October 25, 2009

Audits VI: the wheel spins. Until?

We've established that Audit isn't doing it for us (I, II, III). And that it had its material part to play in the financial crisis (IV). Or its material non-part (II). I think I've also had a fair shot at explaining why this happened (V).

I left off last time asking why the audit industry didn't move to correct these things, and especially why it didn't fight Sarbanes-Oxley as being more work for little reward? In posts that came afterwards, thanks to Todd Boyle, it is now clear that the audit industry will not stand in front of anything that allows its own house to grow. The Audit Industry is an insatiable growth machine, and this is its priority. No bad thing if you are an Auditor.

Which leaves us with curious question: What then stops the Audit from growing without bound? What force exists to counterbalance the natural tendency of the auditor to increase the complexity, and increase the bills? Can we do SOX-1, SOX-2, SOX-3 and each time increase the cost?

Those engineers and others familiar with "systems theory" among us will be thinking in terms of feedback: all sustainable systems have positive feedback loops which encourage their growth, and negative feedback loops which stop their growth exploding out of control. In earlier posts, we identify the positive feedback loop of the insider interest. The question would then be (for the engineers) what is the negative feedback control?

Wikipedia helpfully suggests that Audit is a feedback control over organisations, but where is the feedback control over Audit? Even accepting the controversial claim that Sarbanes-Oxley delivered better reliability and quality in audits, we do know there must be a point where that quality is too expensive to pay for. So there must be a limit, and we must know when to stop paying.

And now the audit penny drops: There is no counterbalancing force!

We already established that the outside world has no view into the audit. Our chartered outsider has taken the keys to the citadel and now owns the most inner sanctums. The insider operates to standard incentives which is to improve own position at the expense of the outsider; the Auditor is now the insider. Which leads to a compelling desire to increase size, complexity and fees of Audit.

Yet the machine of audit growth has no brake. So it has no way to stop it moving from a useful position of valuable service to society to an excessive position of unsustainable drain on the public welfare. There is nothing to stop audit consuming the host it parasites off, nor is there anything that keeps even the old part of the Audit on the straight and narrow.

And this is more or less what has happened. That which was useful 30 years ago -- the opinion of financial statements, useful to educated investors -- has migrated well beyond that position into consuming the very core of the body corporate. IT security audits, industry compliance audits, quality audits, consulting engagements, market projects, manufacturing advice, and the rest of it now consume far more of their proper share.

Many others will point at other effects. But I believe this is at the core of it: the auditor promises a result for outsiders, has taken the insiders' keys and crafted a role of great personal benefit, without any external control. So it follows that it must grow, and it must drift off any useful agenda. And so it has, as we see from the financial crisis.

Which leads to a rather depressing conclusion: Audit cannot regulate itself. And we can't look to the government to deal with it, because that was part & parcel of our famous financial crisis. Indeed, the agencies have their hands full right now making the financial crisis worse, we hardly want to ask them to fix this mess. Today's evidence of agency complicity is only just more added to a mountain of depression.

What's left?

Posted by iang at October 25, 2009 08:46 PM | TrackBack

You wrote:
> What's left?

That depends what you want the answer to be, if you are part of the problem you obviously want all the scrapes you can get, to get a bigger pork barrel :)

That's really the wrong question though. I suppose, the problem isn't what's left, the problem is how to prevent greed so there is something left, which, as a most large organisations have died trying in the past to tame fundamental human traits find out sooner or later, generally isn't possible.

This is just the general outcome, when universities stopped being centres for higher learning and started becoming businesses to churn out graduates; who are brain washed in turn from day one that you have to go to university so you aren't digging ditches and so on.

Society in general is to blame for this, from teachers at schools perpetuating myths, to the universities and into business. Unless and until those very basic issues are addressed and we start rewarding hard work nothing will change, it just morphs...

Posted by: anon at October 26, 2009 05:23 AM

Let's begin by auditing central banks. Here is a petition online to audit the European Central Bank:

Posted by: marco saba at November 14, 2009 08:11 PM
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