For a charm of powerful trouble,
Like a hell-broth boil and bubble.
Double, double toil and trouble;
Fire burn, and caldron bubble.
W. Shakespeare, “MacBeth,” 4.1
The simmering caldron of accountancy regulation was brought to a rolling boil in the United Kingdom on February 22, when the five-strong Audit Investigation Group of the Competition Commission issued its provisional findings.
No less sweeping than its assertion that the supply of statutory audit services to large public companies is rife with adverse effects on competition, the Group's suggested “remedies” would be draconian – among them, mandatory re-tendering for audit engagements every five to seven years, and mandatory rotation of audit firms after seven to fourteen years.
Remarkably, while the UK press treated these landscape-altering proposals as a one-day story (e.g., the Financial Times, BBC and Independent), attention in America beyond minor pick-up from the news services has included not the first word of either reporting or commentary.
Which had better change, and quickly too – not just because the basic impracticality of mandatory rotation is a long-standing barrier to its implementation (here, here and here). It’s because Group Chairman Laura Carstensen and her coven of non-accountants are working to the accelerated timetable of March 21 for comments, and publication of a final report by October 20 of this year.
By then, under the typical regulators’ effects of both momentum and inertia, their “provisional” hell-broth is likely to be fully cooked.
And a toxic brew it is indeed.
The Group did give the market-dominating Big Four tetrapoly a back-handed compliment, by exonerating them from the most malign charges of the profession’s fiercest critics:
“The CC also considered whether the market conditions are conducive to coordination or that Big 4 firms engage in tacit collusion; that they bundle audit and non-audit services together in order to raise barriers to expansion to other firms; that they target the customers of Mid Tier firms with particularly low prices; or that they are able to exercise undue influence over the formation of regulation or on regulatory bodies through their extensive alumni networks. To date, the CC has not identified sufficient evidence to support these other theories of harm.”
Scant comfort, indeed, as they went on to “find” an entire menu of ostensible reasons for a dramatic re-structuring of the audit services market:
“Companies face significant hurdles in comparing the offerings of an incumbent auditor with those of alternative suppliers other than through a tender process.
“It is difficult for companies to judge audit quality in advance due to the nature of audit.
“Companies and firms invest in a relationship of mutual trust and confidence from which neither will lightly walk away as this means the loss of the benefits of continuity stemming from the relationship.
“Company management face significant opportunity costs in the management time involved in the selection and education of a new auditor.
“Mid Tier firms face experience and reputational barriers to expansion and selection in the FTSE 350 audit market.
“Auditors have misaligned incentives, as between shareholders and company management, and so compete to satisfy management rather than shareholder demand, where the demands of executive management and shareholders differ.
“Auditors face barriers to the provision of information that shareholders demand (in particular, from the reluctance of company management to permit further disclosure)."
Beyond these mostly unexceptional characteristics of a properly-functioning market for specialized professional services, of course, the unresolved and gaping logical gap in the Group’s entire approach is two-fold:
- First, Big Four dominance of large-company audit is a natural-market result of client demands for scale in geographic coverage, expertise and exposure tolerance – all of which are beyond the capabilities of the smaller firms.
- Second, at the same time, the widely-shared dissatisfaction of the user community -- that the standard and commoditized auditor’s report is grievously obsolete and provides no value -- is destined to be unrealized by the attempted re-engineering initiatives of such standard-setters as the PCAOB or the IAASB.
Nor is either of these root difficulties touched at all by the asserted but unsubstantiated claims of benefit to audit quality to be wrought by mandatory tendering or rotation.
Instead, within what the FT described last fall as the Commission’s “sheaves of working papers,” there is not a single research under-taking, much less a scintilla of evidence, showing an actual link between the length of an auditor’s tenure and the quality of either its audit work or its client’s financial reporting.
Put in summary, the fundamental dysfunctionalities in the reporting and assurance models are untouchable by the “solutions” urged by those having the authority (if not the evidentiary basis) for their mischief-making, while mandatory re-tendering and rotation remain as “remedies” in search of problems yet to be grounded in reality.
But if not stopped, the Competition Commission is likely to work its will.
A regulator on a results-oriented mission is dangerous enough. But undiluted by the flavoring effects of the facts, the Commission’s recipe for a reconstituted audit structure will leave a foul taste all around.
Those obliged to sup at this devil’s banquet are advised to bring very long-handled spoons.
Thanks for joining this dialog. Please share with friends and colleagues. Comments are welcome, and subscription is easy and free, both on the Main page.
Comments