'Institutional prejudice' restricting audit market

THE BIG FOUR accountancy firms dominate the FTSE audit market thanks to “institutional prejudice,” a House of Lords enquiry into the audit profession has heard.

BDO managing partner Simon Michaels (pictured below right) made the remark when trying to explain the perception of FTSE audit committees who award audits to Big Four firms, arguing that there were mid-tier firms who would have the appropriate knowledge, reach, service quality and expertise to perform the audit but lost out as “size and revenue is seen as quality.”

“It’s frustrating that revenue is seen as reputation,” he said. “We are not seen as big enough for some companies – it’s ridiculous. Making a buying decision outside of the Big Four is seen as a risky bet.”

“The market is so concentrated that I feel that if one of the Big Four exits the market, there’ll be a risk of systemic failure in the market being able to provide services that need to be provided. The audit market needs intervention.”

However Russell McBurnie, finance director of FTSE-listed accountancy firm RSM Tenon plc, ventured that RSM Tenon (and perhaps, similar firms) did not see the Big Four firms as their competitors, but other mid-tier firms instead – therefore having no interest in most FTSE audits. “We would not have the expertise to do a bank audit,” he said. “From our point of view we’d be wary of taking on any of the top hundred.”

McBurnie did note that the current situation leads to, in many cases, “auditor stagnation” where the risk is a lack of value service from a Big Four firm “that [doesn’t] need to go that extra mile to prove that they should have the audit again.”

However, he believed that companies should not compulsorily tender their audits periodically to counter this stagnation. “Companies shouldn’t be forced to re-tender their audits, as they might already have the right auditor for their business,” he said. “What I’d like to see is an open decision-making process making public why they are not re-tendering their audits. What we don’t want to do is force companies to use auditors without the relevant expertise for their business.”

A merger between mid-tier firms – to create a larger firm that would challenge the Big Four – was ruled out by Michaels and McBurnie, with the latter observing that while “it would be a potential short cut in terms of dealing with perceptions about size.” He added that “mid-tiers still have to get over the perceptions of finance directors, investors, brokers, audit committees, and banks – some of whom demand Big Four audits in their bank covenants.”

Increasing investment was ruled out as a possibility, with the firms suggesting that unless there was real competition in the market – and an erosion of “institutional prejudice” against non-Big Four firms – investing in the business with the sole, specific aim of winning Big Four clients would be inadvisable.

One solution was proposed by David Herbinet, head of corporate and public interest market teams for Mazars: joint auditing, which is compulsory in France (Mazars are joint auditors for BNP Paribas, Europe’s third-largest bank).

“A joint audit is essentially two or more firms expressing an opinion together on the financial statements of a group,” Herbinet explained. “The audit is not performed twice: the auditors work together. They look at the most complex and challenging issues together – it focuses on judgement rather than compliance.”

Herbinet believes there are more benefits than disadvantages to this system. “It encourages new players to come into the audit market by offering visibility, and facilitates any change in auditor [by removing the risk of appointing a totally new auditor],” he said. “There is no evidence that… it is expensive or that it means a ‘race to the bottom’ in terms of audit quality.”

Others were not so convinced by joint audits. McBurnie in particular expressed concerns over costs and “responsibilities falling into the cracks between firms.”

Steve Maslin, head of external professional affairs at Grant Thornton, believes the place to start in changing the state of the market is with FTSE 250 audits. “If you move 20% of those audits away from the Big Four, we estimate the size of that market would be £25m to £30m,” he said. “Certainly for our firm – and some others – we believe that those can be served by us straight away. We have the cash reserves that we are able to make an investment – we don’t think [not auditing those firms] is a question of lack of investment capacity.”

“The reality is, buying patterns are such that it tends to be those four firms that are successful,” Maslin added. “If a change was brought about in, say, the next three years, that will provide a more solid platform for more firms to be able to challenge credibly in the FTSE 100 market.”

Responding to Lord Best’s question on what could be done to give business more choice in the audit market, the mid-tier firm representatives responded that intervention was needed – but differed as to who should intervene. Herbinet recommended joint audits particularly for companies with high systemic risk, such as banks, financial institutions and FTSE-listed companies. McBurnie suggested “tackling audit committees as that’s where the decision-making, in terms of audit choice, lies. Strengthen their role.”

Michaels said: “There are ways to ‘de-risk’ the market, but not without intervention – from regulators, investors and government. For example, regulators could have more input in FTSE 250 audits. Government spending [work] could be [moved] away from Big Four firms. If restrictive banking covenants [specifying Big Four audits] could be outlawed, that would open up buying ability.”

However Maslin said: “I think audit is a unique service. Auditors should remember their primary client is actually the investors as a whole… [and as] the ultimate user of audit services is the investment community, larger institutional investors need to take on some of these issues to bring about change.”