Auditors still put management first

Mon, Feb 25, 2013, 00:00

Last Friday the UK competition commission published the results of an investigation into the supply of statutory audit services to large companies in the UK.

It was something of a mixed bag. It concluded that competition is restricted by several factors that “inhibit companies from switching auditors and by the tendency of auditors to focus on satisfying management rather than shareholder needs”.

But they said they had not to date “identified sufficient evidence to support” more serious allegations, namely that the Big four auditing firms (KPMG, Pricewaterhouse Coopers, Deloitte and Ernst Young) “engage in tacit collusion; that they bundle audit and non-audit services together in order to raise barriers to other firms; that they target the customers of mid-tier audit 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.”

Deadline

In other words, the bulk of the allegations routinely thrown at the big four firms have not stuck. But the inclusion of the two words “to date” is presumably significant and implies that they are not out of the woods entirely. The deadline for the commission to file its final report is October 20th and the wording of the provisional report rather tantalisingly holds out the prospect of more to come. But on balance it looks more likely they did not find the smoking gun or guns they were looking for.

The overall impact of last week’s report is thus somewhat diluted and it seems to be more of a glancing blow than a right hook. It is a pity in a way as what they have found amounts to serious failings and that has resonances in the Irish market.

The main criticism, that “too often auditors’ focus is on meeting the needs of senior management who are key decision-takers on whether to retain their services”, will strike a chord with those people in Ireland still struggling to understand how the big four firms got it so wrong when it came to auditing the Irish banks and revealing the extent of bad property loans.

Auditors, the commission found, were subject to conflicting forces. On the one hand they had many incentives to accommodate the management of firms they audited, including “the wish to be reappointed, with the direct benefit of the income of engagement and the indirect benefit to reputation and experience that might allow audit firms to win further engagements”.

There were limited countervailing incentives to challenge management, the most powerful being damage to their reputation should they be seen as being susceptible to the influence of management.

Diverging interests

Where this really becomes a problem is when the interests of management and shareholders diverge. Management, the report says, have at times incentives to manage reported financial performance to accord with expectations and present accounts in an unduly favourable light. “We found that, in general, shareholders would have no such interest.”

It is not that hard to transpose this scenario on to what happened with the Irish banks in the run-up to the crash. And this leads on to the wider issue of how applicable are the findings of the UK survey to the Irish market.

The answer would appear to be very applicable, as the accompanying tables show. When the data used by the commission on the market share of the big four firms by number and value in the UK is compared to similar data drawn from The Irish Times’ Top 1,000 Auditwatch database, the pattern is very similar.

This may provide ammunition to the profession’s critics but it also offers succour to the firms themselves, as the commission’s acknowledgement that they had not found sufficient evidence to support the more serious allegations also has to be afforded equal weight – for the time being.

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