Competition commission has put the cat among the pigeons

Musical chairs for the audit market?

When the relationships between auditors and some listed companies can be measured in decades, with some spanning more than a century, the idea that companies should be forced to retender for audit services as often as every seven years is a bold suggestion indeed.

But this is what the UK’s Competition Commission (CC) has – albeit provisionally and with much further consultation to come before a final statement in the Autumn – suggested this morning, in what the CC’s audit group chair Laura Carstensen admits represents “some quite radical suggestions”.

The issue Carstensen’s group originally set out to address was the perception that extended relationships between businesses and their auditors breed a kind of familiarity that prevents shareholders’ interests from being protected when auditors run the rule over corporate accounts.

It stands to reason, after all, that an auditor with a longstanding rapport with the management of a business might be inclined to audit financial statements in a way more beneficial to the interests of that management team than to its shareholders.

To shake up this supposedly cosy state of affairs, the CC has proposed mandatory retendering and rotation of audit firms. This, in addition to the prohibition of "Big Four only" clauses in loan documentation, which restrict lending to companies audited by PwC, Ernst & Young, KPMG and Deloitte, and measures to increase engagement between auditors and shareholders.

On paper, mandatory rotation certainly looks like it would protect shareholder interests and increase competition, with smaller firms gaining audit market share from the Big Four, which currently take the lion’s share.

In practice, the concept invokes serious practical considerations that many, especially among the Big Four, think could be counterproductive to the quality of audit services.

First and foremost, mandatory rotation has cost implications to both auditors, who spend time and money on pitches to prospective clients, and those being audited. There are also setting-up costs for auditors and companies in new audit engagements.

Audit rotation after short periods also poses a threat to audit quality, particularly as engagements come to an end. Auditor rotation on a seven year basis is arguably ill-suited to large, complicated financial institutions whose inner workings require a long period for audit teams to understand.

In any case, audit firms already rotate engagement partners with clients to ensure independence, so it is not as if the profession has done nothing to address the issue of over-familiarity.  

But then again, this is exactly what consultation periods are for, and the CC itself acknowledges both the range of possible approaches to the rotation and retendering issue, seeking views on rotation periods of seven, ten and 14 years, and the fact that further recommendations would be contingent on responses to the current proposals.

Carstensen, speaking to me for International Accounting Bulletin this morning, said there is “evidence there is a price benefit to tendering, but we have to weigh up the costs and benefits – we want to know how we can find a point of equilibrium where the benefits are captured, but in such a way that it is not unduly costly or burdensome.”

There is plenty of time to find this point of equilibrium. This morning’s release only represents a summary of provisional findings, and the full text won’t be available until next week, with final recommendations to come in August at the earliest.

Nevertheless, they certainly represent a more aggressive stance to shaking up the market than many in the audit market had expected, and are likely to prompt a broader change in attitudes beyond the UK.

For some time the EU has been rumbling through its own debate on audit reform, and after making some fairly conservative recommendations towards the end of last year, has been widely regarded as waiting on what comes out of the CC before making further statements. Certainly, the CC’s suggestions on mandatory rotation are unambiguously more hard line than anything that has come out of Brussels.

Carstensen told me she expected today’s comments and future findings from the commission to have a definite impact on the continuing EU debate. “Brussels has a lot of respect for our process as very rigorous and very evidence based, and I would expect parties there to be very interested in what we conclude, and the basis on which we reach it.”

In this context, one wonders if the decision to start the rotation discussion at a benchmark of five to seven years was a move designed to bring more impassioned debate to a discussion that some perceived as having become quite flat. Whatever the intention, it has certainly had that effect.  

Links:

http://www.internationalaccountingbulletin.com/news/cc-audit-chairman-comments-on-radical-suggestions/

http://www.internationalaccountingbulletin.com/news/cc-provisional-findings-split-the-profession/

Photograph: Getty Images

By day, Fred Crawley is editor of Credit Today and Insolvency Today. By night, he reviews graphic novels for the New Statesman.

Photo: Getty
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Love him or loathe him, Britain needs more Alan Sugar

Big business is driving down wages, failing to invest, and funnelling rewards to the richest.  Entrepreneurs - and the state - need to fill the gap. 

The business baron who loves a bust-up has just been hired by Her Majesty’s Government to tour the country inspiring the next generation of apprentices. And he’s got his work cut out for him.  

Britain is loads more enterprising than it used to be - but the truth is, we’re miles behind our rivals. The good news is that Britain boasts nearly two million more firms than at the turn of the century. Over 40 per cent of Europe’s “unicorns” (new firms worth over $1 billion) are UK based. And by the next election, there will be more self-employed people than public service workers. 

But, here’s the bad news. Globally, we’re only 48th out of 60 in the global enterprise league table - and of the top 300 companies created in the last thirty years, only a handful are British. The only two British websites in the global 100 were actually founded in America - google.co.uk and amazon.co.uk. Worst of all, according to new House of Commons library figures which I commissioned this week, over a million people have left entrepreneurial activity in the last three years. 

Yet in my new history of British capitalism, Dragons, published today, I show how we’re a nation built by some of the greatest entrepreneurs on the planet. They were the buccaneers like Robert Rich, who built the trading companies and colonies of north America. The traders like Thomas Diamond Pitt who built old multi-nationals like the East India Company. They were industrial revolutionaries like Matthew Boulton who perfected the steam engines, and capitalists like Nathan Rothschild who built the bond market. Down the ages, there were of course great rogues and fraudsters, slavers, opium dealers and imperialists, like George Hudson, William Jardine and Cecil Rhodes. And through the centuries, women were in particular, were frozen out of the power structures of the market. 

But, throughout our past, great visionaries like George Cadbury, William Lever and John Spedan Lewis not only created new wealth but invented new ways to share it, from Port Sunlight to Bournville, to the board rooms of the John Lewis Partnership. 

Theirs is the entrepreneurial spirit we are going to need to rebuild Britain. Why? Because we can no longer leave the task to big business. Big business is driving down wages, failing to invest, and funnelling rewards to the richest. Today, UK firms are sitting on an extraordinary £522 billion in cash. And that’s after they lavished out £100 billion in share buy-backs in 2014. According to Larry Fink, the head of Black Rock which is the world’s biggest investment manager, the gargantuans of the global economy are simply failing to invest in the new jobs and industries of the future. 

So we’re depending on our entrepreneurs to turn new ideas into new industries and new industries into new jobs - whether it is in big data, cyber-security, driverless cars, the internet of things, or genetic medicine. It’s not just good for progress. It’s good for jobs. In fact, if our young people today were as entrepreneurial as their counterparts in Germany or America, its estimated they would create an extra 100,000 jobs. 

The big lesson from 600 years of the history of capitalism is simple: entrepreneurs make history - by inventing the future. So we need the government to start doing an awful lot more for the enterprise economy; spreading enterprise education, investing more in science, shifting government contracts to small high growth firms, and sorting out the banking system. But if we want a better future for Britain, we need an awful lot more entrepreneurs to do well. And so we need AlanSugar to succeed.  

Dragons: Ten Entrepreneurs Who Built Britain is published by Head of Zeus today

Liam Byrne is Labour MP for Birmingham Hodge Hill, cofounder of the UK-China Young Leaders Roundtable and author of Turning to Face the East: How Britain Prospers in the Asian Century.