Is letting investors choose auditors the key to reform?

As timing goes for outlining his ideas for empowering investors as a way to improve the audit process, John Coffee could not have hoped for better.

Both the long-awaited CMA market study into audit and the Kingman report calling for a replacement of the Financial Reporting Council were released the morning he addressed those very issues to an audience at the ICAEW.

In a two-day conference looking at financial scandals past and present, the Professor of Law at Columbia University was able to bring an international perspective.

“There have been auditing failures all over the world this year, but the rhetoric in the UK is unique,” he said.

With more accountants per capita in the UK “by a long margin” than anywhere else in the world, he said it was perhaps no surprise that the issue had been a source of such debate.

Scandals including Carillion earlier this year have called for drastic measures including a break-up of the Big Four which dominate the audit market.

The dark side of audit

Coffee said the key to successful reform is making the auditors more accountable to investors. He proposed a system where audit firms, on a client-by-client basis, received a grade of 1-5 (with no grade being allocated to more than 30 percent of those assessed).

Investors could then be asked to vote on which firm they wanted to do the audit. They would be armed with more information than they have under the current system.

Coffee said one of the reasons audits can be less rigorous than the public would hope is that “public companies want their auditor to cooperate so they can claim earnings growth.”

The needs of investors and the management team may be different, in that case. He referred to this as “the dark side of audit.”

While historically, shareholders might have taken on a passive role, Coffee said that the rise of the institutional investor has meant that many will take a keen interest in the workings of the company.

Armed with the right information from the grading, they could choose the best auditor for the job.

Reacting to the CMA proposals

One of the proposals put forward in the CMA market study was imposing a joint audit regime, to include at least one firm outside the Big Four in each audit.

But Coffee was not convinced the Government deciding who should audit a company is the best solution.

“The current proposals are looking to the government, but instead of doing that, you might look to shareholders to have a little more say in the process,” he said.

Since audit is often not the most profitable part of a firm’s business, he did not think that more separation of audit and other services was the answer either.

This was also put forward by the CMA, along with measures to make audit committees more accountable. Their proposals will now go out to consultation.

Changing role of the auditor

What an audit delivers may be some way off from what stakeholders want to see if they are looking to determine the financial health and prospects of a company.

Also announced this week was a new Government enquiry into the scope of audit. It will be led by Donald Brydon, who is currently chairman of the London Stock Exchange Group.

Speaking at the conference, Michael Izza of the ICAEW welcomed the move: “It is time to finally address this expectation gap,” he said.

He said the organisation sees the new enquiry as the next logical step. Izza also suggested that auditors could play a more active role in a company’s AGM, being obliged to present their findings as opposed to attending passively.

John Coffee said the quality of audit will be addressed by a change in the role of auditors.

“The role of an auditor as a bean counter will diminish, and it will become more forward-looking,” he said.