1.
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The easiest improvement would be an expansion of the audit report.
Britain has already replaced the single-page pass/fail statement with a
more detailed summary of auditors’ activities and areas of focus. Bob
Moritz, the chairman of PwC’s American arm, says that reports would be
more useful if accountants audited a wider range of “value drivers”,
such as drug pipelines for pharmaceutical companies or oil reserves for
energy companies. |
2.
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Another help would be greater competition. Because the Big Four
specialise in different industries in each country, many companies have
only two or three candidates to audit them. High concentration has also
hamstrung the courts: in 2005 America’s Justice Department agreed not
to prosecute KPMG for marketing illegal tax shelters, largely because
the government feared that a conviction would destroy the firm and
further reduce the numbers in the oligopoly. But antitrust action
against the Big Four would make matters worse: breaking one up would
leave even fewer firms with the necessary scale. Ironically, the way to
increase competition would be for a group of weaker networks to
consolidate into a new global player. However, even KPMG, the smallest
of the Big Four, is larger than the next four firms combined. |
3.
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Proposals to modify how auditors are chosen or paid invariably involve
trade-offs. The simplest would be to shield the audit committee even
more from management influence, by having it nominated by a separate
proxy vote rather than the board of directors. Whether arm’s-length
shareholders would know enough to do so is debatable. But the change
would reduce the risk of the CFO suggesting an auditor to a committee
member on the golf course. |
4.
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Some critics suggest taking the selection of auditors away from
companies entirely. One model would hand that responsibility to stock
exchanges. However, exchanges might be more interested in using lax
audit rules to induce companies to list than in courting investors by
marketing themselves as fraud-free platforms. To avoid that risk, many
pundits suggest that government should appoint auditors instead—or even
that the profession should be nationalised. “Do people panic when the
IRS descends on them, or when your friendly neighbourhood auditor that
you pay does?” asks Prem Sikka of the University of Essex. “Companies
should be directly audited by an arm of the regulator.”
Small-government types hate either prospect. |
5.
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The most elegant solution comes from Joshua Ronen, a professor at New
York University. He suggests “financial statements insurance”, in which
firms would buy coverage to protect shareholders against losses from
accounting errors, and insurers would then hire auditors to assess the
odds of a mis-statement. The proposal neatly aligns the incentives of
auditors and shareholders—an insurer would probably offer generous
bonuses for discovering fraud. Unfortunately, no insurer has offered
such coverage voluntarily. New regulation may be needed to encourage it. |
6.
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Finally, the answer for free-market purists is to scrap the legal
requirement for audits. Today accountants enjoy a captive market, and
maximise profits by doing the job as cheaply as possible. If clients
were no longer forced to buy audits, those rents would disappear. In
order to stay in business, the Big Four would then have to devise a new
type of audit that investors actually found useful. This approach would
probably yield detailed reports designed with shareholders’ interests
in mind. But it would also allow hucksters to peddle unaudited penny
stocks to gullible investors. Whether government should protect people
from bad decisions is a question with implications far beyond
accounting. |