New Delhi:Dennis M. Nally, chairman of PricewaterhouseCoopers International Ltd, was in India last week to attend the consultancy’s first-ever board meeting in the country. After the meeting, Nally spoke in an interview about challenges in audits and the concerns facing the global economy. Edited excerpts:
We often hear about mandatory rotation of auditors to solve some of the problems in the area of audits. But from your speeches, we notice you are sceptical about that.
We are focused on the issue of audit quality. We welcome the debate, but it needs to be focused on what we can do to enhance quality. Mandatory firm rotation is one of those areas. It sounds good, but when you think about the complexities associated with that, the institutional knowledge that gets lost, which I think is so important to do a high-quality audit, we would remain sceptical that it would achieve the desired result of enhancing the overall audit quality.
What would be an effective solution to these problems?
It gets back to what is the problem you are trying to solve. Some of the proposals that are being talked about, I am not sure, have really identified what the problem is. If there is an issue with regard to what auditors do today and what the expectation is of what auditors do, that ought to be an issue we talk about.
I often refer to that as the expectation gap. There are standards that are out there we certainly follow and adhere to. There is the expectation by investors, regulators, by others involved with the financial reporting process that auditors should do more. They ought to focus on different areas.
That’s a good discussion to have because there is that expectation gap, and those are the areas we should be talking about. For example, could we do something to enhance the reporting of risk? That was an area coming out of the financial crisis. There seems more interest in how companies manage risk, how they report risk, should auditors have involvement with that process? That’s an interesting area to really expand and have good conversation about.
Again, if there is an expectation (that) auditors should be doing more of that, we should be talking about what should be done to meet that expectation.
Other areas deal with (whether there) are opportunities to simplify the way we report on financial information. The auditor’s report today is pretty technical; a lot of jargon involved with it. Is there a way to simplify that, that would be a much better job of communicating what we are responsible for, what we are not responsible for? That’s a discussion area we would welcome.
In the Indian context, given the problems you have had with Satyam Computer Services Ltd (now Mahindra Satyam), you must have gone through a lot of internal restructuring. What have you come up with to avoid a situation like that again?
There are a lot of lessons learnt coming out of Satyam. In a market like India that is fast growing, that’s got a lot of opportunities, you need to build an infrastructure to support that growth, making sure you have the right people in the right jobs. So we made changes from the leadership standpoint to deal with that. We made significant commitments to training and to educating our people. And we have supported our Indian colleagues in terms of resources from outside of India to make sure we have got the right experience to deal with the issues and challenges this practice is facing. We have tried to approach this in a constructive way.
Ultimately, the focus is on what we can do to drive quality. That has been our orientation post-Satyam.
Post-Satyam, one of the fears has been that auditors and their clients get into a clubby kind of relationship, while a brand getting sullied is a long-term problem. It’s seen as a conflict between short-term interest and long-term damage. How does PwC find the balance?
There’s two ways we think about independence. One, is the audit firm independent in fact, or is it independent from an appearance standpoint? Both have to be considered in that context.
There’s a number of things we do from an independence standpoint. We have rotation of partners. Partners don’t stay on the job after a period of time. The whole idea there is that you don’t lose the institutional knowledge the firm has of a client, but that you have fresh perspective coming in on a periodic basis.
We have strict procedures on what partners and staff can do in terms of investing in different stocks, both from a factual standpoint as well as appearance.
There’s a number of things we do internally to drive the message home about being independent and objective. Ultimately, the role of an auditor is a very difficult role, but we know our responsibilities are to the capital markets, to the investors, and making sure we are doing everything we can do to provide an independent objective point of view on a set of financial statements. It’s really key to our success and out longevity.
Moving to the financial crisis, one of the outcomes has been a big expansion of regulatory reach. Do you feel we are probably losing the balance again because no one knows what the unintended consequences of regulation can be?
That is one of the challenges you always have. A crisis sparks action and always will result in change. I think the challenge all of us have is what can you learn from those situations and make sure you really strike the right balance with the types of changes you want to see. I think the tendency is always to overreach. There’s always unintended consequences. Going through the types of reforms that will prevent this type of situation from happening in the future is really important. I think it is also critical to take time to understand what those reforms are. To really make decisions or reform actions based on fact that you really can understand all those consequences, intended or unintended, may be, and do so in a thoughtful way so that you don’t overreach in the process.
What is the sense you have got from your CEO (chief executive officer) survey?
The CEO survey is an annual survey we do. We release it every year in Davos. Over 1,200 CEOs participate. We think we have a pretty good feel for how the CEO community is feeling about prospects. One of the things that was most encouraging in this year’s survey is the degree of optimism the CEO community is expressing today versus a year ago. It is almost at a pre-crisis high. What is interesting is that it was dependent on where the CEO was located. We know this economic recovery is mixed, depending on what part of the world you are looking at. But the CEO community all over is feeling much more positive, much more encouraged about the prospects of the next 12-18 months.
You are probably going to have emerging markets contribute much more to global growth than ever. What are the broad trends emerging out of the change in the pattern of global growth?
We are seeing a real shift in the economic balance here from the West to the East. The growth prospects the business community is looking at will clearly come from emerging markets. With that it presents a lot of challenges.
Companies are historically used to operating in a developed market. They need to get much closer to these (emerging) markets to understand what the business issues are. So you are seeing companies really begin to shift about how they do business in emerging markets.
For example, companies historically would have much more centralized research and development function. You are seeing companies today get R&D (research and development) on the ground closer to the markets themselves so that they can develop products closer to the needs of the market. They are focused on what they have to do differently to capitalize on opportunities in these markets.
You have two large economic powers over the next two decades, US and China, which have very different structures. I don’t think PwC has dealt with a situation where the fundamental differences between the two largest economies are so great. How do you deal with this challenge?
We are no different than our clients. As the economic power base shifts, so will the world of PwC. We look at the growth opportunities of emerging markets like India, China, Brazil—those significant emerging markets that are going to offer us the greatest opportunity for growth. Today, those countries represent about 15-18% of the world of PwC. Over the next five-six years they will almost be 45%. So you can see a shift in terms of where our business is going to be coming from. It does present a lot of challenges. How do we get the resources, the talent, if you will, in those markets to serve our clients? It is our No.1 challenge facing the firm today.
Since you bring an international perspective, are you happy with the state of policymaking in India? Is it too volatile for comfort?
Whenever you are dealing with a market like India, there is going to be unique challenges you have to deal with. To me, that is one of the aspects that makes operating in a market like India, China or Brazil different than what we have come from. The more we, as a firm, can understand those unique aspects and really respond to those is going to be critical... Those are unique challenges that have to be understood; they have to be dealt with if you are going to be successful.