Mazars global head of audit David Herbinet presents his views on audit market competition in response to the Editor’s Letter in January’s International Accounting Bulletin.
I read your Editor’s Letter "Are we heading towards a Big Two market?" (IAB January 2015) with interest. It raises a number of key challenges around global market dynamics linked to the audit reform agenda.
The four biggest networks have a key role to play in the economy – but their global dominance, often founded on various myths, is unhealthy. We need a different paradigm that will make way for a market with more firms allowed to compete and show their worth in the listed company market.
Enhanced competition will lessen a number of potentially significant conflicts of interest, foster innovation in a service which has lost sparkle in the last two decades, and overall better help meet the demands of capital markets and investors.So what are the biggest myths preventing change in the listed company audit market?
Myth 1 – The market is content with a choice of four firmsThe first myth, which is thankfully slowly dissipating, is that nothing needs to change because the market is content with the current situation.
As your letter points out, a number of very significant economies have a Big Two rather than Big Four. Even when there are four dominant firms, with mandatory rotation just around the corner, the choice will in fact be restricted to three (the fourth firm cannot compete). Since it’s likely that at least one other firm will be conflicted, the actual choice could be between just two of the dominant firms.
A FTSE 350 audit committee chairman recently commented: "Everyone wants the situation to be different but everyone expects somebody else to do something about it."
Who will have the courage to make the first move? Could there be more of a collective drive from companies or investors to help new entrants into the market?
Myth 2 – There are only four firms capable of auditing large listed corporatesA commonly used argument to support the status quo is that only four firms are capable of auditing listed corporates. This is simply not true. A large number of listed corporates are no bigger or more complex than many companies that "challenger" firms already audit: capability is proven for a very large proportion of the listed market, even at the bigger end.
My own firm audits many companies which, if they were listed, would feature in the top quartile of companies in their local stock exchanges.
What’s missing is a broader market understanding of these capabilities. I fully recognise that the onus is on challenger firms to promote our worth, but equally we need to be given more opportunities to do so. The approach adopted by the EU will hopefully provide such an opportunity, with tenders open to all firms that want to participate. I hope market participants will be supportive.
Myth 3 – Size mattersAnother common misconception is that you need to be really big to audit large listed corporates – i.e. that a firm not only needs capability but also capacity. It is true that audit firms need to have enough staff, sufficient geographic coverage and specialists in the right disciplines to perform complex audits. But how big is big enough? Not as big as many believe: the global audit of a typical international mid-table FTSE 100 company may require, at most, between 200 to 300 individuals at peak times worldwide. How many staff does such a firm then need in total: 3,000, 5,000, 10,000, 100,000?
In a profession that promotes market transparency, it must be said that many firms could do better in terms of communicating transparently about their global networks, including on turnover (is "aggregated" good enough?), service lines strategy, and governance. The transparency reports published in a number of countries are a good indicator of progress on this front, but there is much still to do. Mazars has published audited group accounts for the last 10 years – and remain the only global firm to do so.
Myth 4 – Audit quality is the most important criteria considered in selecting an auditorAudit quality is a very difficult concept to assess and most stakeholders would probably have different views on what quality actually means. In the context of an audit tender, audit quality raises a clear challenge: it cannot really be assessed ex-ante (i.e. recognised before it is delivered). Proxies for quality are therefore applied during the tender process. These often include brand (i.e. size). We need to develop other proxies more in tune with how actually audit quality looks and feels.
Many commentators say "nothing will change". But we must give the EU reforms a chance: they will only come into force in 2016 so judging their success or otherwise now is very premature. However, I am also very conscious of the magnitude of the change required and my firm is committed to playing its part in making that change happen.