Value of the Competition Commission has been in its very existence

IT’S BEEN TWO YEARS since the Office of Fair Trading originally referred the larger audit services market to the Competition Commission for inquiry. But the announcement of the commission’s final report has been worth the wait.

Since it began its investigation, the commission has been down many lines of enquiry, some of which proved to be blind alleys and others of which they found difficult to deal with, typically as they related to relationships rather than to economics.

It is not a tome containing stunning intellectual discovery, but it contains a lot of common sense. In particular, in highlighting the principle/agent problems inherent in a market where a service is bought by one group of people on behalf of another group of people. It has caused market participants – investors, CFOs, audit committees and accountancy firms – to reconsider the essential role of governance surrounding the audit appointment, in the context of the best interests of shareholders.

A number of the commission’s recommendations attempt to address the lack of alignment inherent in the complex relationships between management, audit committee, auditors and shareholders. These recommendations are welcome.

However, the real value of the investigation has been to draw attention to the potential for poor governance that these imperfect alignments could create. Shining a light on issues that have, effectively, been taken as read has caused investors to demand a more considered approach to auditor appointment and review. It would now be a brave audit committee that did not at least ask itself if it was getting the best quality and value from audit, irrespective of regulation and legislation.

Where the Competition Commission has done less well is in considering ways of creating long-term and sufficient competition in the market. In particular, as economic recovery appears to be gathering pace, we hear the larger firms are intending to recruit enormous numbers of professional staff. By and large, these are not auditors they intend to hire, suggesting the audit business will become a minority sport.

The impact of the Competition Commission investigation, the increased focus on independence that’s inherent in European legislation and an increased regulatory focus elsewhere in the world, in particular the US, could cause the provision of non audit services to audit clients to become a thing of the past. It may be that not all the largest firms will wish to remain in the audit market, as their consulting and advisory businesses feel increasingly constrained by the knock-on effects of audit regulation.

The potential impact of one of the giant professional service firms leaving the audit market would be to increase market concentration to a wholly unacceptable level, which might threaten supply of audit to the largest companies – and certainly to the riskier public companies – and could have catastrophic implications for companies that were not able to reassure the market with audited numbers. This is a threat that simply has not been addressed. It is a missed opportunity. While one hopes that the Competition Commission will not have opportunity to rue the day, in terms of the threat of “4 to 3”, it will not be within the gift of regulators to take sufficient or appropriate action to reassure the markets.

So while their final report is welcome, the value of the commission’s work has largely been in its very existence, drawing attention to flaws in the market and in governance. But its failure to address the sufficiency of suppliers in the market is a matter for regret. The increased liquidity in the market for audit services to the largest companies will not change the dynamics of the market at a stroke. Firms outside the Big Four will both have to step up to the plate and display patience. If they do, the market should look more competitive in five to ten years’ time.

James Roberts is senior audit partner at BDO