RSS feedsThe demise of Arthur Andersen in 2001 left only four major audit firms, performing more than 80% of audits of the major global corporations. This concentration is of even more concern in particular industries with a need for certain expertise, such as banking, insurance, construction and aerospace. Many of the larger companies already make use of several of the Big Four for services for audit, tax, systems design and implementation.
Problems can now arise if a company wishes to change its audit provider, as the non-audit services work that the other major firms have been undertaking for the company can automatically preclude them from being considered as an independent auditor of that company’s financial statements.
When the debate about choice in the audit market began, few realised it would escalate to the levels it has. The Big Four were understandably defensive, fending off accusations that they dominated the market in areas where others were equally capable.
The recent government-commissioned study by research firm Oxera confirmed observations in the market that there is a huge issue of perception by many companies that their choices are limited to the Big Four. It also found competition did not work as effectively as it could.
Although the Oxera report did not set out to examine anti-competitive practices, it noted that there were no suggestion of monopolistic behaviour by the large audit firms: ‘The general perception is that audit quality in the UK has, as yet, largely been maintained at acceptable standards, and some competitive pressure remains for the audit business of those large companies that still have a choice among the Big Four firms.’
This echoes the findings of the Office of Fair Trading in its 2001 report ‘Competition in Professions’.
It also re-affirms a report in 2003 by the US government General Accounting Office, which found that while the level of choice was undoubtedly restricted f or large public company audits, the market in the US was working effectively and that there was no widespread appetite among stakeholders for regulatory intervention to stimulate more choice.
It would then follow that the market’s current level of concentration is at least partly the result of market forces and that market-based information-dissemination actions are therefore the most likely to have an effective impact, in terms of being proportionate to the issue.
Jeremy Boadle, managing director of tax and business services at Smith & Williamson, credits the Oxera research group for finally bringing alive a debate that had previously been held in whispers.
‘There’s a lot more knowledge about the audit market than most people were aware of, including more about the shape of the market and how this is relative to the Big Four. Those on the inside may not be surprised by its contents but it has brought the issues very firmly to the table. Some of the interesting facts include the very low rate at which firms change auditors, showing that one has to be in the market for a long time to build credentials. This leads directly to the decision makers on audit committees, who sit in these positions for just as long,’ says Boadle.
While Oxera may not have provided any answers to the many questions it threw up, it has finally got people thinking about the issue. Unfortunately there is not yet a consensus that a single solution can be reached, and finding one is unlikely to happen overnight.
‘It has made auditors and companies alike realise that it is fundamentally not good for the capital markets to have a limited choice of audits, especially in view of the threat that if the Big Four were to move away from audits, the results may be catastrophic as it will destabilise the market. And yet we need to see change and cannot live under the threat which is practical possibility,’ says Boadle.
The largest firms have openly said there needs to be a broadening of firms offering their services to the market.
In other words, a market-driven solution is being sought by the market, rather than some form of regulatory intervention.
Recent comments by the Association of British Insurers offered further ideas on how to achieve this.
Their suggestions hit a tender spot – essentially blaming the companies themselves for the perception that the Big Four are the only ones worthy of undertaking a FTSE 250 audit.
The comment places the blame squarely at the door of audit committees, banks and investors, urging them to recognise their inherent institutional prejudice and overcome it.
It’s no secret that many companies seek to have only ‘brand name’ audits from the Big Four. ‘Decision makers need to be better informed about credentials and the skills base of auditors. They generally need to have a greater awareness of other firms in the market, outside the Big Four,’ says Boadle.
Deloitte chief executive John Connolly agrees with this, recently stating publicly that there is ample choice of audit firms that extend beyond the Big Four. ‘But choice is an issue for the very largest multinational companies, often exacerbated by the application of national independence rules that either have extraterritorial reach or are unduly focused on the perception of independence.
‘The difficulty is that many of the suggestions to increase choice do so at the expense of quality and could significantly damage confidence in capital markets.
‘Ultimately these firms or networks of firms will need to invest. The scale requirement and investment capacity could be achieved through the combination of two or more firms and/or aggressive organic growth. Almost certainly they must identify the specific industry sectors in which to compete, attract and retain highly skilled people, develop more consistent standards and manage higher levels of risk. Emerging opportunities could exist for mid-tier firms to combine with one of the large Chinese firms where the Big Four do not have a dominant position,’ said Connolly.
Various other ideas have been presented by stakeholders in the choice debate, adding to Connolly’s radical idea of a Chinese merger. These include joint audits, audit liability caps to prevent the collapse of a large company from a damaging lawsuit, as well as more regulatory oversight, and a contingency plan which would take into account the companies that employ the auditors.
John Tiner, chief executive of the Financial Services Authority, has so far agreed with a contingency plan in the event of a large firm’s failure. ‘Though this debate has been taking place in the UK, participants are well aware that, as a global issue, if there was a failure of a Big Four audit firm, there needs to be co-ordinated plans amongst regulators on a global basis to ensure there is no disorderly withdrawal of that firm from the audit market,’ he says.
Tiner further said that firms themselves ought to look inwardly, at ways in which they could mitigate risks in the areas of audit quality, audit firm operating structures and governance of firms.
This would entail continual review and assessment of internal processes, enhanced public disclosure on the loose global network of the Big Four, active dialogue with regulators about the risks and effective governance and oversight of their global business activities.
Boadle adds that one way in which the regulators could demonstrate that quality audits did not only emanate from the Big Four, is by publishing the reports of the Audit Inspection Units, which fall under the authority of the Financial Reporting Council’s Professional Oversight Board.
Little has been said about this, although the public opinion has recently canvassed on the matter.
Currently, the FRC has engaged the market, in the form of a Market Participants Group aimed at seeking market-driven solutions to the lack of choice. The Big Four have rolled back their defensive guns and entered into discussions.
The group - constituting industry figureheads such as Peter Wyman of PricewaterhouseCoopers, Philip Broadley of the Hundred Group and relative newcomers such as Robert Talbut of London Asset Management, and JP Morgan FD Michael Power - has the unenviable task of wading through the mountain of suggestions, raging from the ridiculous to the obvious. They must grapple with the question of how to achieve greater choice.
It will be down to this group to show that it can rise to the occasion and produce some meaningful solutions. If not, it will acquire the unwanted reputation of being just another talking shop.
