PwC UK is considering an overhaul of how its auditors are paid to reduce the risk of conflicts of interest between audit and consulting and head off a possible forced break-up.
The Big Four accounting firm is considering handing oversight of its auditors’ pay and bonuses to an external remuneration committee following the findings of a report it commissioned in June.
The report by Oxford university professor Karthik Ramanna, which is published today, said such a committee was needed for audit firms to “credibly signal” that partners were being rewarded for challenging company directors on their accounts.
PwC will also review the use of client feedback when reviewing the performance and pay of its auditors after the report said the practice discouraged auditors from criticising a company’s accounts.
Mr Ramanna further recommended that audit firms’ non-executive directors launch an annual review of the degree of cross-dependence created by profit sharing across audit and advisory divisions of the firm. “The independent assessment must be made public . . . to adjust audit partner compensation in ways that safeguard the audit firm’s public responsibilities,” he wrote.
PwC asked Mr Ramanna to review the “culture of challenge” at audit firms in June as part of an “action plan” to improve the quality of its audits. Later that month the Financial Reporting Council, the accounts watchdog, criticised PwC for an “unsatisfactory” deterioration in inspection results for PwC’s audits of FTSE 350 clients over the past year. The watchdog said only two out of three audits scrutinised met the watchdog’s standard of needing only limited improvements.
“High margin consulting services by audit firms are creating conflicts of interest for auditors’ mission to challenge,” Mr Ramanna wrote. “The audit firms must credibly signal that partners are being rewarded for skills in scepticism rather than in selling.”
He told the Financial Times that an external monitor of auditor pay was the “only way” that the firms could show they were serious about creating a “culture of challenge”.
Hemione Hudson, head of audit at PwC, said: “We recognise that we need to continue to reinforce a challenge mindset and are actively considering all of the recommendations. We hope professor Ramanna’s independent perspective will also prove useful to the profession as a whole as we work to rebuild trust in audit.”
The findings come as the UK audit industry is being subjected to intense scrutiny. The competition watchdog has called for the Big Four auditors to be broken up after accounting scandals at companies including Patisserie Valerie and Carillion.
PwC pledged at the start of this year, following pressure from politicians, to stop providing consulting services to its listed audit clients in an effort to restore public trust in the sector. It followed similar moves by its rivals KPMG and EY.
Consulting is typically better paid and more profitable than audit work, prompting concerns that an auditor may not be motivated to properly challenge a client’s management if it fears losing more lucrative advisory work.
Atul Shah, an accounting professor at City University, welcomed the report’s focus on culture, but said: “PwC have commissioned this report to show that it is self-regulating. The history of British audit regulation is littered with self-regulation and this needs to change radically.”