Examination of Witness (Questions 280-299)|
TUESDAY 2 JULY 2002
280. Do you think Government should take a fairly
open view about answering parliamentary questions about the nature
of the deals, the trade-offs, exactly what services are being
provided, the competitive arrangements, the benchmarking? The
performance, all of that should be open.
(Lord Sharman) Yes.
281. Whatever the legal form of the firm, a
major audit failure will wipe it out, as has happened to Andersen.
The risk is that a further failure will lead to even greater concentration.
What, if anything, can be done to reverse that trend?
(Lord Sharman) May I just talk about failure first?
The failure of Andersen is more related to what they did after
Enron failed rather than the failure itself. It is obviously speculation,
but my guess is that if they had not got themselves into the situation
of being prosecuted for perverting the course of justice and then
being convicted on that count, the situation for them might have
been very different. What is argued is that the scale of liability
which could result from a major failure is such that it would
bring down one of the other firms. Those things tend to take time
in the courts. Clearly the risk is there. I am not sure what you
do other than resort to competition law and the competition authorities
to look at the industry from time to time. You have four; there
are enormous barriers to entry to that market because of the sheer
scale of resource required to deal with the major global corporations.
The only suggestion I can have is that the competition authorities
should look at it from time to time which is what you would expect.
282. This is as good a time as any for the competition
authority to look at it.
(Lord Sharman) Possibly; yes.
283. In your speech in the House of Lords recently
you touched on some issues in terms of what we might do to address
the recent problems in Enron and elsewhere. One of the proposals
you reject in that is the mandatory rotation of auditors perhaps
every five or seven years, which is something which we know from
press reports the Government are looking at. Why do you think
it would be a bad idea to have mandatory rotation?
(Lord Sharman) Interestingly enough the Senator Sarbanes'
Bill in the United States looks at this and says it is going to
conduct a study and I should be very interested to see the outcome
of that study. The first reservation I have about it is that it
has not worked anywhere where it has been tried. It was tried
in Italy, it was tried in Brazil, it was looked at in this country
by Cadbury, it was looked at in Ireland. The second reservation
I have is that if you look at the incidence of audit failure,
the overwhelming majority of audit failures take place in the
early years of the relationship, the first two or three or four
years. Therefore I would worry about continual changes. The third
reservation I have is that I am concerned that a wholesale continual
re-tendering may, if you have a sufficiently competitive marketplace,
force prices down and have a consequential detrimental effect
on quality. I do not think the model of the Audit Commission,
where rotation is a norm, where you are auditing a relatively
homogeneous entity such as local authorities and people like,
that is valid. That is much more in the nature of a sub-contracting
of a central body rather than an individual relationship. Those
are my reservations about it.
284. I have you quoted as saying that we are
not to forget and over-concentrate on one of the villains. In
all our questions we are looking at the referees rather than the
players. It is the players who have got everybody into this trouble,
is it not? The actual management.
(Lord Sharman) Yes.
285. A feature of some of the American experiences
has been share option incentives related to share prices. There
is growing concern about share options and the size of them and
sometimes, despite what was said, the lack of relationship to
performance. Would you like to comment?
(Lord Sharman) The fundamental argument for share
options is that it will ally the interests of the executive with
those of the shareholders. That is the fundamental argument for
it. In many cases share options work as just additional remuneration
rather than a long-term engagement. I think the better managed
and governed companies in this country, which require their executives
to retain a long-term interest in the stock of the company, many
of them related to the amount of their remuneration, which they
can get either through their stock options or through buying in
the markets, is the right way to go about this. The danger with
these schemes is when they are seen as short-term additional cash
remuneration rather than a long-term benefit of being in a successfully
managed company. There is always a danger that if you over-compensate
in one sector, you will get people to focus on that very simple
thing. In terms of remuneration, I favour a very strong combination
of basic pay, short-term bonuses in cash, dependent on short-term
performance and long-term remuneration based on the longer term.
