1 | COMPETITION AND INDEPENDENCE IN THE ASX LISTED COMPANY AUDIT MARKET: SUMMARY OF FINDINGS

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CPA AUSTRALIA & AFAANZ SYNTHESIS STUDY MARCH 2014

COMPETITION AND INDEPENDENCE IN THE ASX LISTED COMPANY AUDIT MARKET: SUMMARY OF FINDINGS

2 | COMPETITION AND INDEPENDENCE IN THE ASX LISTED COMPANY AUDIT MARKET: SUMMARY OF FINDINGS

CPA Australia Ltd (‘CPA Australia’) is one of the world’s largest accounting bodies representing more than 150,000 members of the financial, accounting and business profession in 121 countries.

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3 | COMPETITION AND INDEPENDENCE IN THE ASX LISTED COMPANY AUDIT MARKET: SUMMARY OF FINDINGS

FOREWORD

Auditing plays a role critical in the effectiveness of our capital markets, the economy at large and the wellbeing of society and communities. Debate on reforms relating to audit has ascended in recent years both internationally and in Australia arising from a number of stimuli. Two primary areas of focus have been the market for audit services and the independence of auditors. To achieve genuine steps forward, basic facts and veracity must underpin discourse – the academic community has a fundamental role to play in this. This short paper summarises insights gained through a collaboration between the profession and some of Australia’s premier academics. The results are apposite to the ongoing discussions on audit policy in both Australia and more broadly.

4 | COMPETITION AND INDEPENDENCE IN THE ASX LISTED COMPANY AUDIT MARKET: SUMMARY OF FINDINGS

ACKNOWLEDGEMENTS

CPA Australia would like to thank for their ongoing support:

The Auditing and Assurance Special Interest Group of the Accounting and Finance Association of Australia and New Zealand (AFAANZ)

Australian Accounting Review

Robyn Moroney (AFAANZ project co-ordinator)

Monash University

Amir Ghandar (technical lead)

CPA Australia

RESEARCH TEAMSAudit Market Structure and Competition

Elizabeth Carson

University of New South Wales

Nives Botica Redmayne

Massey University

Lin Liao

University of New South Wales

Auditor Independence

Peter John Carey

Deakin University Australia

Gary Monroe

Centre for Audit and Assurance Research

University of New South Wales

Greg Shailer

Australian National Centre for Audit and Assurance Research

The Australian National University

5 | COMPETITION AND INDEPENDENCE IN THE ASX LISTED COMPANY AUDIT MARKET: SUMMARY OF FINDINGS

INTRODUCTION

In 2012, CPA Australia initiated two inaugural synthesis studies, in collaboration with the Auditing and Assurance Special Interest Group (AAASIG) of the Accounting and Finance Association of Australia and New Zealand (AFAANZ). The objectives of the studies were to examine the structure of the ASX listed company audit services market and audit independence in Australia. AAASIG and CPA Australia selected research teams1 , who were tasked with extending knowledge and understanding on these topics.

This report summarises the key findings of the completed studies. In brief, these findings include:

• Analysis of market structure, competition and concentration of Australian Stock Exchange (ASX) listed company audits from 2000 to 2011 indicates a competitive and complex market for audit services.

• Growth in audit firms appears to have largely evolved in response to growth in and demand from the listed company market.

• Large audit firms focused on large company financial statement audits, while small and medium audit firms focused on small and medium company financial statement audits.

1 Refer to page 4 for the details of the research team members.

• Reforms on audit independence introduced through the Corporate Law Economic Reform Program Act 2004 (CLERP 9) appear to address the independence concerns identified in prior research.

• There is scope for further research on audit independence post-CLERP 9, including the impact of the audit independence reforms introduced through the Corporations Legislation Amendment (Audit Enhancement Act) 2012.

6 | COMPETITION AND INDEPENDENCE IN THE ASX LISTED COMPANY AUDIT MARKET: SUMMARY OF FINDINGS

MARKET SHARE AND STRUCTURE

• Market share by number of ASX listed company financial statement audits of the largest2 audit firms decreased from 63 per cent in 2000 to 44 per cent in 2011.

• Market share by audit fees of the largest audit firms decreased from 91 per cent in 2000 to 87 per cent in 2011.

• The more moderate decrease in market share by audit fees compared to number of ASX listed company financial statement audits indicates:

− The largest audit firms are focusing on large company financial statement audits, while small and medium audit firms have focused on medium and small listed company financial statement audits, and assumed many of the newly listed company financial statement audits over the period of analysis.

− Large listed companies have grown significantly over the period of analysis due to global and national acquisition/merger activity and growth.

− There has been a significant increase in the size of listed companies at the top tier of the market (S&P/ASX200) as compared to the size of medium and small sized listed companies.

2 Annual firm revenue: Largest audit firms > $500m, large audit firms > $150m ≤ $500m, medium audit firms > $100m ≤ $150m, small audit firms ≤ $100m.

7 | COMPETITION AND INDEPENDENCE IN THE ASX LISTED COMPANY AUDIT MARKET: SUMMARY OF FINDINGS

2011 MARKET SHARE BY NUMBER OF FINANCIAL STATEMENT AUDITS

43.65%Largest audit firms

18.19%Large medium

sized audit firms

27.83%Medium

audit firms

10.33%Smaller

audit firms

2000 MARKET SHARE BY NUMBER OF FINANCIAL STATEMENT AUDITS

62.92%Largest audit firms

7.75%Large medium

sized audit firms

14.42%Medium

audit firms

11.92%Smaller

audit firms

8 | COMPETITION AND INDEPENDENCE IN THE ASX LISTED COMPANY AUDIT MARKET: SUMMARY OF FINDINGS

2011 MARKET SHARE BY AUDIT FEES

4.52%Large medium

sized audit firms

6.50%Medium

audit firms

87.22%Largest audit firms

1.76%Smaller audit firms

2000 MARKET SHARE BY AUDIT FEES

2.84%Large medium

sized audit firms

3.89%Medium

audit firms

90.66%Largest audit firms

2.61%Smaller audit firms

Annual firm revenue: Largest audit firms > $500m, large audit firms > $150m ≤ $500m, medium audit firms > $100m ≤ $150m, small audit firms ≤ $100m.

