Those of us who have an interest in audit reform (who I know are not the biggest group in society) have been awaiting a report from the government on this issue for a couple of weeks now. The reason for the delay is not known. That is it is being related is certain. The possibility that the vested interests in the profession have got their lobbying in early cannot be dismissed. And those vested interests are powerful, whilst the problems are enormous.
In this guest post, my old friend, co-author and former colleague Prof Atul Shah ACA considered some of the issues. I do not agree with everything he has to say, particularly on the history of the profession, but his analysis of its current malaise indicates why reform is overdue:
The industry and profession of accounting are in a profound crisis. Last week, the Chairman and Chief Executive of KPMG in the UK, Bill Michael, was forced to resign for insensitive and discriminatory statements he made to his own financial consulting colleagues, who wanted better bonuses.
In the UK, KPMG has been in the limelight for a spate of audit failures from HBOS in 2008, to Co-op Bank, Carillion and many others, but this has not hurt its pocket nor repaired its broken culture. Even the Financial Reporting Council (FRC), has consistently criticized KPMG for poor audit quality. The multinational corporate clients have been ‘feeding' the Big 4 firms regardless of this record. A senior ‘rainmaker' KPMG partner was recently sacked for alleged misogyny and bullying - of other partners. These are symptoms of a much larger cultural malaise, which is the commercialization and monopolization of accounting and consulting by these giant multi-disciplinary firms. In the hunt for revenues, a culture of greed has become normalized. Well-paid professional employees are demanding even more money.
Historically, the Big 4 started as audit firms, and they were deemed professional because their primary duty was to protect the public interest. Today, the public interest is very far from view, and the private interest has become all consuming, at a time when the planet and our society are facing a profound sustainability crisis. Their wide range of services encourage and breed vast conflicts of interest, which have flourished. Despite being regulators, the Big 4 have become allies of the regulated and facilitate systemic regulatory arbitrage.
Contradictions are rampant. Leaders set the perfect example: If you were to look at the Board members of KPMG UK, there is not a single non-executive outsider in the main Board, and the Chair was also the CEO. This is true even though KPMG ‘polices' the FRC code on Corporate Governance, which recommends a good number of independent external directors as basic to robust governance. As the entire Board is composed of internal partners — there is no room for independent challenge or oversight. The cultural tone at the top is hypocritical at best & dishonest at worst.
There has hitherto been no personal punishment for greed, hubris or audit failures. The FRC has regularly called for a new ‘challenge culture' where professional scepticism is a core part of the audit. KPMG in the UK had opened a private club in Mayfair, to schmooze their favoured clients and fee payers. The ‘clients' of the Big 4 are not the shareholders of large corporations but the managers who run them. Richard Brooks' bestselling book on the Big 4, ‘Beancounters', opens with this slick venue, showcasing the height of hubris, and the real culture which prevails, fuelled by ‘other peoples' money'. Has this culture of strategic networking continued?
To change culture, there needs to be profound structural changes — simply finding a new leader will not do. Audit and Consultancy urgently need to be separated — the two are culturally incompatible. Whereas audit is supposed to be sceptical, consulting is supportive & value enabling. This requires a break-up of the Big 4 — consultants can then keep their own rewards, but also stop relying on audit to get their foot into the corporate boardroom. A smaller organization is much more able to harness these factors than a large one-stop global advisory shop. Culture is about human relationships, trust and relationship capital. This includes equality and diversity across gender, race and faith — and genuinely enabling a plural culture which is beyond box-ticking. If they want to keep the ‘professional' label, such firms must demonstrate public interest through fixed salaries, ethical policing and a more active sense of public purpose. Revenue-based incentives should be removed from the audit partners. They should conduct research and issue regular public warnings on dangerous business and financial risk-taking. Above all, ethics and morality should be at the core of their character if they wish to remain sustainable.
Professor Atul K. Shah teaches at City, University of London, and is author of ‘Reinventing Accounting and Finance Education — For a Caring, Inclusive and Sustainable Planet'.
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The grotesque level of concentration, monopolisation, the inbuilt conflict of interest between audit and consultancy and the resulting disasters of Carillion and the others, seems to be just another aspect of the creeping ‘corporatisation/monopolisation’ across politics, the economy and society in general.
In many countries including ours. Governments are corrupting , manipulating, and/or taking over media, parliaments, the electoral system, the judiciary/ legal systems, independent regulatory bodies, using political, legal, spending, and patronage powers
(Trump, Johnson, Erdogan, Orban, Modi…etc).
The unfettered market’s inexorable tendency to concentration and monopoly seems to help to underpin all this.
Although splitting audit and consultancy has been talked about for years. just like climate change, nothing is likely to happen, other than window dressing.
The current “structural separation” still permits a shared profit pool between audit and non audit partners
This is very obviously a problem, but fundamentally an audit practice simply dosent generate sufficient profits to stand alone. Interestingly audit fees have increased 20-30% in the last couple of years to cover increased quality measures and it still makes insufficient profit.
Not sure what the answer is, although I would say that the notion that a big 4 firm can provide multi line of services offerings to a PIE or OEPI client is dead. It is simply not allowed internally no matter how much noise is made on the topic. Whether we participate in an audit proposal or not has become a rather heated affair!
I speak as a tax partner in a big 4 firm.
A national statutory auditor seems an interesting idea but I fear wouldn’t pay market rates for staff which means it likely wouldn’t work.
Thanks for this.
Three thoughts
1) If cross selling does nit happen why is there so much lobbying to ensure audit divisions can do it in the future?
2) If auditing is not profitable why does any firm do it? They’re not charitable after all, so the claim does not make sense
3) Of course state audit can pay appropriate rates. Companies will have to pay more for audit. That is inevitable and a price of limited liability.
Thoughts?
Fair questions
1. Audit is seen as “brand defining”. Obviously all the big 4 started as mainly audit firms before diversifying. Non audit partners find this v frustrating. We have taken on audits that have generated huge losses for the firm just because we need to be seen as auditing one of the big banks/insurance groups/retailers delete as appropriate. Senior partners in the firm make their name “winning” these audits much to the disgust of the rest of us. Audit is the largest part of our business so they use that muscle to swing decisions their way. Trust me, in a free vote the majority of non audit partners would vote to spin off the audit practice, it’s low margin, high risk and causes the rest of us huge independence issues. As a partner I personally/through my pension cannot hold any interest in an audit client of the global business, probably right from a “perception of independence” perspective but massively inconvenient for a partner with zero involvement with this part of our client base. The sooner we get rid of this business the better!
Cross selling (we would call it going to market with a holistic offering) still happens in the mid market sector but for pie/oepi clients it is not permitted and a breach of these rules in my firm triggers a material personal fine for the partner involved. Personal fines, as you can imagine, are extremely effective at modifying behaviour
On 3 I hope you are right, but the weird regular furore over what mp’s/civil servants get paid bemuses me and dosent make me hopeful. A big 4 manager is on 55k-70k, senior manager 75-100, director 120-200 and partners on 250 plus just to give some perspective. These don’t really sit comfortably alongside civil service pay bands
Thank you
You confirm what I suspected
What we are seeing is market failure
And re the last, medicine is not so far out. I do not think this an issue.
He is right – trying to get the financial sector, including the accounting and audit professions, to “behave themselves” is just superficial posturing. Real, and deep structural change (system redesign I would call it) is what is required in
our banking system, our pensions system, in the overall monetary system, corporate governance and disclosure, including sustainable cost accounting. The whole of the current edifice of finance and money is totally corrupted and is a giant wealth extraction machine….time for some serious Luddism and reconstruction from top to bottom. Time to stop pissing about.