Academics call for reform of audit payment model

Dirk Bierbaum writes that the Wirecard scandal highlights the need to confront the “inherent” conflicts of interest caused by companies paying auditors to monitor their financial reports.

There is endless debate about auditors and ensuring their independence. In the UK over the past five years, this has resulted in numerous reviews producing numerous recommendations, but very few of these resulting in regulatory action.

But one scholar believes he has found the answer. The idea is to change the model so that auditors' fees are paid by independent payers rather than directly by clients.

Dirk Bierbaum, a senior executive at Deutsche Bank and currently a resident director at Aalto University Business School in Helsinki, made his conclusions after investigating Germany's €1.9 billion Wirecard scandal.

Mr. Bierbaum, who is also a member of the International Financial Reporting Standards Foundation (IFRS Foundation), has conducted interviews with a number of senior auditors to discuss who should pay auditors and who should organize the planning and focus of the audit. .

What emerged was the view that the main conflict of interest that undermines auditor independence is the “payment model,'' in which auditors are paid by the companies they monitor.

This creates “an inherent conflict between principal and agent,” Beerbaum says. He recommends change.

“Companies should not pay auditors directly. Instead, companies should pay money into a general audit fund and audits should be paid from this audit fund,” he wrote.

The selection of auditors should also be made by the fund “to ensure auditor independence,” Bierbaum added.

scandal

The Wirecard scandal came to light in 2020 following a police investigation. financial times and whistleblowing.

Following a review of German accounting regulations, Wirecard's audit firm EY was fined €500,000 in 2023 and banned from public interest audits for two years.

Since 2018 and the collapse of construction giant Carillion, the UK has also been investigating audits, auditors and the audit market.

Three independent reviews made numerous recommendations, but none considered the move as significant as Beerbaum's.

When MPs reported in their report on the future of audit in 2019, they flagged “independent appointments” as a “viable option” if all other reforms were ineffective.

“We recommend that the regulator and the CMA consider the possibility of appointing an independent auditor, with a view to developing it as a viable remedy should other remedies and reforms fail. ” states the report.

audit letter

When Sir John Kingman delivered his report on audit regulation in 2018, he was asked to consider independent appointments. In a letter to the then Secretary of State for the Economy, Greg Clark, Sir John said: “I personally do not believe it is right to consider such a major change” due to investor opposition. said.

However, he signaled closer scrutiny of auditor appointments by his proposed new regulator – the Audit, Reporting and Governance Authority (ARGA).

He went so far as to say that regulators should have the power to appoint auditors, but only under certain circumstances. Where audit quality is clearly an issue. An unexpected partnership between a client company and an auditor. If shareholders vote to change the auditor.

Despite the recommendations being made five years ago, the government has yet to create ARGA. The necessary new laws were not included in last year's King's Speech, which is on the UK's legislative agenda. The Labor Party has pledged to push ahead with reforms if elected in the next general election, but no date has been set and it appears to be a low priority.

Since then, the government has given new powers to the current regulator, the Financial Reporting Council, including “contributing to growth”.

Wirecard has similarly highlighted issues of auditor independence in a number of other cases overseas and in the UK. Mr. Beerbaum's paper argues that a new look at the appointment of independent auditors is needed. It's an idea that still has legs.