Competition in the UK audit market is restricted by factors which inhibit companies from switching auditors, and by the tendency or auditors to focus on satisfying management rather than shareholder needs, according to the provisional findings of the UK Competition Commission (CC).

The CC said 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. And, 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.

The CC has announced that until its final report, expected in August, it is to examine the following remedies, the CC is exploring the following possible remedies aimed at increasing competition in the market:

  • Mandatory tendering
  • Mandatory rotation of audit firms
  • Expanding the remit and/or frequency of audit quality reviews under the auspices of the Financial Reporting Council (FRC)
  • Prohibition of ‘Big Four only’ clauses in loan documentation
  • Strengthening accountability of external auditors to audit committees
  • Enhanced shareholder-auditor engagement
  • Extended reporting requirements

The chairman of the CC’s audit investigation group, Laura Carstensen said: "We have found that there can be benefits to companies and their shareholders from switching auditors but too often senior management at large companies are inclined to stick with what they know, particularly when it is difficult to compare with the alternatives and the incumbent auditors are in a strong position to hold onto the business."

While Carstensen said the CC accepted most audits were performed diligently, and that all parties were behaving rationally in response to their incentives, "auditors tend to focus on management interests over those of shareholders. For example, management may have incentives to present their accounts in the most favourable light whereas shareholder interests can be quite different".

The CC also said it has not found sufficient evidence to support the hypothesis that Big Four 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.

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Industry response
The first to respond to the CC’s provisional findings, PwC UK’s head of reputation and public policy Richard Sexton, said:

"The audit plays a fundamental role in the orderly operation of capital markets and serving the interests of shareholders. We are very clear that we report to the shareholders and engage with the Audit Committee as their representatives. We believe that the CC have grossly underestimated the critical role that Audit Committees play in protecting the interests of shareholders."

Sexton added that since the CC had only published a summary of provisional findings, PwC would wait to comment further until full provisional findings were released.

Mid-tier firm Mazars welcomed today’s provisional findings from the CC, wth Mazars’ UK head of public interest markets David Herbinet commenting:

"We applaud the CC’s findings and, in particular, the emphasis on the primacy of the auditors’ duty to shareholders. We’ve been active in this debate for the best part of the last decade and the CC deserves praise for its study: it’s the most thorough and independent inquiry ever into the FTSE 350 audit market in the UK and reflects the situation of most other national audit markets. It’s clearly going to make a significant contribution in Brussels as the European institutions decide the way forward on the future shape of the EU audit market."

Herbinet continued: "No one can deny now that a major programme of reform is required as an urgent matter of public interest. The status quo is not an option. The key objective of reform must be to create a level playing field amongst the various firms with the capability to audit FTSE 100 and FTSE 250 companies. It is vital that all the key players – investors, boards and audit firms – work together to come up with viable and forward looking solutions."