Glendower: “I can call spirits from the vasty deep.”
Hotspur: “Why, so can I, or so can any man;
“But will they come when you do call for them?”
-- Wm Shakespeare, I Henry IV, iii, 1
Can concerns over the suitability of the Big Audit model be addressed by forcing the large firms to shrink their dominant market share – or any of the other "solutions" mooted in the UK by regulators and politicians?
Abetted by the ICAEW, the Big Four floated last month a readiness to reduce their 97% share of the FTSE 350 to 80%. Not good enough, said the Financial Times on September 2, plumping for 60%.
The last year has seen multiple renewals of the perpetual question, “Where were the auditors?” Colonial Bank – Carillion – Danske – Gupta – Steinhoff – ImdB – the examples circle the globe. In London, hostile critics are circling -- fairly salivating at such notions as breaking up the Big Four, stripping them of their ancillary non-audit services, or nationalizing the selection and assignment of large-company engagements.
A blunt truth, for those desiring to maintain the current model of private assurance on the global financial statements of the world’s large companies: none of these can be achieved in a non-disruptive way, nor would they touch either competition or quality, except to be seriously detrimental to both.
To start what will become a series -- the topic being too complex to cover in a single go – there is the simple matter of scale. This graphic[1] arrays ($ millions) the 23 international accounting networks with 2017 global revenue above $ 200 million – from giants Deloitte and PwC at $ 38.8 and $ 37.7 billion down to the $ 361 and $ 207 million of Asia-based ShineWing and UC&CS of Latin America.
The visual message is simple and stark. No network smaller than the Big Four has a prayer of achieving the scale and resources to clamber into a competitive position.
The importance and impact of scale show a fatal flaw in the “market reduction” proposition -- displayed right there on the familiar but under-appreciated “hockey stick” curve. Other examples abound:
- Earthquake damage: there are countless harmless daily tremors, while the exceedingly rare catastrophes are devastating.
- Book sales: a handful of blockbuster authors – J.K. Rowling, Dan Brown, Bob Woodward – overwhelm both the modestly successful and the long tail of unread dissertations and self-publications.
- Destructive weaponry: the number of nuclear weapons is small but existentially threatening, scaling down from warships and assault helicopters to the local impact of hand-carried firearms, clubs and spears.
Not only does scale matter – its impact is exponential. The two largest of the Big Four are ten times the size of numbers nine and ten – and one hundred times the size of the two at the far right.
The issue need not assume quality differences. Hosts of talented but struggling and unemployed actors and musicians and athletes wait on tables and hustle ride-shares, while a handful of super-stars get the plum jobs and sign the extravagant deals. In the 16th century, the small cohorts of Pizarro and Cortés with their Spanish arms, armor and horses subdued the entire Incan and Aztec empires.
On the same core principles -- no amount of best-quality experience auditing community banks and retail brokers and owner-operated corporations can equip any of the thousands of small-network auditors with the credentials, expertise and geographic presence to take on the engagement of a Barclays Bank or a GlaxoSmithKline.
Those examples are cited deliberately. They are urged by the Financial Times as among the “prize mandates,” whose audit committees under a re-engineered model “can as easily appoint an auditor from outside the Big Four as they currently do from within.”
Perhaps not. Shift from the visual to the verbal, with a look at Barclays’s 2017 Country Snapshot. That report, on the global tax position of the UK’s second largest bank by assets and ranked 17th by market capitalization in the FTSE 100, examined and reported on by KPMG, covers 36 countries where the bank’s local turnover ranges from £ 13 billion in the UK down to £ 10 million, plus an additional ten countries below that cut-off.
The scope of KPMG’s tax report, laid out in its footnote, displays the auditor’s obligation to provide holistic global capabilities -- among other matters, to address “which entity to report activity under,” and intra-group eliminations that “include dividend payments, income from intra-group transfers of assets, and income rising from hedging transactions….”
Against those broad needs, an admittedly non-comprehensive sample looked at the publicly-disclosed resources of the four international networks that rank ## 7 through 10, as reported for the ten countries above the Barclays materiality cut-off. Some reasons emerged for possible concern:
- Many of the firms bear the single name or are still under the first-generation leadership of a founder – suggesting at least a question of maturity.
- Several firms disclose that management and service delivery in their locally-listed offices are coordinated regionally or from ex-country locations.
- Of those showing local personnel numbers, a count of five or fewer partners is frequent – several with no more than one or two in the assurance practice.
- And in the disclosures of industry sector or audit practice capability, banking is almost never included.
Emphasizing again, these challenges take no position on any relationship between size and quality – only that the demands of complex multi-country engagements will outstrip the capabilities of networks locally comprising a small-country client base and limited personnel resources.
Coming installments here will go deeper: the impossibility of nationalizing audit assignments; the fallacy that “joint audit” could be a realistic springboard from which a small firm could vault up to an upper tier FTSE-indexed engagement; and the question, if the Big Four were to surrender clients, just who would choose, and how.
For now, it ought to be clear that neither wishing nor complaining, however loud and passionate, make for achievable policy.
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[1] Source: the International Accounting Bulletin
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