Corporate governance: Local trouble

With Sarbanes-Oxley fees resolutely rising and a bonanza of what used to be
called consultancy work, audit firms are doing very nicely indeed. Quite where
that leaves their clients is anyone’s guess. For large companies auditors are an
essential part of the governance package that they must present to the markets.
And the growth over the past decade of the interaction between finance
directors, audit committees and auditors has cemented that importance.

But, increasingly, companies – particularly those with a genuinely global
presence – are going to find it difficult to maintain confidence in what
services their auditors provide. In part, it is not the audit firms’ fault that
they find themselves in this position. But their inability to properly screw
down structures as international firms has exacerbated the problem. The most
recent bust-up in Japan between regulators and PricewaterhouseCoopers is a case
in point. (You will recall that the regulators imposed a two-month ban on
auditing local companies following an investigation into the firm’s audit of a
major cosmetics business.) Now, Japan is a peculiar place for trying to
understand financial relationships if you are an outsider. The way things work
can be opaque. And the relationships between the people involved can be more
complex than most people would like.

But, leaving the Japanese context aside, the end result of the Japanese
regulators closing down the PwC firm has done little to raise confidence in
quite how much control there is from the centre when it comes to the sprawling
structures of international firms. The speed with which the original firm was
ditched and a new one set up suggests that things are more amorphous than the
glossy brochures would suggest. And it is not as if it had happened in some
far-flung part of the globe where a partner firm had gone marginally AWOL. This
was Japan, third leg of the global stock market network.

For companies, the smiling global leader of this or that part of the mighty
Big Four firm can be someone who gives them confidence. But the reciprocal smile
from the client must be wearing thin. The amount of real control exercised from
the centre of the big firms has always been an elusive concept. The sales story
has always been one of seamless service performed from the same manuals around
the world. But clients know better. And they have learned that the hard way.

Audit firms are learning, too. Each spectacular difficulty, like that of PwC
in Japan, acts as a simple driver to ensure that it doesn’t happen again. And,
much as the standard-setters used the aftermath of Enron to stiffen the global
standards base, the firms are using these market pressures to force the more
wayward partnerships in their global offering into a closer alignment with the
mainstream.

But there is another side to this and this is where finance directors could
put in a bit of solid lobbying. They already wield power over the Big Four audit
firms by giving them a hard time. They also need to make regulators around the
world more aware of their concerns. The whole thrust of regulation in the
corporate governance field in recent years has been a major achievement in
settling markets, users and preparers of financial reporting. But the regulators
now resemble a mirror image of the large audit firms and their problems. They,
too, are fragmented when it comes to setting a global agenda or trying to change
the global picture. They are making huge efforts. The main regulators around the
world do now get together in an ad hoc way to discuss and try to resolve the
problems that they see emerging.

The problem is that it is the mainstream regulators that do this. Their
agenda is very similar to that of the large audit firms. They, too, find less
difficulty in getting the main constituents of their global organisation
together and agreeing solutions or common efforts. The problem is in the
far-flung parts, where economic activity is less well-regulated and prone to
explosive change. The firms have trouble with their partnerships in such parts
of the world. Those partnerships, in turn, argue that they cannot conform to
this or that condition because the local law, regulator, or political alliance
doesn’t allow it. The same goes for the regulators. If local regulation, for
political or less than transparent business reasons, goes against the grain and
then argues ‘local sensitivities’, there is often little the rest of the global
community can do.

This is where finance directors should take a hand. They can be assured that
the audit firms will be attempting to bring stability and consistency to the
work that they do. But it would help the firms’ efforts to regain the straight
and narrow if finance directors started putting pressure on regulators wherever
they see problems around the world.

One result of the great revolution in bringing a broad set of international
financial reporting standards to much of the world is that it is growing much
more obvious to everyone that truly global actions on all these fronts are
inevitable. And that means pressure on the recalcitrant governance regimes
particularly. Finance directors should add their clout to this effort.