Better the devil, or auditor, you know

Apologies for those of you who clicked on this blog expecting a discussion of Kylie’s performance at Glastonbury; this blog is in fact about the audit market.

Despite the (not so) occasional accounting scandal, many people could easily make the mistake of thinking the audit market is rather dull. The Big Four dominate the market, and many companies have very long lasting relationships with their auditors. It’s not unheard of for clients to retain the same external auditor for over a century: When the relationship between the predecessor companies of Lloyds Banking Group and PwC began, Germany wasn’t yet a country. Why should we take an interest in a market so resistant to change?

We’ve done our first survey of client perceptions of audit firms and one result is rather surprising—and potentially troubling—for the Big Four: The majority of clients would choose someone other than their current auditor as their first choice for external auditor. This suggests that firms are at risk of a large chunk of their clients switching to a competitor, but raises a question—if most clients really think someone else would do a better job, why don’t we see lots of churn in the audit market?

We think this is where Kylie comes in: it’s a classic case of better the devil you know. If clients were starting from scratch they may well use their first choice firm as their external auditor, but this doesn’t reflect the reality that clients face.

Clients tell us the quality of auditors is very high, so while they might consider the possibility that a different auditor could provide a slightly better job, or maybe a slightly cheaper job, the vast majority of clients think their auditor is decent enough. Why take the risk that the audit will get worse by changing auditors? Not only will the business suffer, but the individuals pushing for changing the auditor will get blamed for the decision. And think about the amount of personal and political capital one would need to expend to make the change: audit committees would need to agree, and in listed companies shareholders will also need to be won over about the need to change auditors. Clients may conclude it’s better to focus on other things if the benefits of a potentially better audit don’t outweigh the risks to them personally, and to the wider business.

While this lack of churn might give the Big Four some comfort, change is coming to the audit market. Accounting scandals involving the Big Four are putting cosy relationships with clients under the spotlight, making audit committees and shareholders more receptive to changing auditors. Proposals in some countries for joint audits could also give smaller, mid-tier firms the opportunity to showcase their abilities to clients and prove they can deliver, giving clients a safer way to test if an alternative firm is indeed better. Mandatory audit firm rotation is forcing companies in some jurisdictions to conduct more regular tenders for external audit services and limit the tenure of their auditor. Mandatory re-tendering gives the opportunity for clients to switch to their first choice, without expending the same level of political capital or taking the same level of personal risk by proposing a change of auditor.

If regulatory changes to the audit market start to take place with some bite, auditors might find that—much like Kylie—clients finally start “spinning around” to their competitors.

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