Breaking Up The Big Four Would Be Premature
The accounting industry has had a rough enough time of it this year, with one bad story seemingly following another. The failure of leading auditors to detect the accounting shenanigans (or “jiggery pokery” as our own Niamh Brennan likes to call it) at companies like U.K. contractor, Carillion; South African retailer, Steinhoff; and at Colonial BancGroup in the US this year has shed the industry in a most unflattering light.
Consequently, the murmurings questioning whether the so-called “Big Four” audit firms should be broken-up have grown louder in recent months. Indeed, the PwC global chief executive recently described the break-up threat as “real.” Proponents of the break-up argue that having say, eight medium-sized companies would lead to better audits and would serve shareholders better. But while the audit industry undoubtedly needs fixing -as this year’s scandals eminently show- dismantling the Big 4 oligopoly is not the best way to go about it.
A major concern in the industry is the concentration of Big Four firms in the audit market. The figures are quite astonishing: KPMG, PwC, Deloitte and EY audit 98% of the companies listed on the UK’s Standard & Poors 500 and the FTSE 350 indexes. Meanwhile, in Ireland, 95% of Public Interest Entities (PIEs) are audited by the Big Four. A recurring issue is the fact that auditors are not paid by shareholders, whom they serve, but by the company whose accounts they examine. The objectivity concerns surrounding this are well-founded, due to the fact that the Big Four firms earn nearly twice as much from consulting and other services as they do from auditing. The recent legislation bans them from providing both an audit and certain consulting services to the same client, but conflicts of interest still plague the industry. In the US, non-audit fees charged to the same client amount to 25% of audit fees, while in the UK the number is nearly 50%.
However, there are better ways than a dramatic Big Four rupture to correct the incentive problems at the core of the industry. For example, the ties between auditors and their clients could be severed by requiring securities regulators to pick firms’ auditors. Another idea mooted has been the mandatory insurance of accounts, whereby companies must buy coverage for losses from accounting errors and the insurers would, therefore, appoint auditors to assess their risk.
Moreover, breaking up the Big Four firms will not solve the problem arising from the many audit scandals because while the audit firm and consulting firm fall under the same brand, they operate independently. In fact, in some jurisdictions, each practice is a separate entity. When both practices serve the same client, the Big Four firms have ring fencing mechanisms which restrict information-sharing between them. In addition, when the client uses both practices, the contracts are structured separately, as if purchasing from two completely different vendors.
The industry also appears to be cleaning up its act, albeit rather slowly. Many countries have tightened their accounting rules after the infamous Enron/Arthur Andersen scandal and the benefits are tangible. For example, in the US, the number of accounts that are restated because of a material error has fallen considerably over the past decade.
As the global economy moves from making goods to selling services, auditing is becoming more complicated: scale and the multidisciplinary expertise of large firms count more than ever- something that EY head honcho Mark Weinberger concurs with. Weinberger firmly believes that in order for high-quality audits to be conducted, the scale of the existing large audit firm needs to be maintained. His firm’s audit team consists of technology, tax and valuation experts and Weinberger views these as crucial to conducting high-quality audits: “We audit Google, Amazon, Facebook, Salesforce and Oracle — you could not serve those clients without a multidisciplinary group of people. People lose sight of that.”
Despite its flaws, to dismantle the audit industry would be rash and untimely because, for the most part, auditors do an adequate job. A few high-profile cases are often used to tarnish the public perception of the audit industry. Indeed, the public often set their expectations too high when it comes to an auditor’s’ ability to detect fraud. The audit process relies on sample data and so, it is almost unavoidable that some errors will slip through. But so long as these errors persist, the talk of a Big Four break-up will continue.
By Neil Stokes – Business Writer