18 Oct 2013 10:00am

Editor's view: The impact of the Competition Commission

So, the final report is in. And after a two-year investigation – arguably the most significant and comprehensive study of the UK market for statutory audit services ever conducted – the verdict is that an overly concentrated market has led to too little switching of auditors and a skewing of the relationships between auditors, management and shareholders

In truth, the final report presented few surprises. The only real uncertainty was whether the Commission would dig its heels in and demand that all companies put their audit out to tender every five years. In the end they fudged it somewhat, agreeing to stick with the recently introduced 10-year tendering introduced on a “comply or explain” basis by the FRC, while very strongly recommending a tender should be conducted every five years and asking Audit Committees to report exactly when they planned to next tender. It also expects them to explain the reasoning behind their decision. In a sense the Commission has played the FRC at its own game and introduced five-year tendering on a comply or explain basis by the back door. The response to the initial suggestion of five-year tendering as a rule was overwhelmingly negative. The Commission seems to expect that by allowing 10 years but expecting five, most audit committees will either settle on something close to seven years or bring the tender in line with the rotation of audit partners (currently every five years).

In a sense the Commission has played the FRC at its own game and introduced five-year tendering on a comply or explain basis by the back door

The overwhelming question never resolved from reading the very earnest and surprisingly readable final report, is what exactly the Commission expects to achieve.

The authors of the report proudly claim, “We expect that the above measures taken together as a package will be effective and proportionate in remedying the AEC. We expect this remedy package to result in a substantially improved environment for competition in the FTSE 350 statutory audit market.”

What is never really addressed is exactly what greater competition – assuming that is the outcome – will actually achieve. For a whole variety of reasons (not least because audit quality is a difficult concept to pin down) the report’s authors admit that there is no objective measure of audit quality. This inherently means that it will never be possible to know whether the new measures will achieve their intended objective.

What is clear is that the Commission expects a lot of the extra activity in terms of tendering and reporting to be carried out by audit committees (with non-executives seen as acting as shareholder representatives) and that the cost of these extra burdens could be as high as £10m a year to the FTSE 350. It expects the benefits in exchange (through an alleged parallel reduction in workload for FDs) to be even greater but can’t offer an meaningful assessment of these savings or benefits. Not many FDs I have spoken to since the Commission first made its pitch for five yearly tendering felt too convinced that their workloads were about to lighten.

The Commission’s report and recommendations will now require an amendment to the Companies Act and will eventually become an extra bit of regulation (which two pieces will be dropped in exchange?). The Big Four will grumble a bit about the outcome but be relieved that the threat of mandatory rotation has receded. The Mid Tier will look forward to some new opportunities and also grumble that more hasn’t been done to break down the Big Four’s dominance. Audit committee chairmen will grumble about the extra workload and FDs will also grumble about the extra effort and cost of more frequent tendering.

The FRC will grumble about not having the resources to do the work required under the Commission’s proposals and will seek more budget to manage that workload. Whether it also adjusts its remit and role in line with the proposals remains to be seen. It will grumble most about not being master of its own destiny and about the interference of the Competition Commission in an area – corporate governance – where it feels it has done a pretty robust job by itself.

The upshot of all this noise is that quality of audits across the FTSE 350 will remain much as it already is. It won’t drop dramatically as a result of these proposals. The business community won’t sit still or stop, but rather will carry on (whisper it) almost as if very little of significance has changed. Perhaps of greater concern, given the time, effort, energy and expense put into this report, is that the quality of audits won’t soar either. There may be a slightly more competitive market, investors might get more engaged with the idea and practice of audit, but not much. The world will carry on as it was before. This is neither the end of the world nor the dawning of a brave new one. Rather it will become little more than one more quite interesting chapter in the long, slow but continuing evolution of audit.

The Commission claims that the lack of competition causes companies to be offered “higher prices, lower quality (including less sceptical audits) and less innovation and differentiation of offering than would be the case in a well-functioning market”. I don’t see that this will make quite as much of a dent in that as the authors expect. 

Richard CreeRichard Cree is editor of economia


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