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Is more competition the answer for audit?

Author: ICAEW

Published: 29 Jan 2021

Maurice Stucke and Ariel Ezrachi, competition law professors and the authors of the book ‘Competition Overdose’, explain what healthy competition in business looks like as part of a series of articles on key themes from ICAEW’s Audit Manifesto.

Maurice Stucke and Ariel Ezrachi have studied the nature of competition for years. As professors of competition law at the University of Tennessee College of Law and the University of Oxford respectively, they have a unique view on the nature of competition. 

They were – and are – great believers in the importance of competition, but both concluded that something was amiss. “There's always this talk about competition, but no one really asks if competition is always good,” says Stucke. “At first, we thought ‘perhaps it is only people around us who are just tired of being in this rat race’. We started questioning: is the competition idea delivering the promised prosperity?" 

Ezrachi and Stucke started speaking to others and heard the same arguments. Buoyed by the fact that others felt the same way, they took their thoughts to the competition agencies, expecting fierce resistance to their ideas. To their surprise, the agencies agreed. “We then realised that what we were questioning wasn't heretical,” says Stucke. “In fact, one of the top economists at one of the agencies said: ‘competition isn't always what it’s cracked up to be.’ What we realised is that there were the warning labels on competition that policymakers just began ignoring.” 

They concluded that in many instances, competition wasn’t serving us anymore – we were serving competition. More competition didn’t bring out our best, as it was supposed to, and often it brought out our worst. This was the impetus behind their book Competition Overdose: How Free Market Mythology Transformed Us from Citizen Kings to Market Servants (2020, HarperCollins). 

Will greater competition in audit lead to better work?

One of the core arguments for audit reform is around competition. There is a belief that more competition in audit would result in better-quality work. Stucke and Ezrachi don’t dismiss more competition as a possible solution to audit but argue that before increasing the competitive pressure, one needs to consider possible market failures to ensure that greater competitive pressure delivers greater benefits. 

“The competition ideal has been oversimplified and distorted,” says Ezrachi. “Corporations often tie competition with liberalisation. Every time the state wants to intervene, regardless of the fact that there may be a monopoly or market failure, they come out and say: ‘the market can correct itself; the Invisible Hand of competition will fix it all’.”

Competition makes perfect sense when you understand its limitations and push for greater rivalry while safeguarding against degradation of quality or race to the bottom, he explains. But the limitations of rivalry as a solution to our economic and social problems are often ignored.

This is particularly damaging in cases where the market encroaches into government services. One case that Ezrachi and Stucke explore in the book is the effect of privatisation on the US prison service. “We also tell the story in the UK about the outsourcing of forensic services,” says Ezrachi. “Everyone told the government it would never work, and yet the government privatised the service. They had to recall lab work samples used in more than 10,000 criminal cases because of quality problems. In that case, unlashing greater competition in a market with limited demand and with ineffective government supervision resulted in quality degradation.” 

Audit sits in somewhat of a middle ground: a regulated sector operated by private entities. Based on that, competition for competition’s sake may not be a simple answer. Stucke gives the example of credit ratings firms as a possible example of how more competition could affect audit. 

“The ratings industry has always been dominated by two agencies and the same argument existed: if there was more competition, we would see more accurate ratings. What we found was when Fitch entered, it actually had the opposite effect. Simply increasing the competitive pressure did not help. One of the things we talk about in the book is misaligned incentives. In ratings, the ratings benefit the investor but are paid for by the issuer. So intense competition and ineffective regulation created the distorted scenario of: ‘if you're not going to give me a good rating, I'm going to go to someone else’. Rather than a race to the top, it created a race to the bottom.” 

Auditing and accounting have that same misalignment of incentives. The people who primarily rely on the audit aren’t the ones that pay for it. But this is not an argument against all competition; it is more nuanced than that.  

“The solution is to have competition in an environment that is conducive to responsible audits and in an environment where you have guardrails: sufficient regulations and accountability to ensure that competition delivers. As a default, generally, competition is great, it benefits us. But if you think that it is a magical remedy that will just fix it all, that's over-simplistic.” 

Guarding against toxic competition

When competition results in a race to the bottom, you get what Stucke and Ezrachi call toxic competition. They describe a sliding scale of competition, from toxic to noble. Policymakers have the power to decide what kind of competition we end up with, shaping policy to ensure that competition in various markets lands on the noble end of the scale.

“Sometimes you're going to have zero-sum competition, but not as often,” says Stucke. “So policymakers can decide where along the spectrum and we shouldn't be resigned to toxic competition; it's not the state of affairs.” 

Even if you aspire to noble competition, there are some things that competition will not provide, so policymakers need to recognise what competition can and cannot deliver. “There might be minimal safeguards, you might have a public access option. You're not going to leave all forms of healthcare to competitive forces, for example, you could have a safety net as well, for those who compete and come up short.”

Crucially, Stucke and Ezrachi argue that it’s not only up to policymakers to get competition right; business and individual citizens also have a role to play in ensuring that competition works for everyone and does not become toxic. 

“There are so many instances where you could see that just increasing the competitive pressure can really backfire. An example which I think is always quite astonishing is the Boeing 737 Max. The quality degradation was, in part, the result of intense competition between Boeing and Airbus. This is where we're coming from. It is certainly not about discouraging more competition, but we shouldn’t use it as some sort of a magical remedy.”

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