The Competition Commission's (CC's) provisional report into the FTSE 350 audit market says restrictions on competition are making it hard for companies to switch auditors. It also says auditors are failing to serve shareholders because of a focus on management needs.
The CC 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 Four find it difficult to show that they have sufficient experience and reputation to win the audit engagements of FTSE 350 companies.
The CC 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.
Other remedial options under consideration include the prohibition of 'Big Four only' clauses in loan documentation and expanding the remit of the Financial Reporting Council's (FRC)Audit Quality Review team reviews.
Laura Carstensen, chairman of the Audit Investigation Group at the CC, said: 'It is clear that there is significant dissatisfaction amongst some institutional investors with the relevance and extent of reporting in audited financial reports.
'This needs to change so that external audit becomes a more genuinely independent and challenging exercise where auditors are less like corporate advisors and more like examining inspectors.'
The CC found that 31% of FTSE 100 companies and 20% of FTSE 250 companies have had the same auditor for more than 20 years. Two thirds (67 %) of FTSE 100 companies and half (52%) of FTSE 250 companies have kept the same auditor for more than ten years.
However, the CC said that its investigation had not found sufficient evidence to support the idea that the Big Four are involved in market collusion, or that they bundle audit and non-audit services together in order to raise barriers to expansion to other firms.
Nor was there evidence of the Big Four targeting customers of mid tier firms with particularly low prices, or exercising undue influence over the formation of regulation or on regulatory bodies through their extensive alumni networks.
The CC says that the lack of competition is likely to lead to higher prices, lower quality and less innovation for companies. As a result, it says, there is a 'rather static market in which too often audits don't fulfil their intended purpose and thus fail to meet the needs of shareholders.'
Auditors also have misaligned incentives between shareholders and company management, and so compete to satisfy management rather than shareholder demand, where the demands of executive management and shareholders differ, adds the report.
While acknowledging 'it will undoubtedly be challenging to change a long-standing and entrenched system', Carstensen said: 'Our proposals will look to create a situation where tendering and switching become the norm, and where greater transparency and information increase both contestability of the market and the ability of shareholders to judge the service they are getting. We also want to increase their influence-and that of the audit committee-over the choice of auditor.'
The CC is to publish it full provisional report and propsed remedies early next week and will invite responses on the findings by 18 March 2013. The final report will be published by 20 October 2013.
To read the CC summary of provisional findings, click HERE
