounting is one that, rather than being… READ MORE

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