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The insidious charms of Shell’s dual votes: But just one factor in the foul up

Financial Times: The insidious charms of Shell’s dual votes: But just one factor in the foul up

By John Plender

Jun 21, 2004

Royal Dutch/Shell is to scrap its priority shares, which carry voting rights controlled by the management. Could this dual voting structure have contributed significantly to the problems that culminated in its cooking the books?

A new study of US dual class companies by Andrew Metrick of Wharton, Paul Gompers of Harvard Business School and Joy Ishii of Harvard University, available on the Wharton web site, throws interesting light on this question.* The economists find that large insider ownership stakes tend to improve corporate performance, while heavy control by insiders tends to weaken it. Performance in the study was measured by Tobin’s Q, an asset-value based proxy for stock returns.

Company values improved as insider ownership rose, peaking when it reached 33 per cent in relation to their share of cash flow such as dividends. Above that level it looks as though insiders lost their desire to accumulate shares and preferred risk averse corporate strategies. Growth in insiders’ voting power, by contrast, caused performance to decline, with the loss bottoming out when they reached 45 per cent of the votes. This is consistent with the entrenchment effect whereby insiders pursue strategies at outsiders’ expense.

The study also shows that sales growth improved as insiders’ financial stakes grew, but worsened as they gained voting clout. The same pattern was found with capital spending and spending on research and development and advertising. In short, insiders with voting clout are reluctant to raise cash by selling shares. They skimp on expenditure to maintain control. On this basis Shell has had the worst of all worlds: managers with economic ownership below US levels, but voting control in the hands of Dutch directors.

Yet I think it is more complicated than this. For most of the last century Shell worked well with low inside ownership and dual voting, demonstrating a strong, cohesive culture and a capacity for self-renewal. The problems set in after it shifted to US-style quantitative performance targets for managers and to stock options, while shedding the old system of controls needed to check and balance ambitious managers.

The dual voting system may have been a factor in Shell’s problems. But I suspect that the Americanisation of pay and performance incentives, capital market pressure and culture change were more important.

*Incentives vs. Control: An Analysis of US Dual-Class Companies.

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