9 | COMPETITION AND INDEPENDENCE IN THE ASX LISTED COMPANY AUDIT MARKET: SUMMARY OF FINDINGS

Medium and small audit firms were gaining market share between 2000 to 2011 in companies below the top ASX listed 200 companies.• Over that period, the number of financial

statement audits undertaken by small and medium sized firms for medium sized ASX listed companies increased from 35 per cent to 56 per cent.

• In the mining industry, the number of financial statement audits undertaken by small and medium sized firms increased from 35 per cent to 70 per cent over the period of analysis.

10 | COMPETITION AND INDEPENDENCE IN THE ASX LISTED COMPANY AUDIT MARKET: SUMMARY OF FINDINGS

TREND IN MARKET SHARE BY NUMBER OF FINANCIAL STATEMENT AUDITS

Smaller

YEAR

Medium sizeLarge medium sizedLargest

%

%

%

%

%

%

%

%

%

MARKET SIZE

• Total audit market size by audit fees for financial statement audits of companies listed on the ASX with audit opinions signed in Australia and disclosing audit fees in Australian dollars increased from A$183m to A$518m from 2000 to 2011.

• The number of companies listed on the ASX with audit opinions signed in Australia and disclosing audit fees in Australian dollars increased from 1200 to 1858 over the period of analysis.

11 | COMPETITION AND INDEPENDENCE IN THE ASX LISTED COMPANY AUDIT MARKET: SUMMARY OF FINDINGS

• The Herfindahl-Hirschman Index (HHI) is a generally accepted measure of market concentration.

• HHI represents market concentration, or the dominance of firms with the greatest market share, as a score between nil and 10,000. Nil represents perfect competition and 10,000 represents a monopoly.

• The Australian Competition and Consumer Commission Merger Guidelines (November 2008) state that the HHI will be an indicator of the likelihood that the merger will raise competition concerns. The threshold at which concerns are likely to be raised is at 2000, or where a merger would result in a change of HHI greater than 100.

• Based on the ASX listed company audit market from 2000 to 2011 there is an overall decrease in concentration by number of financial statement audits from an HHI score of 939 to 742, and an overall increase in concentration by fees from an HHI score of 1852 to 2151.

• The following chart details the movement in HHI by fees and number of financial statement audits over the period of analysis.

• Concentration is illustrated as peaking from 2002 to 2004 by both measures (coinciding with merger activity occurring in that period), and then steadily declining over the period of analysis.

MARKET CONCENTRATION

500

1000

1500

2000

2500

201120102009200820072006200520042003200220012000YEAR

FeesNumber of financial statement audits

MARKET CONCENTRATION

12 | COMPETITION AND INDEPENDENCE IN THE ASX LISTED COMPANY AUDIT MARKET: SUMMARY OF FINDINGS

• In order to provide an understanding of audit firm tenure, the research identified 703 companies listed continuously over the period 2000 to 2011 (companies that listed or were delisted during the period are excluded).

• Overall, 35% of companies had the same auditor for 12 years or more.

• Large companies (S&P/ASX200) were found to be more likely to have longer audit firm tenures. In the top ASX 200 companies, 58% had the same auditor for 12 years or more; only 22% of small companies (smallest 500 listed companies) had the same auditor for over 12 years.

AUDIT FIRM TENURE

24.60%6-11 years

35.00%12+ years

32.00%2-5 years

8.41%1 year

AUDIT FIRM TENURE

13 | COMPETITION AND INDEPENDENCE IN THE ASX LISTED COMPANY AUDIT MARKET: SUMMARY OF FINDINGS

• Concerns in the wake of financial reporting issues during 2000 to 2003 resulted in the CLERP 9 amendments to the Corporations Act 2001, adding substantial new provisions pertaining to auditor independence.

• Many of the proposals in the Ramsay Report informed the CLERP 9 amendments, focusing on auditor independence issues raised in preceding academic literature.

• Reforms on audit independence introduced through CLERP 9 appear to at least in theory substantially address the independence concerns identified in prior research.

• Review of Australian auditor independence research published post-CLERP 9 reveals insufficient evidence to determine the practical impact of the CLERP 9 regulatory changes on auditor behaviour (independence in fact) and perceptions (independence in appearance).

• There is significant scope for further research on audit independence post-CLERP 9, including the impact of the audit independence reforms introduced through the Corporations Legislation Amendment (Audit Enhancement Act) 2012.

• The study identifies particular areas for future research, including the influence of various types of non-audit services on perceptions of auditor independence and how audit team characteristics impact audit independence.

• The study concludes with specific recommendations for how regulatory agencies, the accounting profession and audit practitioners might further engage more with academics in the research process to enhance the quality and relevance of academic research.

AUDIT INDEPENDENCE

14 | COMPETITION AND INDEPENDENCE IN THE ASX LISTED COMPANY AUDIT MARKET: SUMMARY OF FINDINGS

Australian Competition and Consumer Commission, Merger Guidelines (November 2008)

CPA Australia, A guide to understanding auditing and assurance: Listed companies (February 2013)

REFERENCES

cpaaustralia.com.au

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