The Big Four are well known: Deloitte, Ernst and Young, KPMG and PWC. They act as auditors for 90% of the UK’s stock-market listed companies. They have a very close relationship with the companies that they audit and because of this have faced criticism of not warning of the financial crisis. A further accusation is that the relationship between auditors and managers has become blurred.
In some sense, there is a problem of divorce of ownership from control. The companies that are audited by the Big Four have shareholders who are interested in profits and their dividends. But they employ managers who are responsible for the day-to-day running of the business. However, there are concerns that the auditors have become more concerned with meeting the interests of the managers and not of the shareholders. It has been suggested that the company’s management tend to ‘present their accounts in the most favourable light, whereas shareholder interests can be quite different.’ Laura Carstensen, the chair of the Audit Investigation Group said:
It is clear that there is significant dissatisfaction amongst some institutional investors with the relevance and extent of reporting in audited financial reports … management may have incentives to present their accounts in the most favourable light, whereas shareholder interests can be quite different.
The Big Four have been criticised for limiting competition in the industry. The Competition Commission has said that companies typically stay with the same auditing firm and this acts to limit competition. One suggestion to encourage competition is to enforce rotation of Auditors. However, the Big Four have said that the market remains competitive, ‘healthy and robust’ and that any enforcement as noted above would not be in the public interest. Other, smaller auditing companies have praised the preliminary report of the Competition Commission. One firm said:
No one solution will achieve market correction, but rather a combination of tendering requirements, encouragement of transparency and dialogue between auditors, companies and investors, and reform of outdated exclusionary practices should provide a backdrop for a healthier FTSE 350 audit market.
The report is not yet final, but the future of the Big Four is somewhat uncertain, especially with the European Commission’s desire to break them up. The following articles look at this industry.
Big Four accountants reject claims over high prices and poor competition The Guardian, Josephine Moulds and David Feeney (22/2/13)
Competition Commission raps Big Four accountants BBC News (22/2/13)
Big Four’s rivals welcome audit shake-up Financial Times, Adam Jones (22/2/13)
UK’s “Big Four” accountants under fire from watchdog Reuters, Huw Jones (22/2/13)
Big Four chastised by Competition Commission The Telegraph, Helia Ebrahimi (22/2/13)
The uncompetitive culture of auditing’s big four remains undented The Guardian, Prem Sikka (23/2/13)
Big Four accountants ‘in closed club on audits’ Independent, Mark Leftly (23/2/13)
Questions
- What is the role of the Competition Commission?
- Explain with other examples the problem of the divorce of ownership from control. How might the interest of shareholders and managers differ? Can they ever be aligned?
- Is market share a good measure of the competitiveness of an industry?
- What are the benefits of competition?
- Why has the regulator suggested that the Big Four are limiting competition?
- What solutions have been proposed by the Competition Commission? Explain how they are likely to stimulate competition in this market.
The news in many European countries has been dominated in February by the ‘horse meat scandal’. Small traces of horse meat may be the result of faulty quality control. But the significant amount of horse found in several processed meat products suggest fraud at one or more points in the supply chain from farm to supermarket or other outlet. Indeed several specific suppliers, from abattoirs to processors are facing criminal investigation.
The scandal has put the supply chain under intense scrutiny. Part of the problem is that the supply chain is often very long and complex. As the Guardian article states:
The food and retail industries have become highly concentrated and globalised in recent decades. A handful of key players dominate the beef processing and supermarket sectors across Europe. They have developed very long supply chains, particularly for their economy lines, which enable them to buy the ingredients for processed foods from wherever they are cheapest at any point, depending on exchange rates and prices on the global commodity markets. Networks of brokers, cold stores operators and subcontracted meat cutting plants have emerged to supply rapidly fluctuating orders “just in time”. Management consultants KPMG estimate there are around 450 points at which the integrity of the chain can break down.
Then there is the huge pressure on all parts of the supply chain to reduce costs.
Supermarkets use their market power to drive down the prices of the products they buy from their suppliers and this has a knock-on effect backwards down the supply chain. This pressure has intensified as real wages have fallen and consumers have found their budgets squeezed.
At the same time, beef and other meat prices have been rising as the costs of animal feed have soared. This all puts tremendous pressure on suppliers to add cheaper ingredients. Again to quote the Guardian article:
Manufacturers add other cheap ingredients including water and fat, and use concentrated proteins to bind the water and fat in. They may appear on labels as ‘seasoning’. One of the cheapest sources of these protein additives is pork rind. It is possible that horse hide is now also being used. The widespread adulteration of cheap chicken breast with pig and beef proteins and water has been uncovered in previous scandals. The beef proteins were derived from hydrolysed cattle hides. It is not illegal to use these protein concentrates so long as they are identified correctly to the manufacturer.
It is not surprising that if cheap horse meat becomes available to suppliers, such as from old horses towards the end of their working lives, some processing companies may be tempted to add it fraudulently, stating that it is beef.
