LONDON: How tough can life really be at the top of a “Big Four” auditing firm?
You inhabit a world where not only must customers by law buy your product, but, happily, one where the most lucrative also seem wedded to dealing with only the biggest practices — whether out of snobbery, the need for international audit coverage, or just the nebulous sense that investors might otherwise disapprove.
The one nightmare you have is that a giant accounting scandal could somehow bring retribution. Your size and reach makes you a tempting target.
But even here, that same oligopoly rides faithfully to the rescue. Since the demise of Arthur Andersen — the fifth pillar of what was until 2002 the big five accountants — the authorities have helpfully thrown a cordon sanitaire around the survivors, fearing the descent into an even more dominant big three.
It is why when KPMG was found to be peddling illegal tax schemes in the US in 2005, it was let off with no more than a slap on the wrist by the authorities.
Or why the whole big four — PwC, EY, KPMG and Deloitte — emerged from the furnace of the financial crisis with just a minor singeing.
There is, however, one nagging blot on this landscape. Each successive scandal raises the same awkward questions. Does this comfortable structure really promote audit quality?
And by allowing a few giant firms to dominate the profession; has control of this systemically important industry been handed to a few self-interested actors — concerned mainly with preserving their own privileges rather than promoting the public good?
The collapse of the British outsourcing firm Carillion is the latest scandal to cause these worries. Despite absorbing expensive advice and assistance from all of the big four at a princely cost of £51m over a decade, its failure has been dominated by allegations of financial misreporting.
How did the auditors, the giant KPMG, express no concern over reported profits of £150m just months before it emerged these were illusory?
BREAK-UP OF BIG FOUR NEEDED
The UK parliamentary report into the scandal two weeks ago called for a break-up of the big four, saying they operated as a “cosy club incapable of providing the degree of independent challenge” that was required.
It is hard to argue that some sort of shock is needed. Markets only function when participants perceive some threat to their position if they fail to perform or innovate.
Yet in auditing, the moat between the big four and the rest is only widening, despite recent moves designed to reduce conflicts and spark more rivalry. Brought in after the crisis, these oblige quoted companies periodically to re-tender audits.
In March, Britain’s fifth-biggest firm, Grant Thornton, announced it would no longer tender for audits of FTSE 350 companies. It said that all retendered contracts were simply being passed reflexively around the big four.
Add to all that the regulator’s well-known “light touch” approach to the top firms, and you have a situation where big four partners may no longer feel they have to look over their shoulders.
That makes them vulnerable to the blandishments of a high-paying client, whose boss has a life-changing bonus riding on its next figures, and some daring calculations to push.
Rather than holding themselves and clients to the most exacting standards, the oligopolists can use their influence to shrug off liability, introduce overly complex disclosures and procedures that need heavy investment, and find ways to introduce “tick box” formulas into what should be principled rules.
Would break-ups change all this? Potentially yes, if investors were also prepared to step up and be both more demanding of audits, and rewarding of quality.
The present arrangement, in which the company chooses the supplier of the audit rather than the (passive) investor, is unhealthy, leading to the sort of conflicts which bedevil, say, the US health insurance market.
The practical challenges are not insuperable. The big four claim theirs is a special market that needs scale because of the global demands.
But there is little difference to legal services. And there are plenty of international law firms.
The big four are global alliances built on national partnerships. There is a public interest in making life less comfortable for the masters of the auditing universe; not least to restore sterner oversight to those that perform this vital function.
When asked in the 1930s who audited the auditors, Arthur Carter, a partner at the US firm Haskins & Sells responded:
That was queasy then. It should not be acceptable now.