In the WaPo opinion pages yesterday one Duncan Mavin, who got his start in the 90s, says the best way to solve the audit industry’s many conflicts is to kill it altogether.
He starts the piece summoning the ghost of Enron, as all writers do when discussing what happens when audit goes wrong. Bringing things back to this decade, he then talks about what’s going on at PwC Australia even though auditors weren’t the ones using confidential government data to bill clients for tax avoidance plans. It doesn’t actually matter whether it was auditors or literally anyone else at the firm, he says, because the entire industry is broken.
The affair underscores a key criticism leveled at the industry, especially the “Big Four” firms — Deloitte, KPMG, Ernst and Young, and PwC — that it’s a business in which conflicts of interest are inherent. For starters, auditors are paid by the companies they’re auditing. If they find a problem, they risk losing a client. There’s plenty of incentive to look the other way.
The Big Four also run massive consulting arms, which generate billions of dollars in fees by providing advice to clients on technology, taxation, accounting and more. Often, audits are a loss-leader that firms use to secure more lucrative consulting contracts. At EY, a recent effort to split the business in two — ostensibly into an audit firm and a consulting one — failed in part because nobody wanted to be in the less profitable audit firm. EY’s top brass recognize the conflict, but they simply can’t wean themselves off it.
To quickly confirm what he’s saying, let’s look at the biggest of the Big 4: Deloitte. In 2022, Deloitte brought in a record $59.3 billion in global revenue. Of that, consulting had the largest piece of the pie at $25.8 billion (up 24.4% from the year prior), with audit coming in at $11.4 billion. $27.9 billion of that came from Deloitte US and more than half of that $27.9 billion came from consulting (54.0%). And that’s with our sticky independence requirements. In seven years, Deloitte’s global revenue grew by $24 billion, or 69% (nice).
Remember the entire foundation of Project Everest was the idea that if only consulting were free from independence requirements, somehow EY would score the biggest and best clients and convert those relationships into revenue. Carmine Di Sibio famously said the firm was leaving $10 billion in consulting fees on the table if it didn’t split, an amount that would effectively double what consulting is bringing in now. Well, what it was bringing in before Everest crashed and burned. Different topic.
OK, so we know there are conflicts. What’s this guy’s solution?
Many alternatives have been discussed over the years. One is having the government or stock exchange employ its own inspectors, the same way that government inspectors certify the food or transportation sectors? This could work, in theory, but the concept probably hasn’t gotten off the ground because it would require an enormous number of staff being added to government payrolls.
A similar suggestion is that stock exchanges or governments could hire the audit firms, so they would no longer be paid by the companies they assess. But how would governments decide which firm to hire? And would this really improve the quality of the auditors’ work?
Here’s FloQast CEO (and former Big 4 senior auditor) Mike Whitmire talking about that idea in 2019. He too suggests we kill the audit industry but says to hand the job over to the PCAOB.
Well here’s Duncan’s even crazier idea:
The solution I favor is to scrap the mandatory audit requirement altogether. Big, influential investors — pension funds and so on — could still demand their own auditors trawl through the books of companies they invest in. Some professional investors might even have to do more of their own due diligence!
This radical solution comes with some potential problems, of course. The most obvious is that absent mandated audits, corporations would get away with bad behavior. But isn’t this happening anyway? Also, yes, more smaller investors — regular people — would be a little more in the dark. But history tells us they probably shouldn’t rely too much on audits that are fundamentally flawed.
He goes on to say that emerging technology will at some point in the near future be cheap and easy enough that if investors really wanted to comb through hoards of company data, they can deploy AI to do it in a fraction of the time it would take a human or a team of overworked auditors.
A machine could do just as much digging as a 20-something CPA without any of the potential conflicts. Once this becomes a widely available option, surely it will be time to end the audit charade once and for all. In the meantime, doing away with audit requirements would be a step in the right direction.
I can hear the 20-something auditors cheering right now.