审计外文文献翻译

AUDIT MARKET FAILURE
Benedikt Koehler
The auditing profession has called for the current regime of unlimited liability to be replaced with liability caps. The Department of Trade and Industry has tabled proposals to reform the structure of the market for audit services. These proposals fall short of meeting the demand for liability limitation but modify he current regime inasmuch as auditor liability, though uncapped, would be proportional to the damage caused by audit failure. This step is unlikely to reme dy audit market failure. This article argues the distortion of market ncentives in audit markets can be traced to government intervention and the re me dy lies in re placing government interve ntion with c ompetition.
Introduction
Proponents of audit lia bility reform argue that the c urre nt weight of obligations is untena ble. A re gime of unlimited lia bility, coupled with the doctrine of joint and se veral liability, implies that every c orporate insolvenc y can trigge r litiga tion by plaintiffs arguing tha t auditors are c ulpa ble for not spotting trouble in time. Worse, auditors can not only be he ld to acc ount by a compa ny’s mana ge me nt, but by third parties as well. Auditors feel tha t providing an a udit opinion in effect is ta nta mount to underwriting the solve ncy of their clients.
The Ge neral Acc ounting Office (GAO) finds in a surve y of c orporate failures that auditors had qualified their opinion in only half of all cases. Therein lies the crux. Auditors attest whether a compa ny’s accounts are dra wn up in accordance with auditing standards. That is not the same thing as to vouc h for a company’s solve ncy. Auditors argue it is wrong to confla te audit failure and c orporate failure.
In 1992 the Big Six US a uditors state d that without c hec ks to third-party litigation, it would only be a question of time until their number dwindled (Arthur Ande rsen et al., 1992). US le gisla tion passe d in 1995 se t hurdles for filing claims a nd for a while seeme d to ste m the tide of litigation. Yet the de mise of Arthur Andersen ga ve urge ncy to the
calls for a udit market reform. Auditors a ver that insolve ncies are a fact of life and the next major corporate c olla pse is like ly to start a nother round of musical c hairs in the audit sector. Another reduction in the number of auditors with global reach would contra vene the public interest in sta ble fina ncial markets.
Not e veryone is c onvince d of the nee d to cap a uditor lia bility. EU Commissioner Frits Bolkestein, for exa mple, has little sympa thy for the auditing profession’s pleas. First, users of fina ncial accounts are reassure d by knowing a uditors back their attest with unlimited lia bility. Unlimited lia bility concentrates the mind. Sec ondly, argues Bolkeste in, the threat to a udit market struc ture is entirely self-inflicte d. Auditors pursue d a strategy of global growth by leve raging the re putation earne d in na tional marke ts. They could hardly c omplain that the threat of conta gion from partic ular markets might affect the entire operation. Bolkestein is but one of those who belie ve that cappin g claims against auditors is a cure worse tha n the disease (Bolkestein, 2003). Bolkestein ta bles two issues: one is market structure, the other is unlimited third-party lia bility.
Market structure
In almost e very country, the Big Four a uditors enjoy a virtual monopoly in a uditing the large compa ny sector. The ga p separa ting the Big Four and the vast majority of a udit service providers is enormous. The auditing sector is marke d by a stark c ontrast betwee n four globa l firms accounting for the bulk of ind ustry re venue, and small firms with up to four pa rtners accounting for the bulk of industry numbers. The ga p see ms unbridgea ble. The question of ideal c ompany size in a uditing, and why there is little migra tion betwee n segments, is unse ttle d. George Stigler (1958) suggeste d segme nting a n industry into layers of compa nies of similar size and c omparing the ir returns on ca pital. Over time, firms will gravitate towards a size that maximises returns. Stigler’s ana lytical tools do not expla in the peculiar structure of the audit sector.
We cannot be sure whether, in the audit sector, firm size can be divided into a continuous or ste pped c ontinuum. The firm-size dic hotomy in a uditing raises the question of whether la rge a nd sma ll firms are in the sa me market at all.
