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Audit tendering may not turn out as hoped without some market change

Guy Strafford
Jul 1, 2013 9:44:00 AM

Comments 6

Guy-New

The FRC and Competition Commission are causing change in the audit market, and when combined with pressure from the corporate governance teams of the largest investors, there is now real impetus for change.

The market is beginning to become more fluid ahead of whatever provisional findings and recommendations come from the Competition Commission (CC) next month. I am aware of a wide range of FTSE CFOs, Chairpersons and Audit Chairs that have set in train a timetable, either formally or informally, to tender their audit.

It is hard to predict how the suppliers will respond but our experience is that they may react in unexpected ways. In particular there has been an unexpected consequence to the oft asserted pressure on the auditor not to provide material (more profitable) non-audit services to their client as well.

For most FTSE100 companies, in my experience, the value of consulting non-audit services provided by at least members of the Big 4 that are not the auditor, substantially exceed the value of the audit. I can think of many examples where all three of the non-auditors out of the Big 4 are often earning more in consulting fees than the value of the audit. The financial incentives for the other members of the Big 4 are therefore mixed. Whilst their audit partners may be keen to win, the non-audit partners face substantial loss of revenue and may not support it. To argue otherwise is to make the case that professional service business strategy is to seek to be smaller and less profitable. That is not what I see.

In a world of mandated change, what do we do when the economically sensible strategy is to not bid or come an honourable second?

I think that this matters because the number of market participants is so limited. If there were six or more major players I think that there would be likely to be more participants whose consulting revenues were less than the audit revenues and they would be less conflicted.Whilst the Grant Thornton's and BDO's have come on in leaps and bounds there is still a lack of confidence in their capability.

I suspect that the CC needs to think about changes that can build confidence amongst Audit Chairs and CFOs who continue to have significant concerns (some of which may be out of date) about the audit players outside the Big 4. Alternatively they are going to need to think how to develop competition at the smaller end of the FTSE350 as a way of building capability and confidence.

The large company audit market in itself is unlikely to invest in developing the non-Big 4’'s capability, and if they don'’t have it how can they ever expect to attain it? It is possible that the hand of regulation will be not able to deliver the silver bullet of more market participants.

So, should the debate perhaps switch to optimising behaviour and outcomes in a world where the Big 4’'s dominance is likely to persist in the medium term?

Guy Strafford

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