The articles look at the issues of long and complex supply chains in the processed food industry and assess why they have evolved into their current form and the difficulties in regulating them.
Horsegate: heed economics of the cold chain The Grocer, Andrew Godley (16/2/13)
Horsemeat scandal: the essential guide The Guardian, Felicity Lawrence (15/2/13)
After the horse has been bolted The Economist (16/2/13)
Slavery, not horse meat, is the real scandal on our doorstep The Telegraph, Fraser Nelson (14/2/13)
Industry must take the reins on food safety Globe and Mail (Canada)Sylvain Charlebois (15/2/13)
Supply chains changed the growth model The Economist, Richard Baldwin (15/8/12)
Supply-chain management The Economist (6/4/09)
Tesco pledges to open up supply chain after horse meat scandal The Telegraph (16/2/13)
Horse meat scandal: Shoppers who buy ‘cheapest food’ at risk The Telegraph, James Quinn, Jason Lewis and Patrick Sawer (16/2/13)
Let Them Eat Horse Bloomberg, Marc Champion (15/2/13)
Scandal shows meat supply chain must be policed heraldscotland (14/2/13)
MPs push for new powers for FSA as officials seize yet more suspect meat Independent, Martin Hickman (13/2/13)
Questions
- Why do supermarkets and their suppliers use long supply chains?
- Explain the concepts of ‘countervailing power’ and ‘monopsony or oligopsony power’? How do they apply in the processed meat supply chain?
- Identify the types of transactions costs in the processed meat industry.
- In what ways do consumers (a) gain and (b) lose from such supply chains?
- Why is the problem of fraud in processed food supply chains likely to have intensified in recent years?
- How have supermarkets reacted to the horse meat scandal? Why has it taken the scandal to make them react in this way?
- To what extent is the problem simply one of inaccurate labelling?
- To what extent is there a principal–agent problem in the processed meat supply chain?
Over the past five years the Office of Fair Trading (OFT) has been closely studying the market for personal bank accounts in the UK. Last week, it announced its latest findings and the evidence seems to suggest that there remains a lack of competition in the market.
On the positive side, it reports that there has been a large fall in unarranged overdraft fees. However, despite this, according to the OFT banks still make on average £139 per year from every active current account. Furthermore, concentration has increased with the four largest banks (Barclays, Lloyds, HSBC and RBS) now accounting for 85% of the market and there has been little new entry. It appears that one of the key factors in enabling these main players to dominate the market and reap high profits is a lack of consumer switching behaviour. According to the OFT chief executive, Clive Maxwell:
Customers still find it difficult to assess which account offers the best deal and lack confidence that they can switch accounts easily. This prevents them from driving effective competition between providers.
Despite all these concerns, the OFT declined to refer the market to the Competition Commission for a more in-depth investigation and potential remedial action. Instead, the OFT will look at the market again in 2015. Richard Lloyd, the executive director at the consumer organisation Which?, was disappointed with this decision and was quoted in the The Guardian as saying:
Everyone – consumers, the government, leading bankers and now the OFT – seems to agree that big change is needed in banking, and that much greater competition on the high street is urgently needed to make the banks work for customers, not bankers.
Whilst at least for the moment, the Competition Commission will not get the chance to take action, there are still several reforms underway that may affect competition in the market. First, the OFT is increasing pressure on banks to allow consumers to have portable account numbers that they can take with them if they switch provider. Second, as a result of the Independent Commission’s review, banks will be required to switch a customer’s account in one week, rather than the average of 18 days it currently takes, and this process will become much more seamless. Finally, Lloyds has agreed to sell over 600 branches to the Co-op in order to meet the European Commission’s requirements following the government bail-out of the bank in 2008. This will increase the Co-op’s share of the current account market to 7%. It will be interesting to see how these reforms affect the market. If there is not substantial evidence of increased competition then the market is likely to face more scrutiny from the competition authorities.
Bank accounts: OFT says significant change needed BBC (25/01/13)
OFT: banks failing consumers The Economic Voice (25/01/13)
Let’s make bank accounts as easy to switch as mobiles The Telegraph, Andrew Oxlade (28/01/13)
OFT chief calls for more competitive banking sector The Telegraph, Denise Roland (30/01/13)
Questions
- What type of market structure best fits the banking industry?
- What are the barriers to entry in this market?
- What are the key features of the market that reduce consumer switching behaviour?
- Do you think most people are more likely to switch their mobile phone or current account provider? Explain.
- Why does limited consumer switching reduce the intensity of competition?
- Do you think the current reforms will result in a substantial increase in competition?
Last week, the European Commission imposed a record fine of almost €1.5b on a group of firms found to have been involved in price fixing. Between 1996 and 2006 these firms fixed world-wide prices of cathode ray tubes which are used to make TV screens and computer monitors.
The firms involved in fixing the prices in one or both of these markets included household names such as Samsung, Panasonic, Toshiba and Philips. As these tubes accounted for over half the price of a screen this clearly had a significant knock-on effect on the amount final consumers paid. The European competition agency only discovered the cartel when it was informed that it had been in operation by Chunghwa, a Taiwanese company that had also been involved. Therefore, under the Commission’s leniency policy Chunghwa was granted full immunity from the fines.
