22 February 2013

Competition Commission: Audit market not serving shareholders in the UK

In a summary of its provisional findings, the Competition Commission states that because companies find it difficult to compare alternatives with their existing auditor, prefer continuity and face significant costs in switching, they are reluctant to change auditor and so lack bargaining power. Audit firms outside the ‘Big 4’, which dominate the market, find it difficult to show that they have sufficient experience and reputation to win the audit engagements of FTSE 350 companies.

Additionally, although auditors are appointed to protect the interests of shareholders, who are therefore the primary customers, too often auditors’ focus is on meeting the needs of senior management who are key decision takers on whether to retain their services. This means that competition focuses on factors that are not aligned with shareholder demand.

The Competition Commission found that 31 per cent of FTSE 100 companies and 20 per cent of FTSE 250 companies have had the same auditor for more than 20 years, and 67 per cent of FTSE 100 companies and 52 per cent of FTSE 250 companies for more than 10 years. The Competition Commission adds that the lack of competition is likely to lead to higher prices, lower quality and less innovation for companies and a failure to meet the demands of shareholders and investors.

The Competition Commission is now looking at possible ways to encourage greater competition through mandatory tendering and rotation; increasing information and transparency with more frequent reviews and extended reporting requirements; and strengthening accountability and independence by giving audit committees and shareholders greater control of external audit.

The main points the Competition Commission has found are that:

• companies face significant hurdles in comparing the offerings of an incumbent auditor with those of alternative suppliers other than through a tender process;
• it is difficult for companies to judge audit quality in advance due to the nature of audit;
• companies and firms invest in a relationship of mutual trust and confidence from which neither will lightly walk away as this means the loss of the benefits of continuity stemming from the relationship;
• company management faces significant opportunity costs in the management time involved in the selection and education of a new auditor;
• Mid Tier firms face experience and reputational barriers to expansion and selection in the FTSE 350 audit market;
• auditors have misaligned incentives, as between shareholders and company management, and so compete to satisfy management rather than shareholder demand, where the demands of executive management and shareholders differ;
• auditors face barriers to the provision of information that shareholders demand (in particular, from the reluctance of company management to permit further disclosure).

The Competition Commission also considered whether the market conditions are conducive to coordination or that Big 4 firms engage in tacit collusion; that they bundle audit and non-audit services together in order to raise barriers to expansion to other firms; that they target the customers of Mid Tier firms with particularly low prices; or that they are able to exercise undue influence over the formation of regulation or on regulatory bodies through their extensive alumni networks. To date, the Competition Commission has not identified sufficient evidence to support these other theories of harm.

In its Notice of possible remedies, the Competition Commission is exploring the following possible combination of remedies:

• mandatory tendering;
• mandatory rotation of audit firm;
• expanded remit and/or frequency of Audit Quality Review team (under auspices of FRC) reviews;
• prohibition of ‘Big-4-only’ clauses in loan documentation;
• strengthened accountability of the External Auditor to the Audit Committee;
• enhanced shareholder-auditor engagement; and
• extended reporting requirements.

Press release

Report links

© Competition Commission