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Not much to choose

31 Dec 08

Work to improve choice in the UK auditing market has had little effect

by Kevin McMeeking

A study to be published by ICAS concludes that, despite significant investment in recommendations to increase choice in the UK audit market, there will be little or no change.

The Market Participants Group (MPG), convened by the Financial Reporting Council (FRC), argued that its 15 cost-effective recommendations should contribute to increased choice in the UK audit market while at least maintaining audit quality.

This research used semi-structured interviews with stake-

holders to understand the challenges to and likely impact of these proposals, whether


stakeholders wanted to improve choice and, if so, how this could best be achieved.


The stakeholders were partners of the international Big Four, national and regional accounting firms, audit committee chairmen, regulators, shareholders, analysts, banks and the government.


Big Four partners welcomed the proposals, but most other interviewees, including non-Big Four partners, believed that the MPG recommendations will have little impact on choice. Proposals designed to widen the choice of audit firms available, particularly to FTSE 100 companies, were dismissed as ineffective by many interviewees.

Although concerns were raised by shareholders about the rate of auditor rotation, the level of competition and the limited choice in some sections of the audit market, non-Big Four firms do not appear to be targeting FTSE 100 audit contracts.

Measures designed to encourage increased shareholder engagement on auditor selection, improve access to incoming firms and use more than one audit network are expected to have little impact on choice but may introduce additional cost and bureaucracy. Non-Big Four partners provided evidence of contractual obligations requiring a company to hire an auditor from a limited number of providers. These restrictions are clearly inconsistent with the stated aim of improving choice.

The research also highlights the huge implications of a failure of any of the Big Four firms. The general consensus is that audit firms and companies do not fully appreciate the implications of another withdrawal and have not factored this risk into their plans.

There were strong concerns about the potential lack of competition and the risks of lower audit quality, complacency, and conflicts of interest, and fears that the profession would lose many gifted accountants and graduates.

In the UK, if KPMG or PricewaterhouseCoopers succumbed, many companies that search only for a Big Four industry specialist would be left with one or no auditor because the remaining firms may not be able to absorb the extra work involved and many teams would be broken up.

All parties agree that the credibility of financial reporting and auditing would be severely damaged, the economy would be harmed and the profession would take many years to recover.

If a four-to-three scenario arose because a firm elected to leave the market or merged with another, interviewees believed that the effects would be less severe.

A four-to-zero scenario, where if one of the Big Four failed, the rest chose to leave the audit market of their own accord, was mooted. Several partners used this line of thought to argue strongly for the introduction of proportionate liability (in addition to the limitation of liability by contract enabled by the Companies Act 2006).

However, other interviewees were not convinced of the merits of proportionate liability for auditors and argued that the MPG had bypassed the issues of broadening the audit market in favour of recommendations aimed at preventing another withdrawal. Further work on the advantages and disadvantages of limits to liability, proportionate liability and the likelihood of a catastrophic claim is therefore essential.

Six policy recommendations arise from this study:

• The larger non-Big Four firms should implement marketing strategies to inform audit committees of their abilities and work harder to win the tenders for FTSE 350 companies’ audit and consultancy contracts.

• The FRC, as it has indicated, and other stakeholders should assess the level of take-up and the impact of the new auditor liability limitation agreements enabled by the Companies Act 2006.

• The government should seek to remove any barriers to non-Big Four growth, such as contractual obligations to appoint only a Big Four firm as auditor.

• Directors and audit committees should be encouraged to shortlist firms beyond the Big Four.

• The FRC should evaluate the issue of choice in the UK audit market annually. If the supply and demand side measures suggested by the MPG do not improve choice, the FRC should consider non-market-based measures if improved choice is seen as desirable to the majority of stakeholders.

• The FRC, with the support of audit firms and audit committees, should commission a thorough review of the likelihood and economic consequences of a further withdrawal of a Big Four accounting firm from the market. n

Competition, Choice and Governance in the UK Audit Market: Interview Evidence (executive summary and full report) will be downloadable, free, from mid-January from

The research project was funded by The Scottish Accountancy Trust for Education and Research.

Dr Kevin McMeeking is a senior lecturer in accounting at the University of Exeter.t

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