Supply of statutory audit services to large companies

1. Supply of statutory audit services to large companies Inquiry Author Laura Carstensen – Chairman of the Inquiry Group of Members Date 24 January 2013

2. Supply of statutory audit services to large companies • Context • On 21 October 2011 the OFT made a reference to the Competition Commission (CC) to investigate the market for the supply of statutory audit services to large companies (in effect the FTSE 350). • Purpose of the presentation • This presentation will provide some background to the inquiry, outline the theories of harm that we have considered and provide an update on our current thinking and timetable. • We are currently at a sensitive stage, so this presentation is based on published material – see our website! Inquiry

3. Background (1) • After receiving the OFT reference we published on our website an invitation to interested parties to provide evidence about the referred market and sent out initial information requests to main parties (auditors) and interested third parties. • In December 2011, after considering initial submissions received to the above and the OFT’s terms of reference we published our issues statement which set out six candidate theories of harm (see slide 5). Inquiry

4. Procedure/Evidence • We gathered evidence in a number of ways including: • Conducted case studies of 10 FTSE 350 companies and 2 Investors (37 in depth interviews with FDs/CFOs, ACCs and AEPs) • Surveyed company FDs/CFOs and ACCs that were purchasers of statutory audit services (343 FD/CFOs interviewed and 264 ACCs) • Conducted a follow up survey with 71 ACCs • Constructed a public dataset, with the co-operation of the parties, to capture and accurate record of publically available information for FTSE 350 companies from 2001 – 2011 and for Top Track 100 companies from 2006 – 2011 • Issued detailed information requests to the main parties and client data requests to all UK firms that audited a FTSE 350 or Top Track 100 company in the period 2006 to 2011 - 15 firms in total • Held hearings with the six largest auditors, 4 other mid-tier auditors and 3 other interested stakeholders (such as investor groups) Inquiry

5. Theories of harm (ToH) • We set out by investigating six candidate ToH: • The audit market is highly concentrated and there may be high barriers to entry with the result that the four largest firms have market power • The four largest firms could bundle together services in order to create barriers to entry in the market for statutory audit and in related markets • Customer conduct may limit competition, in particular by tendering infrequently • Specific features of the market may make it particularly prone to risks of regulatory failures which could lead to a reduction or distortion of competition in the market • Tacit coordination between the four largest firms may result in less competition in certain sectors • Information asymmetries and conflicts of interest may adversely affect audit quality and allow the four largest firms to maintain market power Inquiry

6. Analysis • After analysing all of the evidence we had gathered, we published in total 27 working papers which set out our initial thinking in relation to all of the above theories of harm and sought views from interested parties. • We received in excess of 142 responses to all working papers following which we have been focussing on two (slightly refined) theories of harms: • Customer behaviour and market structure produce adverse outcomes: in effect whether companies lack bargaining power with regard to audit firms • Principal / agent issues: in effect whether audit firms adequately protect shareholder interests, given that they are (in practice) appointed by company management (and so are in effect agents of management) Inquiry

7. Next Steps • We are weighing up the considerable amounts of evidence we have received – we have published as much as possible on our website • We have a statutory deadline to publish our Final Report by 20 October 2013 (2 years from the date of referral). This cannot be extended. • Ahead of that, we will publish Provisional Findings (PFs), which will be consulted on. We will do this by mid February 2013. • If the Group of Members finds that there is an adverse effect on competition (AEC) in this market, then at the same time as publishing PFs we will publish a remedies notice which will kick off a remedies process to correct the AEC that we find. • Watch this space! Inquiry