Within the large-firm segme nt, howeve r, Ge orge Stigler’s forecast that compa nies gra vitate towa rds ideal c ompany size holds true. Sulliva n (2002) e xa mines the pricing
structure of the Big Eight firms before and after mergers a nd discovers price declines for large clie nts. Ba nker et al. (2003) find ta ngible productivity ga ins after audit firm mergers. At one end of the audit market spectrum, scale economies are real.
Some proffer the working hypothesis that a uditing’s unlimite d lia bility re gime deters market e ntry. Thus, ending unlimite d lia bility would foster c onditions allowing smaller firms to scale-up opera tions. Once auditor lia bility is ca ppe d, according to this line of thinking, smaller firms would c ompete aga inst industry leaders a nd in due course break up the incumbe nt oligopoly.
The Office of Fair Trading (2004) e xa mines this question and does not find the argument compelling. A c onnection betwee n audit lia bility re gimes and market struc ture is in a ny eve nt e mpirica lly unsubsta ntiate d. Three c ountries with ca ps on a uditor lia bility (Austria, Germa ny a nd Greece) are not known to ha ve conspicuously higher inte nsity of audit market c ompe tition for big clie nts. If the searc h for mea ns to improve audit markets has bee n unsuccessful, perha ps it would ma ke sense to look else where for polic y solutions. Argua bly, the proble ms of the a udit sector are
induced by government intervention.
Unlimited third-party liability
Governments ha ve interve ned in a udit liability re gimes for over 150 years. The English Joint Stoc k Companies Act (1844) is the first insta nce of ma ndatory audit provision in legislation. The re mit of publicly ma ndated a udits in the UK a udits was exte nde d to banks in 1879 and to limite d liability c ompanies in 1900. In the Unite d States indepe ndent audits were voluntary until the 1934 Securities Exc ha nge Ac t. At that point auditors acquire d the function of ‘public wa tchdogs’.
Before the 1934 Sec urities Exc hange Act (SEC Act) a uditors were only lia ble to the principals who hire d them. Third-party lia bility claims did not succee d in court. US Supre me Court Judge Benja min Cardozo, in his ruling in Ultra mares (1931), ring- fenced a uditors from ‘a lia bility in an indeterminate a mount for an indetermina te time to a n inde terminate class. The hazards of a business c onducte d on these terms are so extre me as to enkindle doubt whether a fla w ma y not exist in the implicating of a duty
that e xposes to these c onse quences.’The 1934 SEC Act did not hee dCardozo’s warning. The imposition of audits by public man date opene d the floodgates to the flow of third-party litigation that Ca rdoz o sought to seal off.
The SEC Ac t ma de a uditors the target of lia bility claims file d by plaintiffs who read an a udit opinion as a seal of good house keeping. The tide of claims a nd se ttle me nts rose for severa l deca des and hit its high-wa ter mark by the 1990s. In the USA the 1995 Private Sec urities Litigation Reform Ac t curtaile d the scope for third-party la wsuits and brought a measure of re lief to the profession. Since then the twin corporate a nd a udit failures of Enron a nd Arthur Anderse n have once more brought the issue of audit market structure a nd lia bility to the fore. Authorities are looking for wa ys to improve market structure a nd entry c onditions. The following c omments sugge st as a re medy for the dysfunctional a udit market to re in bac k the re mit of government interve ntion.
Market failure or regulatory failure?
