207. Murdo Murchison of Kiltearn Partners said that "there appears to be a lack of competition in a key part of the financial system, which periodically causes a lot of other participants in that system a lot of trouble".553 Stephen Haddrill, Chief Executive of the FRC, told us that the CMA would "need to review the effectiveness of what they recommended" regarding competition in the audit market, "and look at it again".554 The Secretary of State for Business, Energy and Industrial Strategy, the Rt Hon Greg Clark MP, said he was "not averse" to reconsidering competition in audit market, as concentrated markets tended to act against the interests of consumers.555 Similarly, Rt Hon Andrew Tyrie, incoming Chair of the CMA, said that "something needs to be done" about the audit market.556
208. A range of potential policy options could generate more competition in audit. These include:
• more regular rotation of auditors and competitive tendering for audit contracts;
• breaking up the audit arms of the Big Four to create more firms and increase the chances of others being able to enter the market;
• splitting audit functions from non-audit services, reducing both the likelihood of associated conflicts of interest and the potential for cross-subsidisation.
209. The 2013 Competition Commission report considered how the interests of management and auditors could converge on matters of judgement, against the interests of shareholders. At times, management had "strong incentives to manage reported financial performance to accord with expectations and to portray performance in an unduly favourable light".557 To maintain lucrative working relationships, auditors had incentives to "accommodate executive management" in this unwarranted optimism.558 This is the story of Carillion's audits. But the weaknesses in regulation and competitive pressure which not only permitted those failures, but incentivised them to occur, are not restricted to one company. They are systemic in a market that has been stubbornly resistant to healthy competition, to the detriment of shareholders and the economy as a whole. That market is overdue shock treatment.
210. The market for auditing major companies is neatly divvied up among the Big Four firms. It has long been thus and the prospect of an entrant firm or other competition shaking up that established order is becoming ever more distant. KPMG's long and complacent tenure auditing Carillion was not an isolated failure. It was symptomatic of a market which works for the members of the oligopoly but fails the wider economy. Waiting for a more competitive market that promotes quality and trust in audits has failed. It is time for a radically different approach.
211. The dominant role of the Big Four stretches well beyond statutory audits. They have been prominent advisors to Governments of all colours and boast an extensive alumni network which dominates the ranks of regulators and finance directors. They provide a huge range of professional services to major companies, advising on internal audit, tax planning, risk, remuneration, corporate governance, controls, regulatory compliance, mergers and acquisitions, pensions restructuring, business turnaround and insolvency services. If one member of the oligopoly is a company's external auditor, the others can rely on providing other services, at all stages in a company's life cycle, and rack up substantial fees whatever the result. The Big Four collectively even benefit from mutual failure, as one of them will be invariably called in to advise on clearing up the mess left by the implementation of the previous advisors' proposed remedy.
212. The lack of meaningful competition creates conflicts of interest at every turn. In the case of Carillion, KPMG were external auditors, Deloitte were internal auditors and EY were tasked with turning the company around. Though PwC had variously advised the company, its pension schemes and the Government on Carillion contracts, it was the least conflicted of the Four. As the Official Receiver searched for a company to take on the job of Special Manager in the insolvency, the oligopoly had become a monopoly and PwC could name its price. The economy needs a competitive market for audit and professional services which engenders trust. Carillion betrayed the market's current state as a cosy club incapable of providing the degree of independent challenge needed.
213. We recommend that the Government refers the statutory audit market to the Competition and Markets Authority. The terms of reference of that review should explicitly include consideration of both breaking up the Big Four into more audit firms, and detaching audit arms from those providing other professional services.
____________________________________________________________________
553 Q1046 [Murdo Murchison]
554 Q70 [Stephen Haddrill]
556 Oral evidence taken before the Business, Energy and Industrial Strategy Committee on 24 April 2018 HC 985 (2017-19), Q31 [Andrew Tyrie]
557 Competition Commission, Statutory audit services for large companies market investigation, October 2013, para 11.23
558 Competition Commission Statutory audit services for large companies market investigation, October 2013, para 26