Audit firms cannot be relied upon to challenge their clients, writes Hugh Willmott
THE discovery that Tesco overstated its first-half profits by an estimated £250m is, in the words of Dave Lewis, the retailer’s incoming chief executive, “a serious issue”. But so far as one can tell, it is not one that has unduly troubled the conscience of those who vouched for the accuracy of the retailer’s financial statements.
PwC, which audits Tesco’s accounts, let out a muted growl of nervousness in the fine print of the retailer’s most recent annual report. The accountants noted the “risk of manipulation” inherent in the estimates of commercial income, which have a big influence on profits. But they were apparently persuaded by Tesco’s audit committee that the numbers stacked up.
This is a brilliant arrangement. The auditor says it acted responsibly, by flagging up the danger to investors. The directors say that they responsibly discussed the matter with PwC which, as the accredited expert, was convinced that it was all kosher. Neither group considers itself guilty of incompetence or impropriety. Yet collectively they presided over a serious failure of oversight.
The Enron scandal showed that audit firms cannot be relied upon to challenge the accounting practices of their clients. PwC has been Tesco’s auditor since 1983. Last year the firm received a little over £10m for its services, which doubtless paid for a lot of spreadsheets. Yet none seems to have cast much light on the accounting irregularities that have apparently taken hold at the supermarket chain. In the end it was an employee who exposed what was going on, bringing his concerns to in-house lawyers. Something similar happened at Enron. It is not in auditors’ interests to ask questions too persistently.
The auditors are not the only ones who were asleep on the job. The board – especially the non-executive directors, and members of the ethics and audit committees – seems either to have been derelict in its duties, ignored the problem or turned a blind eye.
Six days before the scandal broke, the accounting watchdog published the
latest version of the UK corporate governance code – the document devised in the early 1990s to prevent such upsets. It relies on self-regulation rather than public accountability; London-listed companies must either comply with its requirements or explain why they have not. But complying with the mantra of leadership it expounds would probably neither inhibit nor reveal the subterfuge required to conceal a £250m black hole.
It is all very well to trumpet the vital role of non-executive directors. But the code does not even insist that they should have relevant experience. Until new appointments were made this week, no one on Tesco’s board had executive experience of running shops. That is an odd choice of personnel for the world’s second-largest retailer. According to the UK’s official arbiters of corporate best practice, it is not one that requires so much as an explanation.
Some will protest that the troubles at Tesco are a one-off, and that accounting flaws cannot always be detected. That rings hollow. Tesco’s black hole is not credibly viewed as an isolated blunder. It was the product of a failure to establish adequate regulatory mechanisms for curbing abuses of corporate power.
The present regulatory system undermines public confidence in the integrity of corporate leadership, the integrity of accounting firms and the capacity of self-regulation to prevent corporate abuse. Reform is urgently needed.
Only root-and-branch change to remove the structural deficiencies of the code can provide adequate protection from so-called “aggressive” practices – a layman might call them scheming and deceitful – in which auditors defer to irresponsible corporate leaders with the unblushing approval of the code.
The writer is a professor at Cass Business School
FT
