Big Four Breakup

After much speculation, the Big Four Accounting firms - Deloitte, KPMG, Ernst and Young, and Pricewaterhouse Coopers – are finally being investigated for anti-competitive practices. Despite ardent protests, the companies are now facing a much-needed inquiry, giving hope to the demands for structural change..

After much speculation, the Big Four Accounting firms - Deloitte, KPMG, Ernst and Young, and Pricewaterhouse Coopers – are finally being investigated for anti-competitive practices.  Despite ardent protests, the companies are now facing a much-needed inquiry, giving hope to the demands for structural change in the audit industry. 

Earlier this year, UK lawmakers began suggesting a change in the structure of audit firms when British company, Carillion, collapsed, partly due to KPMG’s failure to challenge its aggressive accounting practices.  In addition, KPMG is embroiled in scandals with corruption in South Africa, negligence in the United Arab Emirates and theft of confidential information in the United States. 

The other firms have also had their share of global controversies but market dominance and the lack of alternatives for clients helps Big 4 firms to endure turbulent times and remain a leading international auditor. In addition to market dominance, across the world, the law requires companies to be audited, thus ensuring a constant demand for audit services.  

On the heels of this momentous investigation is another one by the UK Financial Reporting Council. The rise of controversies involving the Big Four have increased calls for changes, creating the momentum for the rapid transformation of the industry.  As the Competition and Markets Authority (CMA) evaluates the audit industry, any changes they implement have the potential to impact millions of people. In addition to the people within the companies, people investing in defective companies will also be significantly impacted. 

The industry is being investigated for the extent to which small companies are able to compete and the potential for conflicts of interests between the audit and consulting arms of the Big Four. Calls to spin off non-audit services are based on limiting these conflicts of interest, which existing limits and restrictions have failed to minimize. Proponents see the split as a way to ensure that auditors cannot be swayed by the possibility of receiving large non-audit accounts. The widespread push has also motivated the CMA to work quickly in its investigation and it has promised to share its initial findings by the end of the year. 

The fast-moving investigation will hopefully spur the Big Four to take some proactive steps towards addressing these concerns and minimizing the risk of drastic regulations being implemented. However, the Big Four themselves – as expected – have been vocal critics of any changes to their business model. They have cited the benefits of leveraging audit expertise across industries and the need for large multi-functional companies to fully manage the needs of the biggest companies in the world, like Amazon and Alphabet. 

The Big Four has a vested interest in retaining their current model but their current strategy of simply refuting the proposed solution is futile without providing a viable alternative.  As Arthur Anderson – a now defunct accounting firm – shows, the tolerance for pervasive misconduct by audit firms is not unlimited. The firms have also mentioned that spinning off their audit services will be disruptive to the economy and could be detrimental to capital markets. However, this argument fails to consider the current detrimental effect their low-quality audits and oligopoly of the market is having on the economy. In addition, audit services already make up only 30 percent of the firms’ revenue, as of 2017. Leverage expertise and serving large clients will still be possible through their consulting and tax business functions. While providing audit services to firms of Amazon’s size might prove to be a more difficult hurdle, the increased competition opportunities will allow smaller firms to shoulder more of the burden and find viable alternatives to ensure the provision of quality audit services. 

Making significant changes to an industry as concentrated as the audit industry is a monumental task, and is sure to cause some level of disruption. However, the fear of change alone is not sufficient to avoid overhauling the industry, especially in the face of serious conflicts of interest and compromises of audit service quality. The Big Four should stop resisting impending changes and realize that individuals, competitors and regulators are unwilling to continue in this broken system. Embracing this changing tide will make it easier for them to adapt to new regulations, while also helping clients and small audit companies benefit from a more competitive environment.