Audit fees set to tumble as liability reform bites

That is the claim made by Tim Bush, director at Hermes Forcus Asset
Management. It would be ironic, if a policy lobbied for extensively by the
profession were to see its own fees cut back.

Auditors have for some time been calling for reforms to audit liability under
pressure of huge claims and the government is pushing ahead with liability cap
plans.

But the opinion has raised questions as to whether capped liability should
also mean capped fees.

Bush co-wrote a paper on the subject with Stella Fearnley of the University
of Portsmouth and Shyam Sunder of Yale school of Management, entitled Auditor
Liability Reforms in UK and US.

They have said that liability could be lowered either by law or through more
diligent work – neither of which is without undesirable consequences for
auditors.

The legal route would include a variety of reform methods including LLPs,
proportional liability, or liability caps in engagement letters. Bush and
Fearnley propose that this could reduce the insurance value of auditing to
clients and potentially increase the moral hazard for the auditor.

The alternative route of diligence reduces the residual of the audit fee the
auditor can take home. The implication is that it looks like a no-win either way
for the auditors.

Fees could remain a matter of negotiation between client and
service-provider. But if the value of the audit service is reduced through legal
means, it will in turn be accompanied by a reduction in the price customers are
willing to pay.

The authors say global standards and limits will reduce the value of the
audit. In addition, the reduced value may appear to be of concern to the
investors initially but that ultimately, investors will only pay for what such
audits are worth to them, reducing the price of audit services and the esteem
they attach to the limited-liability audits.

It looks like a long-term prognosis, so you might not see fees fall
immediately, if at all, but may do so relative to where they might be or could
be.

Their argument also points out that the whole point of limiting liability,
mooted by the industry, could very well be forgotten altogether.

The DTI, which is pushing the reform, also takes the view that fees will
fall, something the Big Four reject.

Whilst the Big Four control the market for large audits, it might also be
pointed out that they could dictate the fee structure for services with a ‘take
it or leave it’ stance.

PricewaterhouseCoopers has already indicated that it would not bow to the
pressure of lowering their fees, saying they did not expect the company law
reform bill would put them in a position so as ‘to be removed from liability
through these provisions’ – a view backed by Ernst & Young.

Could the introduction of the reforms see a stand-off between investors and
auditors haggling over the fees the latter charge?

TOP SIX UK FIRMS

Stated provisions for liability & charges

PwC ………………………… £43m
KPMG……………. No disclosure
Deloitte ………………… £13.1m
E&Y ………………………… £19m
BDO …………………..….. £5.7m
Grant Thornton ……. £2.9m

Survey conducted March 2006