31 Aug 2006
By Sarah Perrin
Interest in the matter of competition in the audit market has been heightened this year. In April, the Oxera report, Competition and choice in the UK audit market, prepared for the Department of Trade and Industry and the Financial Reporting Council, noted that the Big Four firms account for 99% of audit fees in the FTSE-350 and audit 99 of the FTSE-100. In May, the FRC published a discussion paper, Choice in the UK Audit Market, which considers questions such as how to promote increased choice of audit firms in the large public company audit market.
In July, Labour MP for Greater Grimsby, Austin Mitchell, tabled an early-day motion in the House of Commons condemning the ‘monopoly’ of the Big Four. Mitchell described their market dominance as “anti-competitive, unhealthy and promoting complacency within the industry” and called on the government “to consider structural reform to set the highest possible standards of accountability and transparency”.
The Association of British Insurers, in its response to the FRC consultation, said: “It should be made clear to the large accounting firms that, if their share of the market is deemed to be excessive, they will be obliged to divest part of their business.”
Make the grade
But what of the firms outside the Big Four? Do they want to audit large listed companies? The answer is yes, but with some exceptions. The very largest companies are generally seen as best suited to the Big Four. “The top 150 companies, like the largest banks and insurance companies and natural resources companies like BP, where there is such a scale required to audit them, or such specialisation in the peculiarities of that industry, are best suited to being audited by the Big Four,” says Steve Maslin, head of assurance services at Grant Thornton, currently the fifth largest UK firm. However, once you get to companies around the 151 mark, with market cap of around £1bn and audit fees around £1m, then Maslin sees those as the heartland for firms like GT. “For the majority of such companies, we have the scale, sector knowledge, skills and expertise to deal with them,” he says.
BDO Stoy Hayward, the sixth largest UK firm, takes a similar view. It also recognises that the largest companies require such specialist technical skills that they currently need Big Four audit services. However, BDO is highly interested in other listed company audits and is focusing its attention on companies with a FTSE ranking of between 101 and 350. “We are starting to push more in sectors where we have specialist strength,” says Jeremy Newman, BDO’s managing partner. “For example, we are strong in retail, property, leisure and hospitality and professional services. We have sector expertise here, so let’s focus on those where we can bring added value.”
BDO is notable among Tier A firms for auditing the only FTSE-100 company not to be served by a Big Four firm – PartyGaming. The online gaming company entered the FTSE-100 club last summer on flotation, taking BDO with it. Despite this, Newman understands that board members of other FTSE-100 companies may need more persuasion before appointing BDO as their auditor. “In the 101 to 350 group, where we have half-a-dozen or so audit clients, it’s easier to hold a footprint and demonstrate that we have expertise,” he says.
This summer, BDO was conducting what Newman calls an information campaign directed at finance directors and audit committee chairman in FTSE-350 companies. However, Newman is realistic about the likelihood of picking up new audit work as a result. “Re-tendering in the FTSE-350 is rare,” he says. “Our best chance of getting more of them [as audit clients] is by acting for some that get promoted to that league, and persuading them they don’t need to change to a Big Four firm.”
This alludes to the problem of perception – particularly the assumption that investors prefer companies to have a Big Four auditor. “A lot of decisions are made on the basis of perception rather than knowledge,” says Maslin.
However, institutional investors and representative bodies have now begun declaring their open-mindedness about audit appointments. The Association of British Insurers’ response to the FRC’s consultation says: “Investors need to make clear, as the ABI has recently done, that they do not automatically expect companies to select an auditor from among the Big Four.”
Not on the list
Nevertheless, the Big Four-dominated statistics will take time to change. “We are already providing a number of non-audit services to FTSE-100 and FTSE-350 companies, but we are not there in the audit market, as much as anything because we don’t get onto the tender list,” says Mark Harwood, senior audit partner at Baker Tilly. “Part of the problem is that the rates of switching, or churn, for auditors are very low. So any rate of change is likely to be slow.” The Oxera report found that switching rates were around 4% per year on average for listed companies, and less than 3% for the FTSE-350. Most listed companies tendered only once every five years or less.
Nevertheless, audit committees may find their auditor appointment decisions coming under greater scrutiny. The ABI’s FRC response says: “Companies should keep their choice of auditor under regular review and periodically tender for new auditors,” says the ABI. Finance directors are also in the spotlight. The ABI says: “Quality should be a more important consideration than price. Too many auditors have been effectively chosen by finance directors anxious to make a virtue out of their ability to drive down costs.”
Another possible perception problem for Tier A firms relates to the assumption that a Big Four audit is automatically higher quality. “There’s a size gap, but a size gap doesn’t equal a quality gap,” says Harwood. He hopes that once the Audit Inspection Unit’s reporting on audit quality beds down, this will become clearer.
If you can’t beat them
Firms outside the Big Four are already providing non-audit services to large listed clients. Another way they could demonstrate their capability is through participating in joint audits, an option strongly promoted by Mazars. David Herbinet, head of corporate and public interest markets, notes that his firm is already joint auditor of seven of the largest companies in Europe. “They get the Big Four name on their audit report, but they also get second auditors to provide a different service to them,” Herbinet says. Audit quality is enhanced, Herbinet suggests, by having two pairs of eyes on the job and by being able to challenge management more robustly. “It is easier to contradict positions taken by management when there are two of you, than when you are on your own,” he says. Service quality is enhanced by having healthy competition between the joint auditors.
The Hundred Group’s response to the FRC consultation suggests there could be benefits from a modification of auditing standards to make it easier for the audit of large groups of companies to be undertaken by more than one firm. But Don Hutchison, national head of audit at BDO Stoy Hayward, rejected the proposal outright, arguing that it would cause tension between rival firms and ramp up costs.
One potential barrier impeding Tier A firms from auditing FTSE-350 clients is the need for an extensive and integrated international network. However, the Tier A firms international networks do have considerable reach. Grant Thornton International, for example, has members in 112 countries. Furthermore, GT’s Maslin points out that the legal structures of the Tier A networks are the same as those of the Big Four’s international networks. “We have international audit models that comply with international auditing standards and have invested in people with international technical experience.”
BDO’s Newman thinks FDs could benefit from switching to an audit firm outside the Big Four. “The consistent message I have got from FDs in our post-Oxera information campaign is about their frustration with increasing levels of bureaucracy at the Big Four, inconsistent application of IFRS, partners being in the thrall of technical departments, audit departments being scared to challenge central technical departments…” he says.
By moving to a Tier A firm, Newman argues, these FDs could benefit from a better quality of service. “It’s a cultural thing,” he says. “The AIU (audit inspection unit) report talks about cultural difficulties in some of the Big Four firms. There are also financial issues.” As Newman points out, Tier A firms have lower partner-staff ratios – perhaps 10 staff per partner, compared to 17 or 18 at the Big Four. “We have much more partner engagement,” says Newman.
However, when pitching for new audit clients, Tier A firms tend to be asked questions about their capability for delivering the service – a result of companies’ anxiety around justifying the appointment of a firm outside the Big Four. “It’s quite a negative pitch process,” says Newman.
Nevertheless, the Tier A firms generally seem opposed to market intervention, even if that would improve their chances of making tender lists. They want to gradually build up their client base among the lower levels of the full list first, before looking at the largest companies. “I think the market can make significant progress in increasing choice in the 1,500 or so companies in the full list,” says Maslin. “Perhaps in a few years’ time that would create a platform where we had one or two firms like Grant Thornton, which would be in a better position to challenge at the highest level.”
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