The research by economic consultancy Oxera was
commissioned jointly by the Department of Trade and Industry (DTI)
and the Financial Reporting Council (FRC), the UK's independent
regulator for corporate reporting and governance.
The report, published today, does not demand change; but it will
be used by the FRC as a basis for taking forward a wider
consultation with all stakeholders on the implications that the
current market structure has for the efficient and effective
operation of the market.
Prior to 1998, people talked of the Big Six. Then Coopers &
Lybrand merged with Price Waterhouse to become
PricewaterhouseCoopers (PwC), reducing the market to the Big Five.
Then Enron imploded and consequently Arthur Andersen dissolved in
2002, leaving the market with the Big Four: Deloitte & Touche,
Ernst & Young, KPMG and PwC.
Oxera found that reputation directs FTSE 350 companies to the
Big Four, based on differences – real or perceived – with mid-tier
firms. Ninety-seven percent of FTSE 350 companies use the Big Four
for their audits. They reckon the Big Four are better placed to
offer key components of that work: value-added services on top of
the audit itself; insurance against catastrophes and reputational
risk; and, due to their capacity and international coverage, the
technical audit itself.
While the high concentration of work has led to higher audit
fees, lower fees seem unlikely to widen the market. Some bargaining
on fees takes place during the annual audit firm reappointment
process; but in general the focus of audit committee chairs is more
on quality (and reputation) than price.
Oxera also found that some UK-listed companies, primarily the
financial services firms among the FTSE 100, appear to have no
effective choice of auditor in the short term due to high market
concentration, auditor independence rules, supply-side constraints,
and the need for sector expertise.
Oxera does not expect the market to change. The barriers to
entry into the market for FTSE 350 audits are too high for mid-tier
firms. Any new entrant would need to overcome perception barriers
and demonstrate sector-specific skills, international coverage and
high quality staff to win audits. And the loss of a Big Four firm
could lead to serious problems for some companies and damage
investor confidence.
The FRC says it will evaluate possible measures to reduce
"actual and perceived barriers to entry with a view to improving
market structure." It is also considering options to reduce
the risk of unnecessary failure of a significant supplier of audit
services.
Chief Executive of the FRC, Paul Boyle, said: “A
well-functioning market for audit services is essential to ensure
confidence in corporate reporting and governance. The report from
Oxera raises a number of issues about the structure of the audit
market in the UK. We look forward to hearing a wide range of views
from interested parties in the coming months.”
Trade and Industry Minister Gerry Sutcliffe added: "This
analysis provides the Government and FRC with a thorough and
thought-provoking analysis of the audit market and its dynamics in
the UK."
