“We Have a Cruel Existence”

The words of my Dad about auditing.

I thought the interpretation of the Ernst & Young audits in the Nike case by activists and the public was an interesting one.  Essentially the feeling was that any audit or report brought about by Nike on supplier labor practices would be tainted if that firm was paid by Nike.  My previous understanding of audits was that this was a typical practice, so naturally I had an e-mail conversation with my Dad about it.

Background: he’s a CPA who works in assurance.  Here were his two cents:

It is a challenging issue. Does the government, credit agency or banks want to be in the business of hiring auditors?  While I would be the first to admit that the current system needs improvement because of restatements and other things the auditor missed, I am not sure it will be a lot better with someone other than the company making the auditor selection. If someone is going to cook the books, they will still do so. The other question is whether auditors are attesting on financial statements or are they really an insurance company to look to blame and make claims against if something goes wrong.

Obviously the point of view is relevant, but I thought the fall guy idea was something that hasn’t been discussed much.   It is easy to see that companies could rely on an external voice to claim ignorance.  I’m not laying blame off the ‘independent’ credit agencies here, but it feels as if some of the banks have justified actions by saying, “Hey, the agencies rated the securities AAA!  How could we not choose to invest in them?  Nothing could possibly go wrong here…”

In a perfect world, everything would be completely independent.  Companies, credit agencies, auditors, and insurance would all be separate.  However, we live with limited information and we just need to do what’s possible to try and ensure transparency and hope everybody acts in good faith.  Does anyone think companies shouldn’t select their auditors/reviewers or how else could we do it?  Should governments have more say?

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9 Responses to “We Have a Cruel Existence”

  1. tpm011 says:

    The idea that different companies are hired to enforce the same set of rules does sound fishy and leaves the possibility of scandals. Ideally there would be a government agency that could audit every company but that is simply to much work. The government is generally seen as slow, inefficient and generally bad at what they do, if you want something done right and fast, privatize it.

  2. Jordi says:

    Thanks for bringing your father in. Maybe he can look at the blog? One thought I had was that the focus on financial statement quality may be greater in service and financial firms where it is difficult to concretely asses a firm. It is not like Apple or Toyota can make money with off-balance sheet devices. Errors or malpractice in auditing simply won’t have the same financial impact due to their more concrete assets and inventories.

    Also, the interest in using accounting firms as an “insurance” company may be greater in times when there is less governmental regulation. In other words, if a government is not serving to protect and verify truth claims, then when things go poorly, aggrieved parties will seek recourse through lawsuits. There is a corollary with health and product safety. Firms may not like regulation by law, but they may like regulation by lawsuit even less when it happens to them.

  3. Jordi says:

    Did he say “we have a cruel existence?”

    • Cander says:

      Yes that was his attempt at humor for potentially being a fall guy.

      I do think that regulation by lawsuit is a good point here. It’s one thing to have to obtain external audits, it’s quite another another to have investigators and lawyers on top of the auditors involved.

  4. Jordi says:

    Did he look at your post?

    I am curious what he thought of Enron and Arthur Andersen as well…

    • Cander says:

      I have not had a chance to bring up the Enron/AA connection yet with him. I know from past conversations, from a business standpoint their firm has benefited from the increased regulation to Sarbanes-Oxley, which as we know came partly in response to Enron/AA, and the increased work available due to SOX and the loss of Andersen (consolidation of the former Big 5). I’m fairly sure he felt those involved with Enron at Andersen brought a lot of the issues upon themselves due to lack of independence from Enron. I can talk to him later and give a more precise answer.

  5. Jordi says:

    Credit ratings agencies being paid by those they review seems even more problematic to me. Somehow it seems the consumers of that information- investors- should pay for quality. If we are not going to have a government regulator do it and rely on a market for information, we want as much transparency and independence possible. How can a market be structured to deliver that? Auditors, I think, will claim the audited need to pick the auditor due to trust and confidence issues. Can that happen while someone else foots the bill?

    • Cander says:

      I should clarify, the paragraph above was one e-mail in the middle of a series of e-mails. I felt it was the best summary given of what we talked about. It is actually a response to me comparing auditors to credit agencies and I actually had the same conclusion you did. I think due to the private nature of audits, it is important that a company can have a say in who is looking at their books (or in Nike’s case, their suppliers). Because everyone uses credit agency information, it is probably best if we look to some solution where we can change the consumer relationship of corporations and governments to credit agencies to one where everyone is a consumer.

  6. meganm423 says:

    I agree that in a perfect world companies would be independent from one another however I also agree that this just isn’t possible in todays world. There is too much financial dependence on auditors. How could Ernst & Young or PWC get by if firms were not hiring them. How would the government fairly distribute work to all these accounting firms? I also believe that if this task was given to the government it would be an even bigger financial burden than government already has. This in turn would drive corporate taxes through the roof. Rating agencies definitely should not be controlled by the government either because the rating agencies rate government debt. That would be a severe conflict of interest.

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