Big Four dominance here to stay

Recent Competition Commission findings on the audit market are a distraction from the industry's real flaws

"Companies are offered higher prices, lower quality and less innovation" than would be the case in a more competitive market. That is the conclusion of an investigation by the Competition Commission into the audit services market, which published its provisional findings last week.

Such grumbles are nothing new, and stem from the longstanding dominance of the Big Four professional services firms - Deloitte, Ernst & Young, KPMG and PwC - who between them audit all but one of the FTSE 100 companies. The firms conduct audits, required by law, of companies' financial records and procedures to provide an independent assessment of a company's financial statements to ensure they give an accurate view of its financial position for the benefit of shareholders and other interested parties.

Can't stand me now

However, because of their hunger to retain audit business and win lucrative consulting contracts, auditors are focusing on the interests of companies' management over the interests of the shareholders they are intended to serve, leading to the cosy arrangement between the Big Four and the FTSE 100 noted by the Commission.

Some of the Commission's proposed fixes are more sensible than others. Efforts to increase transparency and accountability are welcome, especially measures that would put more distance between auditors and companies' finance directors by strengthening the position of companies' independent audit committees.

The compulsory rotation of audit firms would improve audit reliability by preventing relationships between auditors and management getting too close, or so the logic goes. And an increased frequency of tenders, it's claimed, would engender the competitive practices that the Commission aims to promote. Second-tier professional services firms such as BDO and Grant Thornton that are chomping at the bit for a larger share of the audit market would welcome this move. However the reality is that the same four firms will continue to pass clients between themselves. And in any case, changing of auditors is not as rare as the commission's provisional findings have implied. PwC's Richard Sexton has been quick to point out that among the FTSE 350 there has been a change of auditor once every month, on average, over the past 11 years.

Up the bracket

Why does the audit industry need help in this area from regulators? The answer is essentially shareholder apathy. Corporate shareholders are typically a fragmented and ever-changing bunch, and audit satisfaction is rarely an evocative enough subject to rouse any objections. But the success of 2012's "shareholder spring" in rebelling against gratuitous executive pay proves that shareholders are not incapable of overriding displeasing board behaviour. The only conclusion: shareholders just don't care enough about audit.

With the proposed regulatory changes unlikely to affect the mechanics of external audit, and with shareholders - the real clients in the relationship - indifferent, will an industry that remains fatally undermined by a worrying misalignment of incentives ever change?

The financial crisis, in which shaky audits played their part, saw widespread calls for the breakup of universal banks. Retail banking operations should be separated, it was argued, from banks' riskier endeavours. Auditors, whose fast-growing consulting and advisory operations have much higher margins than their audit ones, have largely avoided the same scrutiny. And pressure for the audit industry to be seen as the public utility that it is and to be split from the more lucrative business areas of professional services firms, shows no sign yet of gaining momentum.

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