Britain’s biggest companies and their auditors are playing a £10 billion (€11.6 billion) game of musical chairs. When the music stops, we will have learned something about how seriously we should take the Big Four accountants’ opposition to audit market reforms.
Mandatory auditor rotation was introduced by the EU in 2016, aimed at eliminating supposed cosiness between companies and auditors. Lloyds Banking Group, Barclays and BP were among the businesses whose auditors had served for more than a century.
Much of the accounting profession, led by the Big Four – Deloitte, EY, KPMG and PwC – opposed mandatory rotation. The accountants argued a compulsory merry-go-round was unnecessary and would hurt audit quality.
Forced rotation would limit companies’ discretion to pick “the most capable auditor” and impose “additional financial and administrative burdens on companies”, Deloitte said in 2012. Companies “would need to continually educate new auditors on their businesses and risks”, it added.
Early evidence suggests the accountants’ objections were wide of the mark.
In the UK, public interest entities – large listed companies and private financial institutions – must change auditor at least every 20 years and tender the contract every decade at a minimum.
Approximately two-thirds of those that have tendered in the last two or three years have changed and one-third have stuck. If you’d have asked me that 10 years ago, I would have said the percentages were the opposite way around.— Senior Big Four auditor
Early adopters that switched auditors before forced rotation kicked in are now approaching the 10-year milestone where they must re-tender. In the FTSE 350, the appointments will be worth £10 billion over a decade.
If the Big Four’s thesis was right, only a minority of companies will switch this time round. The disruption, cost and risk to audit quality would render change undesirable until it becomes legally unavoidable after 20 years.
Some big names such as Unilever – audited by KPMG – have stood by the incumbent. But Aviva is ditching PwC for EY, while the London Stock Exchange Group and NatWest have dropped EY in favour of Deloitte and PwC respectively.
“Approximately two-thirds of those that have tendered in the last two or three years have changed and one-third have stuck,” says a senior Big Four auditor. “If you’d have asked me that 10 years ago, I would have said the percentages were the opposite way around.”
Some audit partners concede that rotation has forced them to innovate and carry out better work.
New auditors are more likely to require companies to restate previous years’ accounts, say people in the industry. Some will have simply reached different accounting judgments from their predecessors – such calls are part art, part science – but in plenty of cases a fresh pair of eyes has spotted problems.
What is clear is that the sky has not fallen and many in the market believe rotation rules have helped to improve audits even if they have failed to tackle the dominance of the Big Four firms
Meanwhile, switching has been disruptive but less painful than some companies feared. They are open-minded about changing more regularly despite the associated cost increase of roughly 10 per cent. Companies are running more efficient tender processes and auditors are getting better at handing over to competitors.
“The profession has proved that they can manage the transition,” says the audit committee chair of a FTSE 100 company. “The costs are not trivial but I think they’ve led... to better audits, partly because it’s forced firms to up their game but also [because] it has brought fresh insights and views to the company.”
It is too early to conclude the precise effect of rotation on quality. Isolating its impact from a broader regulatory clampdown also complicates the analysis.
What is clear is that the sky has not fallen and many in the market believe rotation rules have helped to improve audits even if they have failed to tackle the dominance of the Big Four firms, which were paid 98 per cent of all FTSE 350 audit fees last year.
All of this is instructive in assessing the Big Four’s opposition to the UK’s proposal to require shared audits of big companies in an effort to boost smaller accounting firms. There are well-founded doubts about whether shared audits can equip smaller firms to win FTSE 100 audits in their own right over the long term.
But the Big Four’s protestations that it will be too costly, difficult in practice and will not improve audits sound reminiscent of their anti-rotation arguments a decade ago. The signs so far suggest that they were wrong then. They should not call the tune this time. – Copyright The Financial Times Limited 2022