What Money Can't Fix
Originally published in the International Herald Tribune on April 6, 2007
Billy Rose, the legendary Broadway producer of the 1920s and 1930s, offered a maxim to anyone hoping to replicate his success: "Never invest your money in anything that eats." Rose was referring to showgirls and racehorses, but his admonition could apply equally to accountants and auditors.
In a report released in mid-March(here), the U.S. Chamber of Commerce, a trade group and lobbyist for American business, advanced the notion that client service by the four remaining global accounting partnerships would be better provided if the accounting firms could bring in outside investors, like private equity or venture capitalists.
The global firms, not so long ago numbering eight, are stretched to their limits by the corporate governance requirements of the American Sarbanes-Oxley law and threatened with multibillion-dollar litigation liability. Cash infusions, the chamber argues, would either support survival-level insurability, or encourage the creation of new firms to lighten the load of and provide competition to the current Big Four.
The business group's report - the latest of a growing body of commentary bemoaning the erosion of American competitiveness in world capital markets - makes some good points. It calls for cooperation among domestic and international policy makers, and it suggests that U.S.-based auditors of public companies might better operate and be regulated under national government charter, supplanting the current patchwork of state-level authority.
But on the issue of outside capital, for several reasons, the report is wrong. It is not a solution.
For starters, what would be the real role of venture funding or private equity in a global accounting partnership? The business model is that the firms are capitalized by their partners' collective contribution, and the partners share in the profits. But the Big Four firms already manage to run their global operations today on the modest working capital provided by their individual partners. Simply put, they don't need the money.
And since no capital comes cost-free, the accounting partners would have to vote away major portions of their current personal profits to pay the handsome return on investment that private equity investors would demand.
If the idea is that fattening the firms' balance sheets would cushion a huge litigation charge, then it's doubly perverse. If increased capital acts as a form of self-insurance, a simpler solution is immediately available: New insurance companies might provide the Big Four with the high-limit coverage that is not available today.
The trouble is, the business case goes the other way: Billion-dollar coverage is not to be had at any price. Rational insurance industry decision makers see the accountants as effectively noninsurable at levels meaningful to their survival.
And for the other perversity, exposing any additional capital to the hazard of plaintiffs' claims would only feed the beast of litigation. It's basic economics: Prices rise to eat up available subsidies. If dog food costs $1 a can, and for public policy reasons a subsidy of $1 is made available, the consumers' cost immediately becomes $2.
The same goes for litigation settlements. Arthur Andersen's defunct U.S. unit has just settled its Enron litigation for $72.5 million - the most the plaintiffs could get out of the dry husk of this once-great enterprise. But in 2002, plaintiffs hailed Enron as the first billion-dollar settlement payment from an audit firm - an outcome frustrated only by the death of the Andersen global partnership, the golden goose that laid those eggs.
The chamber's other argument in favor of outside capital is to finance new competitors to the Big Four. But studies last autumn by two consultancies, London Economics and Oxera (here) , concluded that creation of a Big Fifth or Sixth would require talent, funds and risk appetites that simply do not exist. Shrinkage to the critically small quartet has followed a natural, inevitable and irreversible evolutionary course. There is neither incentive nor authority to expand among the Big Four, their smaller brethren or the clients - and certainly not with regulators.
Finally, despite Billy Rose's caution, venturesome capital has an insatiable and nearly unreasoning appetite, with an urge to engulf and devour that now runs from the Four Seasons hotels to Boots pharmacies to Madame Tussaud's wax museums. If the private equity funds saw a compelling case to invest with the accountants, they would already be there.
In short, pumping outsiders' funds into the accounting firms is a solution nobody wants, for a problem that their money cannot solve. The suggestion is not a silver bullet, but a popgun blank.
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