Includes “No sooner did the news break than the spotlight fell on PricewaterhouseCoopers (PwC), one of the “Big Four” global accounting networks (the others are Deloitte, Ernst & Young (EY) and KPMG). Tesco had paid the firm £10.4m to sign off on its 2013 financial statements. PwC mentioned the suspect rebates as an area of heightened scrutiny, but still gave a clean audit. PwC’s failure to detect the problem is hardly an isolated case. If accounting scandals no longer dominate headlines as they did when Enron and WorldCom imploded in 2001-02, that is not because they have vanished but because they have become routine.
… And although accountants have largely avoided blame for the financial crisis of 2008, at the very least they failed to raise the alarm. America’s Federal Deposit Insurance Corporation is suing PwC for $1 billion for not detecting fraud at Colonial Bank, which failed in 2009. (PwC denies wrongdoing and says the bank deceived the firm.) This June two KPMG auditors received suspensions for failing to scrutinise loan-loss reserves at TierOne, another failed bank.
Just eight months before Lehman Brothers’ demise, EY’s audit kept mum about the repurchase transactions that disguised the bank’s leverage. Auditors perform a central role in modern capitalism. Ever since the invention of the joint-stock corporation, shareholders have been plagued by the mismatch between the interests of a firm’s owners and those of its managers. Because a company’s executives know far more about its operations than its investors do, they have every incentive to line their pockets and hide its true condition. In turn, the markets will withhold capital from firms whose managers they distrust. Auditors arose to resolve this “information asymmetry”.
… 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. 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.”
Read the full article on: The Economist