Published: April 07, 2004 in Knowledge@Wharton On January 9, Royal Dutch/Shell, the third largest oil company in the world, announced that its reserves — the measure of oil still in the Earth that it controlled — was overstated by 20%. Mild as that statement might sound to the uninitiated, to financial markets it came as an earthquake -- and the reverberations have not yet ended. In February, chairman Sir Philip Watts apologized to investors in a lengthy analysts' meeting. In March, Watts and heir apparent Walter van de Vijver were sacked and further adjustments to the reserve accounts were made. The Securities and Exchange Commission and the U.S. Department of Justice and various European entities have confirmed ongoing investigations.

 

When the brouhaha broke out, the international financial press was quick to label it "Europe's Enron", much as it did when accounting scandals surfaced at Parmalat, the Italian conglomerate. As the media hubbub over alleged corporate wrongdoing grows louder, is it likely that Europe might see its own version of corporate governance reform, comparable to the Sarbanes-Oxley legislation in the U.S.? Two Wharton experts -- Christian Leuz and Robert E. Mittelstaedt Jr. -- have different perspectives on the situation.

 

First, some background: Oil reserve accounting is an arcane subject, but vital for investors. Obviously, investors buy a company’s shares to get a stake in current and future earnings. For energy companies - or any firm that has its product sales capped by limited supply versus potential market demand - investors have to take into account how long resources to generate future earnings will last in calculating their expected return. Thus, the stock price of an energy company is intimately tied to the amount of oil or gas reserves it claims. When Royal Dutch/Shell, considered one of the stodgiest of the large energy companies, lopped off 20% of its declared oil and gas reserves, investors and analysts were stunned.
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