Method in the madness

The list of companies sent by the RBI for bankruptcy resolution shows their auditors do not belong to the big four, or even the big six

In the list of about 40 companies sent by the Reserve Bank of India for bankruptcy resolution there is a curious pattern. The auditors of these companies do not include any one from the big four, or even stretching it more, the big six. 

The omission remains glaring even when one stretches the list back by another couple of years. This is clearly not happenstance. These companies were under financial distress for several years. Their leverage rose sharply over the period. These are major corporate citizens and the pressure on their balance sheets had the potential to destabilise their lenders too, as we have discovered to our cost. The RBI action against them has not come overnight since the banks gave them a long window of forbearance, even as their losses mounted. Yet during the lengthy phase none of them found it necessary to subject their accounts to scrutiny by the big four. 

Some of these companies instead resorted to creative practices, in some cases just using the equivalent of sledgehammer approach like non-recognition of interest expenses in accordance with the new IND AS (Companies—Indian Accounting Standards) rolled out by the ministry of corporate affairs from 2015. 

The list is most illustrative. Not only have none of them retained the services of the top audit firms, at least a quarter have changed their auditors too, in the past three years, up to financial year 2017-18. Some of those changes came about as the norms to rotate audit firms came into force from 2017, but others possibly did a bit of auditor shopping. 

In any case, it can't be a coincidence that the list of companies accounting for about a third of the bad debt of Indian banking business have found compelling reasons not to visit the largest audit firms in the business. 

The firms in India or abroad are free to choose their auditors depending on whom their shareholders vote for

There has been a fair bit of commentary in the Indian business circles on whether there is any difference in the quality of audit offered by the big four that separates them from the smaller audit firms. Ever since the Satyam saga broke 10 years ago, this has been debated every winter. Audit by the big four, as the Satyam case in 2009 for PwC and IL&FS in 2018 for Deloitte shows, has often failed to red flag transgressions. But has the audit by others done a better job? The list of companies pulled up by the RBI does not make any compelling story for preferring the smaller ones too. 

To examine the issue from another angle, let us see which audit firms dominate the universe of markets for listed companies in other major economies. Of the 16 largest financial markets in the world the percentage of firms audited by the big four is the lowest in India. In 2017, the percentage of firms in the UK not audited by the big four was 1 per cent. It is still higher than Germany, Netherlands or Spain where it is even less. In Asia, Japan scores just 8 per cent, China just 1 and in Singapore is at 2. In Australia it is again close to nil. India by comparison has 32 per cent. 

Can it again be a coincidence that we are sitting on the largest pile of bad debts globally? Of course the firms in India or abroad are free to choose their auditors depending on whom their shareholders vote for. The auditors, whoever they are did not create the corporate malfeasance. The reasons why these companies have landed with the resolution professionals is because of other reasons including at times promoter malfeasance. But clearly the red flags did not go up in time. 

That raises a more disturbing question. If we still assume there is no discernible difference between the quality of audit as practiced by the big four and everybody else, it must seem the problem lies with the fraternity of domestic chartered accountants as they exist in India. In other words, is the scrutiny of the role of the big four about their misdemeanour hiding a larger problem of corporate governance practices among the larger fraternity of auditors in the country? 

Let's examine another piece of evidence. This is gleaned from the list of Indian companies that have floated debts or shares abroad. Here too, the list shows no Indian company steps into the world of international finance without a certificate from the big four. International creditors would be most reluctant to offer any money to an Indian company if they cannot recognise the signature of the auditors. The companies too recognise this and comply with this practice. The local office of the clutch of well-known foreign banks would themselves advise the company to get the signature. 

Sanjay Sinha, founder of Citrus Advisors says this is inevitable: “On the international shores, comfort among the investors doing due diligence comes from having one of the big four names.” 

In addition, in the tightly-knit world of international finance the big four stand out for the experience they can offer any clients based on their global experience, their technology and the knowledge base they possess having worked on several geographies. Are we missing the wood for the trees here?