286. How do you relate that to what has happened?
(Lord Sharman) What has happened in the United States
is clearly that the levels of remuneration have just got completely
out of control.
287. In which aspect?
(Lord Sharman) Both in scale
288. No, I mean in terms of the basic salary,
the bonuses or the share options?
(Lord Sharman) Mainly in the stock related aspects
of remuneration; mainly that.
289. What would your comment be about the British
(Lord Sharman) If you look at most of the companies
I am involved with at the moment, the stock options are well under
290. Hopefully that is a temporary situation.
(Lord Sharman) I hope so.
291. We are talking about the relationship.
(Lord Sharman) Yes, I think the relationship, with
one or two exceptions is pretty sound. I think remuneration committees
have done a reasonable job in this country.
292. On the issue of transparency and accountability
and the role of the audit committee you have made a number of
points to us. I am thinking of Enron, where on the audit committee
they had an American judge, an ex-British Cabinet Minister and
the head of the audit committee was a professor of accounting
at Stamford University. Some witnesses have said to us that it
was like a train coming down the line at 200 miles per hour and
it should have been seen. No matter how much quality we have in
the audit committee it seems as though gigantic mistakes can be
made. How can we prevent those mistakes being made? For example,
the role of an auditor has been described to us as a trade-off
between the auditor and the company. You mentioned having a more
prominent role. Should there be a check of the books between the
auditor, someone from the audit committee and perhaps one of the
executives and some legal basis for that?
(Lord Sharman) The issue in the States and here is
slightly different in that there is a requirement for the board
as whole to approve the financial statements. That usually takes
place on the basis of the audit committee recommendation, the
audit committee going through them in some depth and then the
financial statements to be signed off, usually by the Chairman
or the chief executive and the finance director. The issue is
that you need to take that verification process as far away from
management as you can or make it independent of management as
you can. This is why I believe that the appointment and management
of the relationship with the auditor ought to move much more into
the remit of the audit committee rather than the financial group
in the corporation.
293. What we find in situations which happen
is that people put their hands up and say, "Nothing to do
with us guv". Should there not be an accountability at the
end of the day in which there is a legal obligation?
(Lord Sharman) You have a legal obligation in this
294. Further strengthen it.
(Lord Sharman) The board is very clearly legally responsible
for its accounts. The consequences of it? People will ask what
happened where they were wrong and what happened to the board
and the answer is, not very much. It would be something which
would bear study.
295. Do you not think we live in a country where
the social advantages of being recruited as a non-executive director
and the benefits it brings are as important in people's minds
as the legal obligations it carries?
(Lord Sharman) Not in today's world. That may have
been the case. That is certainly not something which went through
my mind when I was recruited. The first thing I wanted to know
was much more about the company, much more about its arrangements
and a considerable amount about the financial arrangements in
296. You said earlier that one of the reasons
you would not be in favour of mandatory auditor rotation was that
it appears that the majority of frauds or problems arise in the
early years of a new firm coming in. This seemed to be a powerful
(Lord Sharman) May I just clarify what I said? I did
not say the majority of frauds arise; fraud happens all the time.
The majority of auditing failures. Where there are auditing failures,
not all of them result in an Enron or a WorldCom or anything like
that. The majority of them, if you look at the statistics, happen
within the first three to four years. That worries me. It is because
you are learning the business.
297. Are you saying it is easy to pull the wool
over the eyes of a new auditor?
(Lord Sharman) Perhaps; yes, it takes time to understand
298. Should shareholders be given more opportunity
to participate in governance?
(Lord Sharman) I think they have plenty of opportunity.
They should be encouraged to participate more.
299. More formal opportunity.
(Lord Sharman) If what you have in mindI am
supposing hereis the notion of shareholder committees and
things like that, I can see some merit in them, but I am not sure
that will solve the problem.
Chairman: Thank you very much for your
paper and the opportunity for us to hear you this morning. It
has been very valuable. Thank you.