Holding the big four to account

A break up of the large accounting  giants  may occur naturally, rather than by legislation.

Too big, too concentrated and unable to spot the emerging problems on financial institutions’ balance sheets. These are some of the accusations levied against the big four accounting firms. Indeed, it strikes many as odd that audit, tax and a range of related consulting services, should be concentrated in a mere four firms. Not least, Michel Barnier, the European Internal Market Commissioner, who has put forward a range of proposals to help reduce the dominance of the big four. These include compulsory rotations, joint audits and more frequent competitive tendering amongst a wider range of accounting firms.

Barnier may be on to something; the average audit tenure of FTSE 100 companies is forty-eight  years, this and the fact that all but one of these firms is audited by the big four, suggests that this industry may be closer to a cosy oligopoly than a competitive market.

The one organisation which doesn’t have its beans counted by the big four, Randgold Resources, is audited by BDO Hayward. BDO and other middle market firms are often considered too small to compete for global audit work. According to BDO’s managing partner, Simon Michaels, “audit is the only industry where five billion revenue and presence in fifty-one countries, is considered too small”

The dominance of the big four is a fairly recent phenomenon. Readers will remember the big five, prior to the collapse of Arthur Anderson, and the big six before that. Yet the consolidation of audit services to a mere four firms was a fairly natural transition. David Tweedie, IASB (International Accounting Standards Board) Chairman, reckons that the number may also expand naturally as China continues to develop its own accounting principles and qualifications.  

Tweedie believes that China’s growth will continue to impact on the market capitalisation of firms globally. Already we see the US market cap shrinking from over half of listed companies to a third globally. This is having some interesting effects on an industry which is often derided as a little dull. Middle market firms are already punching above their weight in China and could well become the Anglo American arms of future Chinese accounting goliaths.

This is buoyed by the fact that accounting firms are run as local partnerships rather than global companies. Each partnership in its respective jurisdiction has limited liability to the rest of the wider global partnership. Auditing firms are closer to networks of independent partnerships rather than large multinationals. This should make it easier for Chinese firms to grow and form links with existing western firms.

Yet there are reservations over Chinese expansion in audit services; hardly unexpected in an industry where prudence and conservatism are at a premium. Some objections smack of protectionism and seem quite hypercritical. For instance, the requirement that Chinese qualifications are taken rather than the ACA or CPA (British and American accounting qualifications respectively) is similar to what many countries have imposed in the past.

Other requirements are more contentious. China wants local partners to dominate local offices by 2017. With a string of recent accounting scandals in China, many see this as premature. Inexperienced local partners could well be more sympathetic to government officials which is unlikely to put shareholders minds at ease.

Coming to an amicable solution is difficult. Ideas such as joint audits make accountants and shareholders equally uncomfortable, yet other remedies to the big four dominance prove either illusive or just as unpalatable.

Regulators should hold back. The emergence of China will bring vitality and competition to the audit industry. However if the big four prove capable of dominating Asia as they have the West, expect more grumbles from regulators.