The problem, as diagnosed by the Commission, is that companies are too reluctant to consider switching audits, both because of the costs of doing so and the difficulty they find in comparing options. Audit firms outside the Big Four have difficulty in winning work because of a monopoly on experience and reputation that the very big firms supposedly enjoy.
The statistics are stark. More than half of the largest companies have had the same auditor for more than 10 years. The Commission found this unacceptable. It considers that auditors’ duties to shareholders are being compromised because their relationship is entirely with the company, rather than also with its investors. The Commission is determined to correct this misalignment.
Now the spotlight will turn to remedies. These need to be sensitive and proportionate, but must also bring about real change to avoid a forced return to this topic the next time a financial crisis hits, companies fail, and consequently audit relationships are called into question.
In fact, the market is already recognising the need for change. Large firms, like BG and Schroders, have responded by tendering their audits, and I don’t doubt there will be more tendering among competitor firms for the audits of listed companies. The Financial Reporting Council, the industry regulator, has taken steps towards mandating such tenders for the largest publicly-listed firms, and eventual compromise over proposed European legislation will accelerate this. More than this, demand for good corporate governance demands it.
This process is also extending to other services historically offered by auditors, as concerns mount over the propriety of audits being offered alongside more commercially acute projects, potentially interfering with the independence of the auditor. Companies are establishing “panels” of advisers, whose offerings they can compare on a project-by-project basis, increasingly using procurement advisers to demonstrate the need for both value and impartiality. The fees earned for other services provided to big companies by their auditors have also plummeted. EU regulation will keep them at a low absolute level.
The choice of remedies must meet the needs of the market. They needn’t be swingeing, but they must bring some liquidity to what has been a very static set-up. Mandatory rotation has been shown to increase concentration. Tendering, meanwhile, does not appear to have the same effect and can improve audit quality. It should form part of a package of measures.
The Competition Commission’s inquiry will result in major change. There will be no overnight shift in the extraordinary level of concentration at the higher end of the audit market, but we need to start an irreversible process of opening up – giving the market both liquidity and transparency. This will benefit the UK economy.
James Roberts is senior audit partner at BDO.