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Fixing the persistent shortcomings will require serious reforms in three areas. To increase competition and rein in the dominant position of the Big Four, joint audits including at least one challenger firm should become mandatory. Auditors should be prohibited from providing their audit clients with consulting services to eliminate conflicts of interest. And the European Securities and Markets Authority (ESMA) should directly supervise the biggest audit firms to ensure effective oversight. With bold and binding tools, European decision-makers can finish the job and finally turn the EU audit market around.
Executive summary
The European audit market is broken. When the global financial crisis
revealed substantial weaknesses at some large financial institutions,
also the audit firms that had provided them with ‚clean‘ bills of health
were pilloried. The subsequent EU reforms targeting the financial
sector did not forget the audit profession. But extensive lobbying
efforts by EY, KPMG, PWC and Deloitte – the Big Four audit firms –
prevented serious change. While the measures adopted in 2014 were a
step in the right direction, they failed to achieve the main objectives:
greater competition, reinforced professional scepticism, and restored
confidence in companies’ accounts.
Concentration of market power at the Big Four, impaired auditor independence, and inadequate public oversight continue to undermine audit quality. These shortcomings are particularly pronounced at the top end of the audit market, where public interest entities (PIEs) suffer from a lack of choice. To strengthen audit quality, this paper argues that bold and binding measures are necessary in the following three areas:
First, the barriers that currently hinder challenger firms, i.e. Non-Big Four audit firms, from entering the market should be removed. To equip smaller audit firms with the expertise needed for the audit of large companies, the EU should require PIEs to engage at least one challenger firm as shared auditor and, after a transitional period, as joint auditor. In addition, all national audit supervisory bodies should offer complete transparency on inspection results and sanctions. Moreover, aggressive pricing strategies undermining audit quality should be tackled head-on and liability caps currently discriminating against smaller audit firms should be made more proportionate. Taken together, these measures would boost challenger firms‘ ability to compete with the Big Four.
Second, remaining conflicts of interest should be eliminated. The easiest way to strengthen auditor independence is to prohibit audit firms from providing their PIE audit clients with non-audit services. Furthermore, to curtail the company management’s influence, auditors should be required to present their findings at annual general meetings and answer questions raised by shareholders.
Third, public supervision of the audit profession should be beefed up. The biggest audit firms should be directly supervised by the European Securities and Markets Authority (ESMA) to ensure effective oversight at European level. Finally, the application of the European rulebook should be further harmonised across member states to meet the goal of a Capital Markets Union.
After some glaring audit failures in the recent past, the EU audit
legislation is once more under review. The European Commission has
staged a public consultation and is set to publish its legislative
proposals in early 2023. This time, Europe needs to finish the job and
adopt bold and binding measures. With the right tools, political
decision-makers can finally turn the market around.