Friday, 22 February 2013

UK: audit market not serving shareholder interests says Competition Commission

The Competition Commission has published preliminary findings in respect of its inquiry into the market for statutory audit services: see here (pdf). The Commission has provisionally concluded that there are features of the market that create an adverse affect on competition and that this results in companies being offered higher prices, lower quality and less innovation (and differentiation of offering) than would be the case in a market without the adverse features. The Commission's accompanying press release, available here, carries the headline "Audit market not serving shareholders".

A summary of the Commission's preliminary findings is available here (pdf) and the full preliminary findings report will be published shortly. Possible remedies are outlined and include mandatory tendering, mandatory rotation and greater shareholder engagement: see here (pdf). The following features of the market have been identified by the Commission:
  • Barriers to switching: [i] Companies face significant hurdles in comparing the offerings of an incumbent firm with those of alternative suppliers other than through a tender process, [ii] It is difficult for companies to judge audit quality in advance due to the nature of audit; [iii] 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 face 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). 
Further information, including all of the Commission's supporting documentation (e.g., working papers), is available here The Commission's final report is expected in August this year.

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