Are auditors failing boards of directors?

Are auditors failing boards of directors? New data from a UK agency suggests there are serious problems in the entire sector and that some of the biggest corporate failures of the last decade occurred without any stern warning from auditors in the leadup. 

It’s a good thinking point for your continuous corporate governance training. Let’s dive in:

A report by British think tank The Audit Reform Lab has suggested severe underperformance in the audit industry when analysing the 250 largest collapses of publicly traded companies between 2010 and 2022. 

The report said that in these cases, three in four audit reports “failed to raise the alarm” in the year before collapse. 

“There are serious concerns that auditors are not challenging enough,” the executive summary read. “Of the Big Four auditors, EY performed worst – warning of going concern risks for just 20% of collapsed firms. PWC provided warnings in 23% of cases, Deloitte 36% and KPMG 38%. Auditors outside the Big Four performed even worse – providing warnings for just 17% of collapsed firms.”

The report also found that the average pay for partners at these firms rose by 31% in the same time period – leading The Audit Reform Lab to suggest that the agencies are “currently incentivised to maintain good client relationships, rather than apply the principles of professional scepticism and enforce prudence.”

It means that auditors may have trouble carrying out one of their core duties: analysing a company’s financial activity and warning of danger whenever needed. 

If it’s true, this is bad news for businesses and their boards of directors, who will often depend on audits as the most reliable external assessment.

This report comes from the UK, where heavy criticism of auditors’ strength has been ongoing for many years. Critics have also targeted the national regulator of auditors, the Financial Reporting Council (FRC), for weak and lax oversight. 

Many politicians in the UK—spurred by pressure from organisations such as The Audit Reform Lab—have called for stricter rules. While the government has promised them, plans have repeatedly suffered delays.

The data says that auditors are not only failing boards but entire companies on the verge of collapse. 

This is a severe problem because audits are designed to be the most invasive examinations of a company’s operation. If the audit can’t pinpoint serious risks to the company’s sustainability (or won’t – to preserve client relationships), it is a red flag.  

So, it’s no surprise that directors will examine this report’s findings and wonder if their company is being let down. 

That said, we should contextualise this more:

While the report shows failing grades for the Big Four auditing agencies, it also shows a significant difference between the best and worst-performing entries. So, there is a caveat that some auditors appear to be failing boards more than others. 

1. Because of this, you must do your homework on your (prospective) auditors’ past performance. 
2. However, remember that poor audit performance does not absolve a company from professional, legal and financial fallout. In other words, just because you’re not told about the mistakes you’re making doesn’t mean you won’t get blamed for them. 
3. It may be a different story if an auditor fails in their duties intentionally or through serious negligence, but that’s a case-by-case issue.

You may look at reports like this and worry you’re not getting what you need from an audit. That said, while auditors may need to address underperformance within their own ranks, there are things directors should keep in mind:

Boards should avoid thinking of audits as painful inconveniences. Instead, they should use the opportunity to appreciate the valuable insights they might gain into the company’s inner workings.

The ability and persistence to ask questions define an excellent board in any context, not just audits. 

If you’re a director and have been handed an assessment of your company’s financial position, cash flows, expenses or other crucial items, remember to think like a director and ask every question that comes to mind. 

Ask about the methods, the results, and what they mean in the short and long term. Ask anything that will put your auditors’ work in full context so that you know what it says about your organisation. 

If we truly are living in an era of poor auditor performance, directors should take the initiative and become more curious about the information they have. This could plug a crucial gap. 

You can read the full report from The Audit Reform Lab here.