11th June 2010:

Concentration, Competition, Choice

There has been a fair amount of comment in the press recently on the above issues – though in truth they are all aspects of the same issue namely whether or not it is healthy for the audit market to be so heavily dominated by four firms and, if not, what can and should be done to change the status quo.  I was thus particularly interested to read the fifth progress report from the UK’s Financial Reporting Council on the implementation of recommendations intended to promote choice in the UK audit market.
 
This is, in my view, a realistic report on progress or rather the lack of any real and meaningful progress.  As Stephen Haddrill the Chief Executive of the FRC said “…whilst progress has been made…it is clear that the risks arising from the extent of concentration in the audit market persist…”
 
The report also included a number of other comments that whilst related to the UK I believe are true in many countries.  These include:
 
“It is clear … that the largest firms focused heavily on their size in their [audit] proposal documents.  The firm’s size, together with its brand, was marketed as a proxy for quality.”
 
“Most of the audit committee chairmen… expressed the view that they would like a larger number of firms to choose from.  However, the majority were also reluctant to select a non-Big Four firm for perceived reputational reasons.  This was surprising as most of the companies were from the smaller listed market…”
 
“… the biggest challenge to increasing choice in the audit market remains the question of perception.”
 
The report also commented on the use of ‘Big Four only’ clauses and noted that “Twenty eight companies stated explicitly that they were not subject to any contractual restrictions on their choice of auditor.  It is unclear how many of those that were silent on the issue are subject to some form of restriction…”  The report also referred to “…anecdotal reports of contractual restrictions…”
 
This remains a disappointment to me as we have frequently pointed out examples of these restrictions, both to the FRC and others.
 
I recently saw a particularly offensive version of such a clause, namely:
 
“The parent company, although not legally obliged to do so, undertakes to submit its individual and consolidated accounts to an annual audit by one of the four most solvent and internationally renowned audit firms (the Big Four).”
 
No doubt the comment “not legally obliged to” is to ensure this is not a contractual obligation and need not be disclosed in the UK, where this is a requirement to disclose contractual commitments of this nature.  However, there is no doubt that this is an obligation a company would be foolish to ignore.
 
Further, the suggestion that the Big Four are the “most solvent” audit firms is difficult to sustain, if not offensive, not least given their own comments on the potential impact of pending litigation as part of their arguments for audit liability reform.
 
I was therefore especially pleased to see the comments in a recently published OECD report on this.  The report is from the OECD Competition Committee and is entitled ‘Competition and Regulation in Auditing and Related Professions’. It makes a number of interesting points on both regulation of and competition in the audit profession.  In particular, on page 27 of its report, commenting on ‘Big Four only’ clauses they state that
 
“…such restrictions are not based on a qualitative assessment of the pool of audit firms available and prevent excluded audit firms from competing with the Big Four firms and thus entering or expanding further into the audit market for quoted and larger companies...”
 
I couldn’t have said it better myself.

 Global Accounting  Standards & Regulators  5 Comments June 11th, 2010