Select Committee on Treasury Minutes of Evidence

Examination of Witness (Questions 280-299)



  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.

Mr Laws

  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.

Mr Mudie

  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 counterparts?
  (Lord Sharman) If you look at most of the companies I am involved with at the moment, the stock options are well under water.

  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 country.

  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.

Mr Cousins

  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 the company.

Mr Tyrie

  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 point.
  (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 a business.


  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 mind—I am supposing here—is 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.

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