The Australian Treasury’s consultation into the regulation of accounting, auditing and consulting firms in Australia closed on Friday 28 June.

Much of the consultation was specific to audit and consulting services provided by the big four accounting firms. One question was of relevance to remuneration consulting, among other types of consulting, on which we based Guerdon Associates’ submission:

“Noting the competition issues raised in the audit sector, including the dominance of the largest accounting firms in the ASX 200 market, are there similar competition issues in other services provided by the accounting firms, including tax and consulting services?”

The Treasury consultation paper showed that, contrary to what some might expect, most of the big 4 audit firm revenues do not come from audit services. Rather they come from other services including tax, IT, legal, accounting, strategy and remuneration and governance consulting. These services are mainly procured by client company management.

Remuneration and governance services would not account for a large portion of these multi-service firms’ revenues. This fact, combined with the processes and governance of acquiring these services, represents a conflict of interest.

If consulting firms are selling a broad swathe of services to a company, and the company management decides which consulting firm is selected to provide these services, the consulting firms will want to ensure they do not upset the company’s management or they might reduce their likelihood of winning lucrative jobs.

Remuneration and governance services have the potential to cause upset, as they relate to how much and under what conditions management is paid. Therefore, broad based consulting firms which earn significant revenues outside of remuneration and governance consulting might be conflicted in ensuring the advice is not unfavourable to management. Quid pro quo, management would be more likely to appoint conflicted advisers, in a cycle that maintains the potential for conflicted remuneration and governance advice.

This has been recognised overseas. As an example, the NYSE has listing rules requiring compensation adviser independence standards, including consideration of:

1. Whether the adviser’s firm provides other services to the company;
2. The amount of fees from the company received by the adviser’s firm relative to the total revenue of the adviser’s firm;
3. Conflict-of-interest policies of the adviser’s firm;
4. Any business or personal relationships between the adviser and members of the compensation committee;
5. Any stock of the company owned by the adviser; and
6. Any relationships between the adviser or the adviser’s firm and an executive officer of the company.

The Treasury paper’s suggestions for resolving conflicts of interest tend to focus on applying corporate disclosure standards on audit firms. We fail to see how this will resolve conflicts of interest in the area we have highlighted. As the Treasury paper acknowledges, audit firms have, in effect, a corporatised operating model so disclosure of the model would not resolve conflicts of interest. In addition, they have no agency issue, as partners are owners and management in one.

Therefore, it is suggested a better model would be akin to that used by US stock exchanges to minimise conflicts of interest associated with board remuneration advice.

Treasury’s consultation paper can be found HERE.

Guerdon Associates’ submission can be found HERE.

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