The cartel members held frequent meetings in cities across Europe and Asia. The top level meetings were known as ‘green meetings’ as they were often followed by a round of golf. Interestingly, this is not the first time the game of golf has featured in an international cartel. In the famous lysine cartel an informant working for the FBI used the quality of the golf courses to convince the cartel members to meet in Hawaii, where the FBI had the jurisdiction to secretly record the meeting as evidence.
The screen tube cartel is one of the most highly organised cartels the European Commission has ever detected. Different prices were even fixed for individual TV and computer manufacturers. Furthermore, compliance with the cartel agreement was strictly monitored with plant visits to audit how much firms were producing. The cartel was also clearly very aware that it was breaking the law and that information needed to be concealed as some of the documents discovered stated that they should be destroyed after they had been read. One document even said that:
“Everybody is requested to keep it as secret as it would be serious damage if it is open to customers or European Commission.”
Another interesting feature of the cartel is that it occurred at a time when the technology was being replaced by LCD and plasma screens. Therefore, the cartel appears to have been partly motivated by a desire to mitigate the negative impact the declining market would have on the firms involved.
According to the Independent newspaper:
“Philips said it would challenge what it called a disproportionate and unjustified penalty. Panasonic and Toshiba are also considering legal challenges. Samsung reserved its comment.
TV makers in record 1.47bn-euro fine BBC News (05/12/12)
TV computer makers fined $1.93 billion for price fixing Corporate Crime Reporter (05/12/12)
European antitrust fines: a new wave of deterrence? EurActiv, Mario Mariniello (11/12/12)
Questions
- What is the impact of a successful cartel on economic welfare?
- Describe the impact declining demand has on firms in a competitive market.
- Why might it have been necessary for the cartel to charge different prices to individual TV and computer manufacturers?
- Why would the cartel need to audit how much members are producing?
- Why do competition authorities offer immunity to firms that inform them about cartel behaviour?
- Based on the evidence in the articles, do you think the firms involved have grounds to appeal the fines imposed?
Two of the biggest publishing companies, Pearson of the UK and Bertelsmann of Germany are to form a joint venture by merging their Penguin and Random House imprints. Bertelsmann will have a majority stake in the venture of 53% and Pearson will have 47%.
The Penguin imprint, with a turnover of just over £1bn, has an 11% share of the English language book publishing market. Random House has a 15% share, with turnover of around £1.5bn. The new ‘Penguin Random House’, as it will be called, will have nearly 26% of the market, which should give it considerable market power to combat various threats in the book publishing market.
One threat is from online retailers, such as Amazon, Apple and Google, which use their countervailing power to drive down the prices they pay to publishers. Another threat is from the rise of electronic versions of books. Although e-books save on printing costs, competition is driving down prices, including the prices of paper books, which may make publishers more reluctant to publish new titles in paper form.
There has been a mixed reception from authors: some are worried that an effective reduction in the number of major publishers from six to five will make it harder to get books published and may squeeze royalty rates; others feel that an increased market power of publishers to take on the online retailers will help to protect the interests of authors
The following videos and articles look at the nature of this joint venture and its implications for costs, revenues and publishing more generally.
Videos and webcasts
Penguin and Random House merge to take on digital giants Channel 4 News, Matthew Cain (29/10/12)
Penguin and Random House confident merger will be approved BBC News, Will Gompertz (29/10/12)
Penguin Books and Random House to merge BBC News, Matt Cowan (29/10/12)
Articles
Random House and Penguin merge to take on Amazon, Apple Reuters, Kate Holton (29/10/12)
Pearson’s Penguin joins Random House Independent, Amy Thomson and Joseph de Weck (29/10/12)
Penguin and Random House sign merger deal Financial Times, Gerrit Wiesmann and Robert Budden (29/10/12)
March of the Penguin The Economist, Schumpeter blog (29/10/12)
Penguin chief: News Corp can’t derail Random House deal The Guardian, Mark Sweney (29/10/12)
Penguin and Random House confident merger will be approved BBC News, Anthony Reuben (29/10/12)
And so I bid Penguin a sad farewell Independent, Andrew Franklin (29/10/12)
Questions
- How does a joint venture differ from a merger?
- What types of economies of scale are likely to result from the joint venture?
- How are authors likely to be affected?
- Will the joint venture benefit the book reading public?
- The relationship between publishers and online retailers can be described as one of ‘bilateral oligopoly’. Explain what this means and why it is impossible to determine an ‘equilibrium’ wholesale price of books in such a market.
- What criteria would the competition authorities use to assess whether or not the joint venture should be permitted to proceed?
- What is likely to be the long-term outlook for Penguin Random House?
- Assess the benefits and costs of a News Corporation takeover of the Penguin division? This was an alternative offer to Pearson had it not gone with Bertelsmann. (News Corp. has the Harper Collins imprint.)