Why Chairman James Doty of the Public Company Accounting Oversight Board keeps pressing mandatory auditor rotation, neither useful to the capital markets nor achievable for large global companies (see his latest, June 2), remains beyond sense.
Doty, hands full with the challenge of an official re-think of the standard auditors’ report (here), is supported by blogger Tom Selling, whose Accounting Onion provides lucid and incisive commentary on the politicized and intellectually incomprehensible inconsistencies of global accounting standards.
Much as I value Selling’s work, I would be reluctant to call a “disagreement” my inability to share his enthusiasm (here). Instead, some “additional thoughts”:
The context for rotation – especially the long tenure and duration of auditor relationships among large companies – reminds me of the loyalties in the farming community of my youth.
There, partisans of the trucks made by Ford or Chevy passed their abiding devotion along from fathers to sons, while on each farmstead along the rural roads, the tractors and combines glowed exclusively in bright Farmall red or the deep green of John Deere.
These intense affinities were debated non-stop in the village café and the adjoining pool hall, by sunburnt advocates wearing baseball caps branded to proclaim their choice of machinery. The system was stable -- client service was dependable if unimaginative, the cartel of dealers prospered, and it would have been thought foolish to sacrifice decades of accumulated knowledge, relationships and bins of technology and spare parts for no identifiable advantage.
Out in the fields of corn and soybeans, meanwhile, there was no rational performance difference between the competing commodity brands. Cosmetics were immediately obscured under the prairie dust, and a dirty red tractor worked not any better or worse than a green one.
In today’s audit market, to which the metaphoric characteristics of farmyard equipment extend, Selling’s endorsement of mandatory rotation omits a number of considerations.
To start, while correct that “audit failures … are small potatoes” below the mega-level of Lehman or AIG, Selling misses the stumbling block of international impossibility.
Which is, for example, that American rotation would impose on such global-scale but US-listed companies as Deutsch Bank or Total or Banco Santander or Nokia. Would the regulators in Germany or Switzerland or Spain or Finland adopt and enforce the obligatory sacking in their countries of, in these cases, KPMG or E&Y or Deloitte or PwC? And if not, how do those parent-level firms possibly coordinate and perform their locally-contracted statutory engagements?
No way -- given the halting steps of the PCAOB in the nine endless years of its aspirations – reflected in its still-complete exclusion from China (here) and the twenty-page list of large companies outside the US where, as of last year, its auditor inspection access was denied (here and here).
Second, where does the wheel of rotation turn for these companies? Where are alternatives to be found? It is not appreciated that the malign effects of independence and scope-of-service restrictions, and the uneven distribution of Big Four resources in the large economies, have squeezed or eliminated any viable rotation opportunities. Back to the study for the Financial Reporting Council in 2006 (here), and instances in the UK where “companies may have no effective choice of auditor in the short term” (emphasis added).
Third, Selling too gently observes that, “we don’t have a lot of evidence that audit firm rotation is going to work.” Truth is, we have none – the only experience being Italy, where rotation has contributed to greater Big Four concentration, and figured not least in the divided-audit environment at Parmalat.
Fourth, Selling’s attribution of significance to the AICPA’s lobbying against rotation, back when the Sarbanes-Oxley law was passed in 2002, misses the irrelevance of that body to today’s market. That’s because, at the big-company level (the segment that matters, as he and I agree), rotation would be a pass-the-parcel exercise among the Big Four. Their dominance in the scope and coverage gap with the smaller firms has only grown over the last decade; rotation would if anything likely further squeeze the smaller firms out of the top-tier market.
Finally and most important, Selling asserts that the overhanging prospect of rotation would improve performance – in his hypothetical, “the fifth year of a 7-year relationship” – “some yet-to-be-disclosed successor auditor will have every incentive to examine each page of the old working papers with a fine tooth comb.”
This is backwards, and the incentives go the other way. A successor’s incentive and mandate are to examine old work only to lay a foundation for the current year’s engagement. To do otherwise, recalling that the successor is not an agent of law enforcement or regulatory oversight, is to pry for skeletons in old closets on a gratuitous basis.
Consider the hindsight judgment that a prior error might require correction. The company is in no position to force the now-dismissed prior auditor back onto the job of re-issuance. Yet the successor is in no position to re-perform old and stale work – at least not without inflicting massive time and cost on the current job.
To sum up: the case cannot be made at the large-company level that mandatory auditor rotation confers any benefits or justifies its costs. It is particularly impractical at the global level in any event. And requiring rotation only for smaller companies would be expensive, ineffective and politically impossible.
The proposition that rotation deserves a try, only because “every other device for loosening the bond between auditor and client has been tried and fallen far short of the mark,” is not a strategy, but a wish – and a wistful one at that. Better to focus on ideas that are both justifiable and within the range of practicality, than to continue lobbying for one that is neither.
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