Charlotte Aguilar-Millan inspects the relationship between corporate change and regulation in her ninth blog post for our Emerging Fellows program. The views expressed are those of the author and not necessarily those of the APF or its other members.

The purpose of regulation is to enable the transparent and trustworthy operation of businesses. This includes the regulation of how employees are treated, regulation on where goods are received from and also regulation of the figures reported to shareholders. It is this last example which has come under a great deal of scrutiny in the past few years: the external auditing of accounts.

The purpose of an external audit is to provide an independent opinion to the shareholders on the truth and fairness of the financial statements. It provides accountability to the stakeholders the company about how the directors operate the company. The standards to which an audit is completed were first introduced nearly 100 years ago; the 1930s for America and 1940s for the UK. Since then, regulations have been tacking on new requirements but not overhauling old requirements to reflect how businesses operate in an age of very different technology.

Carillion, previously the UK’s second largest building company, collapsed in January 2018 as a result of soaring debt and cashflow issues. KPMG, Carillion’s former auditors, gave Carillion a clean audit opinion up until it’s collapse. According to the regulations, it would appear that Carillion did not raise any red flags. As the Financial Times points out “auditors who want to work for and retain a client — and its fees — may be less inclined to scrutinise”. All auditors are reliant upon the client to pay their fees, yet they must also retain objectivity and independence.

During 2018, the year Carillion collapsed, KPMG were fined £3 million and £4.5 million for the inadequate audits of Ted Baker and Quindell respectively. Yet no Partner in firm was fired, demoted or even struck off. This means that those involved are still able to provide an opinion on whether companies are operating appropriately. In the same year, KPMG’s divisions expanded (including audit by 8%) leading to a Partner profit share jump to over £600K per person.

Where the Partners are reliant upon their client’s long standing, it is little wonder that levels of scrutiny by auditors is put into question. Further, as demonstrated in the previous few years, there are no material consequences if they do not. The fines auditors have received represent a ripple in the ocean when compared to the profits they are generating. Public trust is at a loss. The private sector is not willing to be held accountable by their actions.

True independence should be demonstrated through a regulating body used to allocate audit clients to auditors. This should be based on experience, risk profile of the client and the resources the audit firm have available. Once an auditor is appointed, this should be fixed for a set number of years.

Currently the private sector can select an accommodating opinion and ditch those who do not align with their methodology. Further, the Big Four would no longer be able to cherry pick their clients. This was demonstrated in August 2019 with Sports Direct seeking new auditors with the largest 5 audit firms declining to tender.

By using an allocating intermediary, the private sector could make transparent their resource available, whilst also demonstrating objectivity where their fees are not reliant upon keeping the subject of audit placated. Reform from within the corporate sector has proven to be ineffectual. Only once external oversight is placed on corporates will they change. The only form of change that will boost corporate change is a true reform of regulation.