December 9, 2020

Sustainability: Are Proxy Fights Looming?

Liz blogged last summer about how some short-term activists were making a pivot to ESG and wondered whether this trend would intensify. There have been whispers that investors want to see more climate expertise on boards – but not much has come of that so far. Earlier this week, though, the WSJ reported that Engine No. 1 LLC, a new activist investor with a focus on sustainability, has taken aim at Exxon Mobil:

Engine No. 1 LLC, an investment firm launched by Chris James last week, is preparing to send a letter to Exxon ’s board urging the Irving, Texas-based company to focus more on investments in clean energy while cutting costs elsewhere to preserve its dividend. The letter, a copy of which was viewed by The Wall Street Journal, identifies four people the firm plans to nominate to Exxon’s 10-person board.

The article also identifies CalSTRS as one shareholder that supports Engine No. 1’s cause. CalSTRS issued a press release confirming that it intends to support Engine No. 1’s alternate slate of board members, which includes a link to Engine No. 1’s proxy fight website.

We’ll see where this goes — the WSJ article notes that it’s possible the campaign will fall flat. A CNBC article discussing the matter says that for a long time, Exxon would’ve been an unthinkable target for activists given its size. In an effort to get large investors on board with the campaign, CalSTRS reached out to Larry Fink, BlackRock’s CEO, although the article notes the pension fund hasn’t received a reply. But Exxon’s shareholders have been at the forefront of climate-related shareholder proposals before. In 2017, shareholders approved a climate change proposal at Exxon, and back then climate proposals weren’t seeing much success.

Audit Fees: Effect of Negative Auditor Attestation Persists for Several Years

Audit Analytics recently released a report looking back at 18 years of audit and non-audit fees paid by accelerated and large accelerated filers. The report covers the period 2002 through 2019 and is heavy on data – but what I found interesting was an analysis of fees paid by 105 companies that disclosed ineffective ICFR during FY 2016. Although one would expect that an adverse auditor attestation could lead to increased fees, the report says those higher fees persist for several years. Here’s an excerpt:

Companies that disclosed an adverse auditor attestation paid more non-audit fees, including audit related, the year of the disclosure. These same companies experienced an increase in audit fees that peaked the year after the disclosure. An increase in fees attributed to negative auditor attestation persists for at least three years after the disclosure when fees, excluding audit related, ranged 54-83% higher than average and when including audit related, were 48-76% higher than average.

The report also includes detailed trend data showing the split between audit and non-audit fees. In a bit of good news, the amount of non-audit fees was the lowest ever paid in 2019 at $112 per $1 million in revenue if audit related fees were included and $58 if excluded. Average audit fees paid per $1 million in revenue dropped to $495 in 2019 after several years of running above $500.

Benefits of Audit Partner Rotation?

The recent SEC amendments to the auditor independence rules generally provide more flexibility to companies when selecting an auditor. One topic about auditors that’s been quiet for a while now, is “auditor rotation.” One reason could be because the five-year rotation requirement in the United States for audit engagement partners seems to have quieted calls for auditor rotation. Now findings from two recent studies suggest auditor partner rotation doesn’t deliver many benefits.

A article discusses findings from two studies that analyzed the two most frequent reasons in favor of auditor rotation: assumptions that personal ties developed over time between auditors and clients can compromise the accountants’ independence and as a result, audit quality; and that mandating rotations brings a fresh look to audits that likely enhances quality of reporting.

The first study from Auditing: A Journal of Practice and Theory found that there was no significant fall-off in reporting quality over the course of partners’ five-year tenures and little or no evidence that fresh looks make for improved audits. If anything, the study found a decline in audit quality with a new engagement partner, possibly reflecting less knowledge about the client than the previous engagement partner.

In another study, this one from Accounting Review, findings indicated audit quality over the five-year rotation cycle is unrelated to the length of the audit partner’s tenure with clients, except for restatement announcements, which were more frequent in the first two years after rotation. This study suggests there is a benefit of fresh looks but at the same time found that other important indicators of audit quality do not. The researchers concluded that for the average client engagement, mandatory [partner] rotation appears to be short enough to prevent capture or complacency and at the same time finding only limited evidence of fresh-look benefits – potentially because audit firms anticipate and invest resources to reduce potential disruption from mandatory audit partner rotations.

With these two studies suggesting audit partner rotation has little impact on overall audit quality, perhaps the real benefit of mandatory audit partner rotation is that it calms those who’ve called for periodic audit-firm rotation.

– Lynn Jokela