Break up the Big Four: The radical proposal that's going mainstream
The Big Four is an oligopoly. Don’t take AccountingWEB’s word for it: Bill Michael, chairman of KPMG’s UK arm, admitted as much, too.
“We are an oligopoly — that is undeniable,” Michael said. “I can’t believe the industry will be the same [in the future]. We have to reduce the level of conflicts and . . . demonstrate why they are manageable and why the public and all stakeholders should trust us.”
The term oligopoly is a portmanteau of oligo (small number) and monopoly. It’s a market form where a small number of competitors share and dominate a market. Looking at audit, it doesn’t require a Sherlock Holmes-like acuity to see the market for what it is.
The question, now, is what to do about it. Impetus has been added by a slew of financial reporting failures including Tesco, HBOS and, of course, Carillion. The quality of Big Four’s audit work has been repeatedly questioned by MPs, campaigners and the FRC.
One solution with increasing cachet is breaking up the Big Four audit oligopoly. Previously the sole province of the fringe left, the necessity of a market-busting breakup has seeped into the mainstream. Stephen Haddrill, the head of the FRC, has publicly backed the idea.
The Big Four’s top brass have drawn up contingency plans for when the break-up happens. The break up will cleave the Big Four’s audit arms from its ever-growing consultancy business, ergo ending a pesky conflict of interest.
John McDonnell, Labour’s shadow chancellor, has been a vocal advocate of busting the audit oligopoly. Indeed, McDonnell has long been an interested observer of the accounting profession. Earlier this year at Davos, he suggested that accountants take a Hippocratic Oath.
Now, in a recent interview with the FT, the shadow chancellor described the Big Four as a “cartel”. “They have demonstrated that they have a range of conflicts of interest,” said McDonnell. “I don’t think they have addressed the public anger about their role.”
He added, however, that he’ll delay any final policy decisions until he has received a report on the accounting profession. McDonnell has commissioned AccountingWEB regular Prem Sikka to write the report.
Speaking to AccountingWEB, Sikka outlined the audit problem as a “state-secured monopoly”. The law requires entities of a certain size to be audited; a requirement currently dominated by the Big Four.
The problem, said Sikka, is that the Big Four aren’t neutral. “In society, there are numerous auditors. The National Audit Office audits public bodies, HMRC does audit, immigration officers do audits when they check your passport, the train guard audits your tickets.
“In all of these cases, the auditee doesn’t appoint the auditor, neither do they remunerate the auditor. The auditor is entirely concerned with audit. You don’t go to the airport and say to the immigration officer ‘Here look at my passport, but can you also sell me some consultancy services?’ In that sense, financial auditing is completely out of line.”
Audit forms one part of a range of services offered by the Big Four. And, as many critics have suggested, the integrity of the audit is impugned by the profit motive. KPMG or PwC don’t want to rock the boat as it may endanger their lucrative consulting work.
As Sikka noted, none of the four firms exclusively view themselves as audit or accounting firms. “They don’t advertise themselves as accounting firms or auditing firms. The majority of their income doesn’t come from these services.”
So a breakup is looking more and more likely. But what they might look like is up for debate. It certainly would entail a lot more than simply creating four new audit only firms. “Those businesses would still be massive,” said Sikka. “We need to grow the mid-tier firms, too.”
Replies (11)
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Its not hard to do.
Its just not profitable.
If 4 became 8 by mutual consent of the cartel, ie jumped before being pushed it would reduce the main metric partners judge themselves on. ie how many millions they have made from writing the reports they are asked to write by big business and government.
Eg EY's laughable justification for HS2, who's nose is also massively in the trough for fees on........HS2. It just seems to entrenched now they don't even try and hide it.
This Big 4 bloke may as well have confirmed The Pope is of a particular religion.
Hmmm - we've seen a similar problem with the Banks
Also there was a similar shake up a number of years ago, but the fundamental problem still exists that the Audit firms also have (lucrative) consulting businesses and the problem also lies with the Directors and shareholders of the companies being audited, who should be looking out for such conflicts of interest when appointing.
In my opinion, breaking the big 4 up will not make much difference (BT, Banks...) but forcing the PLC's to change auditors, say, every 3 years might, especially if those auditors are appointed by the Government (as an independent body) rather than by the directors. Combine this with some real power to do something when audits fail and we might get somewhere.
There is an urgent need to decouple audit from the other services accountancy firms offer and not being incentivised to "win other business" off the back of audit would allow the Audit and other services to stand side by side, but also on their own merits.
https://www.ft.com/content/36188f82-b6a9-11e8-bbc3-ccd7de085ffe
I don't know, but here's a slightly different thought. How about we:
- prohibit auditing firms offering any consulting services (although, I will say, as a "client" there are times when it is highly beneficial to get advice from our auditors, because we have a relationship with them and they know us, our situation and our history, so perhaps we should put some form of value or percentage limit rather than an absolute ban)?
- have a mandatory "X" years rotation requirement (3 or 5 years)?
- prevent any ownership cross-holding by owners of the audit firm of consulting firms (and vice versa), and connected parties, and all forms of ownership structures intended to circumvent such rules, including opaque foreign ownership structures?
Sorry, forgot to say it should "all of the above" and not any 1 from 3!!
Of course it is comforting to deal with someone you know, and you do build up personal relationships as the years roll by, and of course the auditors get to know you, and mutual trust develops......
And that is why the current system has failed. All those reasons for snuggling up to the audit firm, and using them to do other things, are the cause of the current mischief. Because that comforting, personal, mutual understanding and trust is actually the crack through which the malfeasance eventually squeezes in.
A good auditor should be cordially detested by the people being audited. It should go with the territory. Just like non-executive directors who the MD can't wait to get rid of because of all the pesky challenging questions they ask, the auditor should be seen as a ruddy nuisance. If that's not the case, the auditor isn't doing their job properly.
The main problem with the ‘big 4’ is that the toothless FRC does nothing to properly monitor them or punish them for their continuous breaches of audit regulations not least conflict of interest etc etc
Maybe labour could be the regulator? I would like to be a fly on the wall at the meetings between momentum and the chief partners at PWC!
The HBOS Carillion etc audit reporting failures pale into insignificance compared with the dodgy bank audits they performed in Latvia (Parex), Ukraine (Privatbank) and the like. Take a look at last week's "Private Eye" (#1478) for some real mutli-million shockers.
Part of the problem is that the auditing company doesn't want to rock the boat because their client is paying the fees, and won't re-hire the auditors if the audit shows them up.
One-year enforced client rotation could solve this as there would be little (or less) incentive to cover stuff up.
Definition of an auditor:
Those that go round after the battle bayoneting the wounded.
Never understood why I have to pay for an audit when as a Director I have to sign a letter absolving the auditors of any responsibility.
My experience is that these auditors send in the juniors to do the work and pocket their partner fees.
First up against the wall in the revolution.
We need to reverse the test. The rise of consultancy was because this was an add on to the captive audience that auditors had. The balance has changed. We should now be able to regulate the big 4 as consultancy firms, and debar them from taking on audit work for their consultancy clients