If MPs on the Business and Work and Pensions select committees get their way, the days of the ‘big four’ audit firms – Deloitte, EY, KPMG and PwC – could be numbered.
The pair’s joint report on the collapse of Carillion recommends that the Government refers the audit market to the Competition and Markets Authority (CMA), something for which the regulator’s incoming chairman, the former MP Andrew Tyrie, has already indicated an appetite.
There are two specific terms of reference suggested by the committees to such an investigation.
One is that the CMA considers breaking up the big four into more audit firms. The other is “detaching” audit arms from those providing other professional services, such as consulting, something into which all of the big four have branched out during recent years and which has proved highly lucrative for them.
Neither solution would be straightforward.
Forcing the big four to hive off their consulting arms would run the risk that the more talented staff would head for that part of the business, where the rewards would be higher, rather than the audit arm.
Non-audit work now makes up £4 in every £5 worth of fee income garnered by the big four.
Over time, the pure audit firms might also struggle to attract talent, as a lot of audit work is time-consuming and, frankly, boring. The big four attract talent partly by offering employees the chance to do both consulting work as well as audit.
Forcing people to do just audit might ultimately result in the quality of audits getting even worse. There is also the question of what companies themselves want. Most seem to want to work with professional services firms that provide a range of services, not just audit, particularly the larger companies – who require their auditors to have global reach and expertise in specific industry areas.
So how about breaking up the big four? That is certainly a solution many will find tempting in view of the lack of competition in the market.
The big four have a 97% share of the market in auditing Britain’s top 350 companies and the situation is getting worse.
Grant Thornton, the biggest audit firm outside the big four, recently said it would no longer tender to do audits for FTSE-100 companies because the cost of bidding for work it was unlikely to get was too great. Its chief executive, Sacha Romanovitch, told Sky News last month that the sector should be investigated by the CMA.
Breaking up the big four was ruled out when the Competition Commission, one of the predecessors to the CMA, investigated the lack of competition in audit between 2011 and 2013.
One of the main reasons given is because auditors carry unlimited liability. That naturally tends towards players becoming larger. It is not unknown for auditing firms to collapse – the so-called ‘big five’ became the big four after Arthur Andersen’s criminal conviction for auditing the crashed energy firm Enron – and the fees available are unlikely to be worth enough to make small audit firms want to take on the risk of a large audit account.
Moreover, there is the issue of global reach. Companies operating in more than one country like their auditors to have similar scale. The big four are global businesses.
Forcing a British-based multinational to have a non big four auditor in this country would be pointless when that multinational would, in all probability, be falling back on one of the big four to audit their operations outside the UK. A break-up of the big four would need to be imposed on a global basis, not just here in the UK, to be effective.
That is not to say there are not alternatives to breaking up the big four.
One alternative, which is gaining in attraction, is to insist on ‘joint’ auditors – with each auditor being able to challenge the work of the other – for all listed companies.
France introduced this measure in 1966 to create more checks and balances in the system and to improve the quality of audit work, rather than to improve competition, but it has had that effect.
In the UK, in 2016, 68 firms provided audit services to 1,631 companies with the big four having 59% of the market.
In France, during the same year, 308 firms audited 678 companies and the big four had just 46% of the market.
If enhancing competition was the aim, the existing big four could be prohibited from bidding for joint audits, which would open the door for smaller rivals like Grant Thornton, RSM and BDO. The Competition Commission considered this measure in 2013 but ruled it out on cost grounds.
Another possible alternative should be to force companies to change their auditors more often.
Under EU rules introduced just under two years ago, companies must put the job of auditing their accounts out to tender once every decade and must change their auditor at least every 20 years.
However, some EU countries have gone further, with Italy insisting companies change their auditor every nine years and the Netherlands every 10 years. Further afield, Brazil insists on a change of auditor every five years, while China insists all financial institutions change their auditor every five years.
So making companies change auditor more frequently could have appeal, although as the Competition Commission pointed out in 2013, it would also push up their auditing bills.
Other solutions could include making any company coming to market subject itself to an audit nominated by the stock exchange on which it is floating; making auditors take out insurance to cover liquidator’s fees if a company whose accounts they sign off later goes bust; forcing the rotation of partners working on a specific client’s audit or toughening the powers of audit committees in companies.
Shareholders in listed companies have a role to play here, too, by keeping the auditors on their toes.
While votes against the remuneration report of a company have become common, as have protests against the reappointment of directors, it remains exceptionally unusual for investors to vote down the reappointment of auditors.
During the year before Carillion’s collapse, for example, 97% of the company’s shareholders voted to reappoint KPMG as auditor. That said, there are signs that things are starting to change, with 78% of shareholders in SIG voting against the reappointment of Deloitte as auditor following an admission from the building materials company that it had been overstating its profits.
But a break-up of the big four into a number of smaller players is not the way to bet. If it were that simple, the Government – and governments elsewhere – would have done it by now.