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Mandatory auditor rotation for large companies – impractical, ineffective, costly, and increases concentration in Big 4 – other than it’s a great idea

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Reservations are surfacing about the idea of mandatory auditor rotation, particularly for the really big companies. That is an idea being pushed by the PCAOB. See previous post.

Jim Peterson, at Re:Balance, has a long list of concerns with the idea, as discussed in his post Mandatory Auditor Rotation – – Further Thoughts on PCAOB Chairman Doty’s Bad Idea.

My summary of a few of his ideas:

*International impossibility – How would mandatory rotation work out for the big international companies that are based in the US?  They would have to change firms in perhaps 50 or maybe 150 countries around the world.

Here are a few questions I would have, looking at it from the view of one company. Would the regulators allow a change in auditor in every country where we operate? Is there sufficient staffing at the new firm in every location where we have operations? Who can we get to take on all the tax and consulting work in countries where independence rules require splitting out that work from the audit?

*What are the alternatives? The concentration of experience in some CPA firms means there may be limited options for many firms. One study in the UK suggested that in many situations

companies may have no effective choice of auditor in the short-term.

How many firms could step in to the largest audits? My wild guess is that the second tier firms could not even staff a Wal-Mart or Exxon/Mobil audit. Oh, and can you imagine the independence problem of taking on an audit of Apple when it would constitute a huge portion of total firm-wide billings? If, as it is claimed, the mere volume of Enron fees compromised Andersen’s independence (which I don’t believe), what would the fees of J&J or P&G do to a firm in the second tier?

Way back when I worked at two of the big firms, I was aware there were certain industries where one particular CPA firm was dominant. That means there is a heavy concentration of experienced managers and partners. That also meant there was a concentration of the powerhouse thinkers. Having to move to another firm because the clock ran out means loosing a tremendous base of industry knowledge at every single level at your auditor. What is the cost of every firm gaining that level of knowledge and experience in every industry just so the work can be spread around?

*Lack of any evidence that auditor rotation accomplishes the intended goals. With a lack of any evidence that mandatory rotation would improve performance we would be proceeding on faith alone.

*Impact would be to swap work amongst the Big 4 and likely increase concentration.  On practical basis, the Big 4 would just pass work around. A serious unintended consequence is that it might lead to increased concentration in the Big 4 and squeeze out second tier firms.

Great summary from Mr. Peterson:

To sum up: the case cannot be made at the large-company level that mandatory auditor rotation confers any benefits or justifies its costs. It is particularly impractical at the global level in any event. And requiring rotation only for smaller companies would be expensive, ineffective and politically impossible.

Written by Jim Ulvog

June 21, 2011, 9:13 am at 9:13 am

Posted in Audits

Tagged with ,

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