Restricted entry to the audit club

Finance directors are being held partly responsible for the current state of
the UK audit market. April’s report, Competition and Choice in the UK Audit
Market, published jointly by the Department of Trade & Industry and the
Financial Reporting Council, stressed the influence that FDs have over the
choice of auditor.

While audit committees are now increasingly having a say in the appointment,
they are still taking a lot of notice of the finance director’s views on the
matter. Indeed, many chairmen of audit committees are – according to the
research, conducted by economic consultancy Oxera – little more than finance
directors in disguise. Chairmanship of audit committees is dominated by
ex-finance directors, more than half of whom have worked for one of the large
audit firms.

No one who knows anything about the state of the UK audit market would have
been in danger of having any reaction nearing surprise on reading the 167-page
report.

The big guns
For FTSE-100 companies there is no option but to go for one of the Big Four. The
report labelled this attitude as the IBM effect (you know, you never got
sacked…). In other words, finance directors of big companies want a Big Four
firm as insurance against catastrophe and to minimise the reputational risk.

Despite this desire for a big name to put at the bottom of the statutory
audit report, what finance directors and audit committees really appreciated was
the informal advice and help that the audit partner handed out to the executives
and non-executives alike.

This advice concentrated on new developments in auditing standards: best
practice in the industry on dealing with certain standards and how the company
could improve its internal processes and controls.

So, however much others may wring their hands and worry about the domination
of the Big Four, UK plc doesn’t really care. Well, not quite. The report
revealed that this Big Four stranglehold on the market is having a real impact
on the room for manoeuvre among top finance directors, who probably aren’t that
used to being thwarted.

The report uncovered evidence that “occasionally” Big Four firms decline to
bid for the audit on the grounds that the non-audit fees the finance director is
handing over are more valuable than the prospect of the audit fee. If the Big
Four take a commercial decision not to go for the audit, then it is possible
that a major company would have no one to turn to but the incumbent auditor.

Like all of these reports, stakeholders could find whatever they wanted in it
to justify their position. So one source at the ICAEW said no one was
particularly worried at the findings because there was no evidence uncovered of
anti-competitive behavior. True, although it wasn’t Oxera’s remit to root out
such behaviour. On the public record, the ICAEW stuck to its mantra of audit
quality, while at the same time maintaining a painful balancing act fearful of
upsetting entrenched views across the firm-size divide.

Competitive market
With or without the support of the ICAEW, the Big Four are hardly quaking in
their boots. Peter Wyman, head of professional affairs at
PricewaterhouseCoopers, said: “I’m not convinced that there is a substantial
problem. My initial impression is that we are operating in a fiercely
competitive market.”

Leave aside the temptation to dismiss the comment as a Mandy Rice-Davies
moment. Maybe the audit market is tough if you are in it. The introduction of
international financial reporting standards, the emphasis on compliance led by
Sarbanes-Oxley and the drive for quality, plus the lack of alternatives have all
helped firms increase their fees. Oxera says fees have gone up roughly in line
with their clients’ turnover, but whether this increase has helped to boost the
Big Four’s profit margins only the firms know. And they are not telling.

One possible move to help mid-tier firms make more of an impact is, according
to the Institute of Chartered Accountants of Scotland and the mid-tier firms
themselves, to press ahead with proportionate liability, as envisaged in the
Company Law Reform Bill. As the Scottish ICA said, it is “essential in an
attempt to ensure that, at the very least, the current level of competition is
maintained”.

Pick up the pieces
BDO Stoy Hayward and Grant Thornton, the two firms most likely to pick up crumbs
from the Big Four table, noted the “systemic risk to the capital markets of the
current set up” and what they termed “institutional prejudice” against the small
number of other audit firms that can compete in the public company audit market.
The two firms said that the report highlights dissatisfaction of many
stakeholders with the status quo and they hoped the report would foster debate
and lead to change.

The primary conclusion from the report is competition is not working as well
as it would with a greater number of competitors in the markets for auditing
FTSE-100 and FTSE-250 companies. But it is hard to see a strong desire for
increased competition among the government, the accountancy profession, the
Financial Reporting Council or even top FDs.