Why are auditors rushing for the exit?

There has been a rash of resignations by company auditors in the current year. Though the act itself is not novel, the sharp rise in its incidence highlights a malady. The resignations of independent directors and company secretaries, coinciding with a sharp fall in the affected companies’ share prices, cannot go unnoticed.

This is happening amidst all-round signs of deteriorating corporate hygiene. This is causing the government to tighten regulatory and supervisory efforts.

Auditors are meant to act as a watchdog protecting shareholder interests while company secretaries have to ensure statutory and regulatory compliance. The Companies Act 2013 made the role of auditors more rigorous, including the obligation to report fraud.

Particularly unfortunate is the instance of several auditors quitting their assignments days before the date for the finalisation of accounts. The matter must be truly serious as the auditors could well have stayed on and “qualified” the accounts.

Impact of resignations

There is a growing feeling that auditors are taking such drastic action because they fear being caught in the overall corporate wrongdoing. The fate of Price Waterhouse, which is under a two-year ban on its auditing practices in India, including its role in the Satyam scam, haunts auditing firms.

It is well known that a deviant businessman requires the support of an obliging lawyer and accountant. Unfortunately, there is no immediate solution to the problem. The only way things can change is by the corporate sector giving a better account of itself. In this auditors can play a positive role by performing their watchdog role better. An early warning of resignation can put pressure on managements to change their ways or face the consequence of eroding shareholder value. If independent directors and company secretaries do the same then the combined impact can be decisive.

A positive role can be played by the professional body, Institute of Chartered Accountants of India, discharging its self-regulatory role with greater alacrity. Its mandate is to regulate the profession of accountancy by laying down ethical standards. But realistically, a self-regulatory organisation cannot be too far ahead of the general standard of its members. We are then left with the market instruments available to ensure better conduct and governance. The governance premium that particular firms enjoy is the market’s way of rewarding better governed firms. This acts as an incentive for other firms. This governance premium has built into it the value created by a rigorous auditor with exacting standards.

Institutional investors and particularly proxy advisory firms which have given themselves the role of looking after the interests of minority shareholders can and do create an atmosphere in which the right kind of auditor can discharge its role the right way.

Rating auditors

A more direct way of incentivising and encouraging the right kind of auditing is to rate auditing firms according to perception and measurement of their auditing standards. Auditing firms will aspire to securing higher rating when they see that this will fetch them a premium in terms of fees just as a financial offering with an investment grade rating is able to offer a lower coupon rate.

Now that there is a compulsory periodic rotation of auditors, and auditing firms have to compete to get business, the competition can be over offering higher standards, and not assuring greater leeway to managements.

At the end of the day the issue of auditors’ conduct is intrinsically tied to the level of governance that a management sets out to achieve. A good section of listed Indian firms remain family controlled and ensuring governance dos and don’ts, like the actual independence of independent directors, are more an exercise in ticking the boxes rather than following the norms in substance.

This brings us to a Catch 22 situation. Good governance standards can be achieved in a firm only if it has the right kind of guidance and oversight from its auditors. But a firm is likely to get the right kind of auditors only if it is has the reputation of being properly governed. The dilemma lies in deciding which comes first.

The reality is that few firms seek guidance from auditors for better governance, and few auditors firms have the ability to offer such advice.

The writer is a senior journalist

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