The 1934 SEC Ac t mandate d audits in the public interest. This ste p broade ne d the range of a uditors’contractual obligations. The SEC Ac t did not define what these liabilities were and it was left to the courts to interpret the m. The adde d lia bility to third parties c ha nge d the incentives of a udit market actors. Auditors are liable to the c ompany that hire d the m, and to third parties tha t did not. Companies pa y auditors, third parties do not. The impact of third-party litigation risk on a udit service pricing is not tra nsparent. Third-party litiga tion risk can be reflecte d in audit service contracts in three possible
wa ys. The first is that third-party litigation risk is priced into a udit c ontracts a nd compa nies foot the bill for free- riding parties. That mea ns compa nies overpa y. The second is that third-party litigation risk is not priced into a udit service c ontracts: in tha t case, auditors are underpaid. The third possibility is that c ompanies perceive auditor accounta bility to third-party liabilities as a be nefit to the mselves a nd are pre pared to reward this service. Researc h suggests this is the case. If so, this ha s some bearing on the issue of audit market reform. Companies in Spain, for e xa mple, report they c hoose a large a udit firm in the e xpectation that this will improve their cre dibility with business partners a broa d (Moizer et al., 2004). Another study rela te s the effect of a udit market
reform in Ca na da, where in 1994 le gislation ga ve certain large private compa nies a n exe mption from ma ndatory audits. Subseque ntly, a bout a quarter of all eligible
compa nies re duced the e xte nt of audit services. Those that c onti nue d audit services at pre-reform le vels stated tha t the ir motivation was to maintain cre dibility with outside parties (Rennie et a l., 2001). Clearly, auditor third-party accounta bility is a ke y
benefit to c ompa nies.
This finding has some bearing on reforms of audit regula tion. Compa nies that do not provide the information investors e xpect ha ve diffic ulty attracting investment. Over time, a company’s c os t of capital will signal whether the le vel of disclosure is right. The Ca na dia n experie nce shows c o mpanies choose the level of inde pende nt a udits that suit their nee ds. If compa nies are prepare d to hire auditors voluntarily, governments nee d not compe l the m.
An objec tion a gainst a switch from ma ndatory to voluntary re porting might be tha t this would not make a differe nce. If private and public incentives overla p, outcomes in the market would be ide ntical. This objection overlooks tha t dropping government-
ma nda ted a udits would allow flexibility in two respects. Both the le vel a nd the form of audit services could vary. Where re gulation dete rmines the level of a udit services, these ma y be overprovide d or underprovide d. An exa mple of each possibility follows.
In Florida, regulation precludes some municipalities from putting their a udit contracts out to te nder. Re gulators wa nt municipalities to pic k their a uditor solely on quality. Restricte d and unrestric ted a udit markets in Florida allow c omparison of the effect on marke t outc omes. Munic ipa lities with bidding restrictions te nd to pa y more for audit services and to win more a wards for high standards of financ ial disclosure
(Hac ke nbrac k et al., 2000). One might suspect that this is a case of gold plating. A case underprovision of audit services, on the other ha nd, beca me appare nt inGerma ny whe n corporations won the right to switc h from domestic to US acc ounting rules. Daimler
Be nz ava ile d itself of this opportunity. Eve n though itsrestated acc ounts showe d a loss rather tha n a profit,the compa ny’s post-restate me nt share price went up. This investor reaction is c onsiste nt with theexpectat ion that ca pital markets re wa rd
increase dtra nsparenc y (Le uz and Verrecchia, 2000; Myddelton, 2004).
More over, imposing uniform accounting sta nda rds diminishes scope for the audit sector to develop varia nt disclosure for ms. Re gulatory competition in corporate governa nce is trie d a ndteste d in US fina ncial markets. An e xa mple is the highly sophisticate d fra me work for corpora tegovernance in the USA regarding domicile of
inc orporation. US c orporations are free to c hoose the ir domicile and over time realised that pic king the right location for incorporation gives an e dgein raising capital. Market discipline, rather tha n governme nt directives, creates incentives for choosing whe re to inc orporate. Similarly, giving compa nies an option to express a prefere nce for alternative accounting sta ndards would allow marke t forces to determine optima l reporting regimes (Sunder, 2002).
The De partme nt of Trade a nd Industry’s proposa ls will not affec t the top-hea vy structure of the audit market. A more effective way to increase c ompe tition in a udit markets would be to re lease companies and auditors from the require me nt to c omply with guidelines impose d by governme nt. This step would e nd the distortion of ince ntives and re lease pote ntia l to ne gotiate a udit c ontracts that meet the re quire me nts of
compa nies, a uditors a nd third parties.
References
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Benedikt Koehler works at the Fina ncial ServicesAuthority. This article is writte n in a personal ca pacity(bene diktkoehler@).。