Four firms dominate the auditing business globally and, between them, would appear to have more than 280,000 employees dedicated more or less exclusively to audit and assurance, generating approximately $48bn in fees. By Stephen Kingsley.
Auditing is a big and costly business, but what value does it really deliver? Unquestionably, users of capital markets and the financial information on which those markets depend are looking for certainty – this is particularly true today. So, when analysts and others look at financial information provided by corporates, they really do want to believe that what they are looking at is complete, accurate and fairly presented.
The notion that an outside expert has examined this information ought to give them the comfort they seek. The question is – does it? Put another way – we all want to see truth and fairness in corporate reporting, but is external auditing an effective way to achieve this objective?
Just as importantly, even if external assurance is thought to be a good thing, is a rules-based system operated by what is essentially a legally mandated oligopoly of four global firms the best way of delivering it?
I believe that it is time for the principle of statutory auditing to be debated openly and honestly, since there ought to be some doubts as to whether the concept is workable in practice. Here are some reasons why.
Whose job is it anyway?
External auditing involves the transfer of responsibility for the accuracy and completeness of financial information from management to independent expert. But the transfer is not complete, as a quick scan of a typical audit report will confirm. The extent to which responsibility is transferred and, therefore, the extent of auditor liability for errors and omissions is a grey area. From time to time, this is tested in the courts. Most often, however, it is settled behind closed doors – which means that the uncertainty persists. There is also uncertainty about who is entitled to rely on information signed off by statutory auditors. The result is confusing – both for the audit firms and for their external stakeholders.
The nature of the process
External auditing is relatively straightforward and is unlikely to add a lot of value where management has put together a comprehensive set of financial information and where “there is nothing to hide”. External auditors are really needed when management does have something to hide, and where the truth has either been massaged or masked. Unfortunately, in my observation and experience, auditors are near-defenceless in such situations. Indeed, the extensive caveats in their contracts and reports confirm this.
Moral hazard
Management may feel that the auditor can and should be blamed when accounting and reporting issues surface. We should remember that it is management’s responsibility to prepare financial information – as audit reports make very clear – so management really needs to be fixed with the responsibility of any material errors, particularly if these are deliberate. Again, the very existence of the external auditor helps to blur responsibility for external reporting.
However, much of the debate around statutory auditing tries to deal with two different problems - the lack of competition to the Big Four and auditor liability. While it might be interesting to introduce more firms into the global auditing game, I doubt it would change the dynamics I have described. In any case, given the enormous barriers to entry, introducing a new competitor would be a real challenge.
As for auditor liability, lack of limitation clearly concentrates the mind and does not seem to, of itself, have led to the collapse of any major firm – including Arthur Andersen. At best, it seems to be a peripheral part of the problem.
There seem to be two questions that we should be debating:
- Is the concept of statutory auditing itself flawed?
- If it is not flawed, is a four firm oligopoly the best way to deliver the assurance on corporate reporting that we seek, or should we be inviting others (for example, rating agencies and insurers) to the party?
Stephen Kingsley worked in theFinancial Services Practice of Arthur Andersen for 30 years, latterly as head of the Firm’s Global Practice. He is currently a director in the London Office of LECG, the expert services firm.
