Update: The Competition Commission concluded that the domination of Big Four accountancy firms has an adverse effect on competition in the market for listed company audits.
The long-awaited provisional findings into the audit market was released at 7am on Friday 22 February and found a lack of effective competition that encourages corporate auditors to focus more on the interests of the managers who appoint them than the shareholders they are supposed to serve.
Recommended remedies
1. Mandatory tendering
2. Mandatory rotation of audit firm
3. Expanded remit and/or more frequent audit quality reviews
4. Prohibit ‘Big Four only’ clauses in loan documentation
5. Strengthen accountability to the audit committee
6. Better shareholder-auditor engagement; and
7. Extended reporting requirements.
Source: Competition Commission remedy notice The latest report is a major milestone in a 16-month probe that was set in train by a critical report from the House of Lords economic affairs committee in 2011.
After poring over research documents, surveys and evidence from its own enquiries, the investigation team concluded that Big Four firms hold most of the big company audits, and that these organisations rarely change auditors.
"Essentially we identified two clusters of issues," audit investigation chairman Laura Carstensen told AccountingWEB. "The first was 'stickiness' and propensity of companies not to switch auditors and adverse issues that can result. And the second was to make sure auditors are more squarely aligned with what shareholders want."
The adverse effects of concentration of listed company audit work in so few hands include higher prices, lower quality and less innovation and differentiation than would be the case in a more open market.
This determination will come as little surprise to anyone who has worked in the profession or who has read the audit market investigation evidence published so far. If their conclusions are somewhat underwhelming, this is partly due to the project structure. With the initial findings now published, the investigation will move into its remedies phase, and seek feedback on proposals for regulatory reforms to address the audit market’s underlying problems (see box above).
Lack of competition also carries the risk of auditors being insufficiently independent from executives and insufficiently sceptical of their attempts to present the accounts in the best possible light. But when it looked into the potential for the provision of non-audit services to corporate audit clients, Carstensen's team did not find evidence of any problems.
She acknowledged the commonly held belief that "bundling" can compromise independence, but answered. "We didn’t find evidence, so our remedies didn’t address problem that we didn’t find."
The recommended remedies themselves hold few surprises, nor it might be said much to frighten the big firms. In several instances, they build on reforms and guidance that have already been put in place.
They start with mandatory rotation and tendering of audit work, either every five or seven years - with views sought on the advantages of seven, 10 and 14 years. A revision to the Combined Code for corporate governance effective from last October already requires FTSE 350 companies to put their audit out to external tender every 10 years, but the Competition Commission team concluded greater frequency of tendering may be required to address effectively the lack of market competition.
More frequent tendering should be mandatory, and the investigation team do not favour the "comply or explain" approach adopted by the current cod, "as this may undermine compliance with this remedy". In some instances, thought, the team can see a need for a mechanism
for the FRC to let companies off the requirement to switch auditor.
The recommendations also include "open book" tendering that would give firms pitching for the work access to the incumbent auditor's files to give prospective auditors a better understanding of the company’s control environment and audit issues.
Faced with evidence that finance directors frequently control the relationship with external auditors - and exert pressure to keep surprises away from audit committees - the Competition Commission wants to limit their role in selecting and appointing auditors to "the minimum necessary". The proposed remedy is to give responsibility for tendering and negotiating work and fees to audit committee chairs, making them "solely and unambiguously" the client of the audit engagement partner.
The suggestions to enhance shareholder-auditor engagement include propsals to let shareholders call for an audit tendering process. Audit engagement partners may also have to make presentations to shareholders at AGMs and hold open Q&A sessions on the conduct and outcomes of their audits.
Compared to these fairly minor adjustments, mandatory rotation forms the bedrock of the recommended remedies, yet critics have argued that it could end up strengthening the big firms’ monopoly of listed company audits if rotation just meant companies moved their audits from one Big Four firm to another every few years.
However Grant Thornton, the UK's number five accountancy firm, welcomed the findings and put out a statement this morning voicing hope that the probe would lead to "an appropriately balanced package of remedies" that would improve market diversity and assist firms such as Grant Thornton to accelerate their expansion in this market."
Carstensen made it clear that her team’s terms of reference did not extend to proposing a radical overhaul of the profession, and emphasised that the provisional findings were just one step of a continuing, and open consultation process.
“This is the Compettion Commission and the job we’re given is to idenitify if there is a competition problems and then to identify what remedy would be proportional to address those problems,” she said.
“I think we’ve come up with a number of novel points, particularly to give shareholders more visibility.
“Once you get a more contestible market with less security of tenure and more access for shareholders to express their demands, you should get from that process an adaptation of pricing, quality and service. We’re not in business as the Competition Commission to give anyone a leg up, but to open the door so people able to pitch for work get more opportunities to do so.”
Interested parties have until 21 March to submit their comments and alternative suggestions to the investigation. These responses will be collected and digested over the summer, with the final deadline for deciding any statutory action set for October 2013.
If the provisional findings contain few surprises, the material gathered during the investigation should hold some interest for students of the internal practices of firms at the top end of the market, including:
- Summary of provisional findings
- Notice of possible remedies
- A survey into the strength of competition for audits at FTSE350 companies that found that they put tenders out and switch auditors infrequently, and as a result have little evidence to assess the value they are getting for the fees paid; 40% of these companies would not consider an auditor other than one of the Big Four firms,
- Responses to investigation working papers
- independent reports commissioned from outside. , but does not give many clues as to which way the enquiry will go with its recommendations. The FTSE 350 survey, for example,
- The majority of FTSE 350 companies surveyed did not consider their choice of auditor to be limited to the Big Four firms, this was the case for around 40%.
- A study of inertia and conflicts of interest published last October that found 66% of finance directors/chief financial officers surveyed had previously worked for one of the Big Four audit firms, and around 60% of audit committee chairs.