House of Lords hearings could impact on Big Four dominance

Finance directors have so far felt themselves largely untroubled by the debate raging around audit firms. But with a series of hearings in the House of Lords over audit market concentration, and in particular whether or not the Big Four firms – PricewaterhouseCoopers, Deloitte, KPMG and Ernst & Young – have been too dominant in the market at the expense of smaller and mid-tier firms, some are starting to take an interest, as talks move to fee structures and service levels.

FDs are starting to realise that the eventual outcome of the hearings may have an impact on businesses and their relationships with their auditors. BDO managing partner Simon Michaels argued at one hearing that “institutional prejudice” on the part of audit committees, banks, investors and FDs is what prevents mid-tier firms from being appointed as auditor to many large companies.

But with mid-tier firms being investigated over the quality of their audits – an example being the recent Accountancy and Actuarial Discipline Board investigation into Baker Tilly over its audit of Tanfield Group – do Michaels’ protests ring hollow?

The snob factor

To some extent, Michaels is right, says Neil Tyagi, FD of EagleBurgmann Industries UK, who has discussed audit service issues on Financial Director’s LinkedIn group. “There’s quite a bit of snobbery about the Big Four,” Tyagi admits. “A lot of FDs are guilty of perpetuating it. When looking at competitors’ accounts, many FDs will look at whether their auditors are a Big Four.”

However, Narin Ganesh, regional FD of Crown Worldwide, had not heard Michaels’ argument before. “It could stem from the number of FTSE finance directors, or their predecessors, who are ex-Big Four,” he surmises. “There is an assumption about the relative capabilities of Big Four and mid-tier firms. I would say my recent experience with one of the Big Four has been positive, largely down to the attitude of the audit partner – who I regard as pragmatic and commercial. But I can think of another example in a former FD role I held, where the audit experience with another Big Four firm was bordering on a fiasco.”

So why use a Big Four firm over a mid-tier? For large, global businesses such as EagleBurgmann, Tyagi says only the larger audit firms have the knowledge and experience to deal with some of the issues their businesses have. But it may be less about practical issues than a form of peer pressure to do so that informs the choice, he says. “Some businesses might feel that others will look at them more favourably if their auditors are a Big Four firm – the perception is they will appear as bigger companies,” he explains.

The other problem for UK mid-tier audit firms is that FDs of international businesses may not have so much say in which firm they choose as auditor: often this is dictated by an overseas parent company. Ganesh admits that if he were able to choose, he “would be quite keen to look at mid-tier firms” on the basis of value for money: “I don’t think they would do any worse or better a job than the Big Four.”

One suggestion posed in the Lords’ hearing was that of joint audits, where two audit firms express an opinion on an organisation’s financial statements rather than performing the audit twice. The idea, said David Herbinet, head of corporate and public interest market teams for mid-tier audit firm Mazars, was that the auditors work together, “looking at the most complex and challenging issues… it encourages new players to come into the audit market and it facilitates any change in auditor.”

Joint audits have proved particularly successful for Mazars in Herbinet’s native France, where they are compulsory. But will they work here?

“I imagine there would be an element of cost increase, and some FDs and boards would be concerned,” says Tyagi. “I think a second opinion can be good: it would ‘double-underline’ what you’d expect more capable firms to do. I would be all for Big Four firms partnering with smaller firms.”

Ganesh, however, is cautious about joint audits being used for smaller entities. “I can see some merit for using them in the case of large businesses, but not for SMEs,” he says.

But joint audits are not a panacea for business failures or recessions, adds Tyagi. “I don’t think they would prevent a global meltdown like in recent years,” he says. “That was not the fault of external auditors – it was the responsibility of the internal audit functions of those businesses.”

Another suggestion, put forward by Russell McBurnie, FD of audit firm RSM Tenon, was that of companies being made to periodically re-tender audits, or to provide reasons for why they reappoint their current auditors. Ganesh says “the periods have to be reasonable – you don’t want to be putting your audit work out to tender so frequently”.

One thing some auditors could do, says Tyagi, is improve the quality of the notes and disclosures in the accounts. “Some competitors’ accounts disclosures are better than others. With some of our smaller UK competitors, which use smaller audit firms, their disclosures are not nearly clear enough and we struggle to understand them,” he says.

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