Judge: “I’ve listened to you for an hour, and I’m none the wiser.”
Barrister: “None the wiser, perhaps, my lord, but certainly better informed.”
-- F.E. Smith, First Earl of Birkenhead (1872-1930)
This series continues, on the proposals floated in London that, as claimed by the proponents, would address issues of quality and competition in the Big Audit market.
The advocacy is vigorous: papers released by the profession’s regulator, the FRC and the nation’s competition authority, the CMA; and a position by a UK government ministry. Proposals include splitting up the Big Four, forcing them to divest their non-audit services, mandating joint appointments, and even turning over the auditor evaluation and selection process to official authority, with the declared intent to reduce the Big Four’s dominant market share of the FTSE 350 down to 80% or even 60%.
Leaders of both KPMG and Deloitte have taken positions that no ancillary work be done for audit clients except as part of the audit. Will such a pre-emptive shift persuade the aggressive critics, or merely be chum for the sharks? Time will tell, and soon enough; although the Financial Reporting Council as the UK's audit regulator is effectively sidelined in the discussion, with the announced departure of its chief executive Stephen Haddrill, the inquiries fast-tracked by Andrew Tyrie at the CMA and City grandee Sir John Kingman are sprinting to their intended yearend conclusions.
Postings here on September 25 and October 8, October 16 and October 24 aimed to bring reality to bear, starting with a graphic illustration of the actual details of the market. With what measure of success? Only to say that the longer the official hand wringing continues, uninformed by attention to the hard facts, the more likely will be the deep and fundamentally harmful effects.
Here a step back, to consider the supply-side.
For context, the 2018 results: First out of the gate was EY on September 13, with global revenue of $ 34.8 billion, Assurance growth of 4.4%, and Advisory and Transactions chalking up 10.1% and 13.9%. Deloitte followed on September 18, muscling its leading position up to a global $ 43.2 billion, with Consulting growing at 15.7% and Audit at 7.7%. On October 1, PwC kept its second spot at a global $ 41.3 billion, with its Audit growing at 4% and Advisory at 10%. KPMG, typically reporting near the year-end, is expected to remain a trailing fourth.
To visualize how completely the Big Four's massive numbers overwhelm the rest, here from the International Accounting Bulletin are the 23 largest networks by 2017 revenues ($ millions):
| Deloitte | 38,800 | Grants | 5,005 | Kreston | 2,262 | RussellBfd | 460 |
| PwC | 37,680 | Crowe | 3,813 | Mazars | 1,680 | MGI | 429 |
| EY | 31,404 | Nexia | 3,620 | PKF Int | 1,298 | ECOVIS | 375 |
| KPMG | 26,400 | BakerTilly | 3,400 | UHY | 540 | ShWing | 361 |
| BDO | 8,133 | MooreSte | 2,909 | SFAI | 524 | EC&CS | 207 |
| RSM | 5,095 | HLB Int | 2,369 | PanChi | 464 |
The trend carries forward for another year -- audit practices continuing to lag consulting, with revenues essentially stagnant save for the effects of fee increases and perhaps uplifts for incremental expansion of work done to issue the standard “pass/fail” report.
That cannot be a surprise. In the FTSE 350 sector where the regulators’ agita is burbling, both the sector itself and movement of clients between auditors are basically zero-sum. That is, since by definition the number of engagements is fixed and constant, acquisition of a FTSE 350 engagement by one firm – Big Four or otherwise -- necessarily means its loss by one of the Big Four.
Where then, would a small firm go, as either a successfully tendering newcomer or as beneficiary of government-coerced market re-allocation, to acquire the necessary qualifications? Neither a losing incumbent Big Four firm nor its experienced although now-redundant engagement team would have any reason to find a migration attractive.
Instead, a larger firm will re-deploy its personnel, through the inevitable effects of retirements, relocations, out-placement and other turnover. Even if a Big Four team could be enticed to move – although with what inducements to “trade down” would take some persuasion – a shifting of bodies, desks and telephone numbers would have no impact on the level of performance quality or actual quantum of competition.
Nor could the newly challenged small firm expect to raid elsewhere. There would be no obvious incentive for team leaders at the other large firms to give up the stability and perquisites of a secure Big Four position, to be lured into the disruption and uncertainty of a supplicant seeking a seat at the big table.
Neither are experienced Big Four partners, capable of leading complex large-company engagements, sitting idly in wait to be poached. The next generation of once and future expertise is developed over a full cycle – staff to senior to manager to partner – with massive efforts of time, training and experience, and through a winnowing process against demanding standards.
The FRC, if it survives, or any other agency that would presume to judge and compare the qualifications of smaller firms to assume the audit of a company of global scale should, then, be able and ready to pose these questions early in its evaluations:
- “As you have never audited a company of this size in this sector, what expertise do you actually have in place today, by which to understand what your staffing and other needs would be?”
- “Assuming you can answer that question, from what sources do you expect to grow, hire or otherwise obtain the personnel and expertise that this engagement will require and that you presently lack?”
Regulators hubristic enough to believe themselves competent to conduct that inquiry would well consider the Dunning-Kruger effect -- that the lower one’s qualifications in an area demanding expertise, the less able to judge both one’s own ability and that of those being assessed, and the more likely are serious errors based on misplaced over-confidence.
Better, they would heed the late William McDonough, first chairman of the Public Company Accounting Oversight Board in the US. Asked in 2005 what the authorities would do in the event of another Big Four failure, he said:
“None of us has a clue.”
This series will continue. Thanks for joining. Please share with friends and colleagues. Comments along the way have been welcome, and are invited, and subscription sign-up is easy and free – both at the Main page.
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