A lot has changed in the past 125 years. Since 1890, the year in which Shredded Wheat, the popular breakfast cereal, was created and the fire alarm was invented, modern society has been transformed completely, from the discovery of antibiotics to the development of airplanes, television, and the internet.
But one thing has remained stubbornly constant: the accounting firm used by Procter & Gamble, the consumer goods company behind products such as Pantene, the shampoo, and Gillette, the shaving brand. P&G’s relationship with Deloitte is coming under increasing pressure to end. A number of the world’s largest investors are becoming concerned about the remarkable length of some of these relationships and the ability of audit firms to deliver independent advice when they have worked for the same company for decades, if not centuries.
The ‘Big 4’ audit firms service a third of India’s listed companies audit business by value. Between them PwC, Deloitte, KPMG and EY and their many affiliate firms in India audit close to 60 percent of the Nifty 500 companies, as per 2017-18 data published by Prime Database. Over the last two decades, the expansion of these large audit firms in India, known as the Big 4 globally, subsumed several local Indian firms such as BSR & Associates, AF Ferguson & Co., SR Batliboi & Associates. While many retain their Indian identity due to Indian laws, the loose networks they form have grabbed audit assignments of India’s biggest companies. Foreign investors, too, have found comfort in knowing that the Indian company they are investing in is audited by a brand they recognise.
In the past few years the Big 4, which audit over 90 percent of FTSE 350 companies in the U.K. and S&P 500 companies in the U.S., have made the headlines due to several audit failures across the world. Now India is witnessing the same. Each one of the four are facing sanctions or investigations over fraud.
This year, eight companies in the S&P 500 will have their annual reports signed by the same auditors that have verified their financial statements for at least 100 years. Johnson & Johnson is the latest to join the club with PwC, carrying on a relationship that started in 1920. Meanwhile, General Electric Co. will get one last signature out of an 111-year streak with KPMG. The manufacturer is dropping KPMG after a series of financial missteps and will switch to Deloitte in 2021. Coca-Cola Co. could take the empty spot on the list next year if it remains linked to Ernst & Young, which started working with the beverage company in 1921.
“Auditor tenure at P&G is completely ridiculous. I am shocked,” says a corporate governance expert at one of the UK’s biggest fund houses, speaking on condition of anonymity. He adds: “From an investor perspective, I think we have been spending far too much time speaking to remuneration committee chairmen and not nearly enough time talking to audit committee chairmen. I do not think you would find anyone who would think having the same auditor for 100 years is a good thing.” Investors have intensified their focus on auditor independence in the aftermath of the financial crisis. Questions were raised about why the big four accounting firms (PwC, Deloitte, Ernst & Young and KPMG) either failed to spot or failed to highlight mounting problems in the banking sector.
Worryingly for some investors, P&G is by no means alone in its decision to stick with the same auditor for a substantial length of time. General Electric, one of America’s best-known conglomerates, has used KPMG for 106 years, according to figures compiled for FTfm by MSCI, the data provider. Caterpillar, the heavy equipment company, has used PwC for 90 years, while Goldman Sachs, the investment bank, has employed PwC for the past 89 years. Bram Hendriks, senior corporate governance officer at NN Investment Partners, the $227bn Dutch fund house, is concerned. “An excessively long association between the auditor and its client may constitute a threat to independence. Auditor tenures of 50 years plus are considered excessive,” he says.
Peter Lundkvist, head of corporate governance at AP3, the Swedish national pension fund, adds: “The independence of auditors from the company and its management is critical for maintaining investor confidence. In some cases companies have had the same audit firm for more than 100 years. It is very difficult for auditors to claim that they are independent in these cases.” There could be many more companies with extended auditor relationships, but it is difficult to tell. MSCI estimates that only 56 per cent of all S&P 500 companies disclose how long they have used the same auditor, although this is an improvement on 2012, when just a quarter of companies volunteered this information.
In the Russell 3000 index, meanwhile, there are 114 companies that have used the same auditor for between 50 and 99 years, according to Calstrs, the $193bn Californian pension fund. Another five companies in the Russell 3000 index have had the same auditor for more than 100 years.
Calstrs says it expects companies to change auditor every seven years. “Regular rotation is seen as necessary to maintain external auditor independence and to avoid the types of cosy relationships that could lead to conflicts of interest,” a spokesperson for the pension fund says. Although the issue of lengthy auditor tenure appears to be of growing concern to a number of investors, there are no examples of shareholders rejecting the reappointment of an auditor among the 3,000 largest US companies in the 2014 voting season.
Institutional Shareholder Services, the proxy adviser that helps investors decide how to vote at company meetings, says that of the 17,810 votes held on auditor nominations at large companies globally last year, only 16 failed. This means that investors approved auditor nominations on 99.9 per cent of occasions. Asset managers are not only reluctant to reject auditor reappointments, many of them, particularly those based in the US, are also unwilling to discuss their views on appropriate auditor tenure.
BlackRock, JPMorgan and Franklin Resources are also among the companies that do not disclose their auditors’ tenure, according to MSCI. One of the asset managers, who did not want to comment on the record, says she believes the problem may lie in the fact that investors simply are not aware of how long some auditors have been in place. “There is a complete and utter lack of awareness around this issue,” she says. This lack of awareness could be resolved soon.
The US Securities and Exchange Commission is planning to consult investors this summer on whether large companies should be forced to disclose how long their auditors have been in place, according to Joseph Carcello, a member of the regulator’s investor advisory committee. Mr Carcello, who is also executive director of the University of Tennessee’s corporate governance centre, adds that the regulator is keen to see companies publish better-quality audit reports.
Pirc, the shareholder advisory group, has adopted a policy of recommending its clients oppose the reappointment of auditors when they have been in place for more than a decade. Pirc believes the impact of this policy could be substantial, given that its clients account for £1.5tn of assets and are estimated to hold approximately 1 per cent of the shares of S&P 500 companies collectively.
Paul Lee, head of corporate governance at Aberdeen, believes more US investors will begin to question auditing arrangements at the companies they invest in. He says: “If additional transparency alerts people to the fact that many companies have had the same audit firm in place for upwards of 50 years, then that can only be a good thing. Auditors are the independent eyes and ears of shareholders within the corporate reporting process and we need them to be free to do that to their best ability.”
Many of the companies that have had the same auditor in place for close to a century did not want to comment for this article. General Electric, the conglomerate that has used KPMG as its auditor for 106 years, was the exception. It said: “The board of directors annually reviews KPMG’s independence and performance in deciding whether to retain the accounting firm. “The board considers KMPG’s audit performance, their ability to handle the breadth of our worldwide operations, an analysis of their known legal risks, the audit quality and efficiency benefits of having a longer-tenured auditor, and controls in place at GE and KPMG to mitigate against any potential independence concerns.
“In our engagement with investors, they generally have not had an issue with KPMG’s tenure — they are more focused on disclosure. As a result, over the past few years, we have significantly enhanced our proxy disclosures around the auditor engagement process.” Procter & Gamble, Caterpillar, and Kimberly Clark all pointed FTfm in the direction of their proxy statements — documents they must send to their shareholders containing relevant information ahead of an annual meeting. P&G said that “the retention of Deloitte to serve as the company’s independent external auditor is in the best interest of the company and its shareholders”.
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