“If the fans don’t want to come to the ballpark, you can’t stop them.”
Hall-of-Fame baseball player and philosopher/sage Yogi Berra
And if the audit regulators don’t want to grasp an issue beyond their reach, you can’t stop them either.
Although, a problem postponed is not one avoided, but only kicked temporarily into the ditch.
That’s why it matters that Richard Moriarty, newly installed chief executive of Britain’s Financial Reporting Council, has accepted – as reported by the Financial Times – that “it would not be a failure if Deloitte, EY, KPMG and PwC still audited almost all of the FTSE 100 by the end of his term.”
In other words, quits at last for the ill-founded rhetoric, since Carillion’s collapse back in January 2018, that reductions in the Big Four’s dominant share of the large-company audit market would somehow be desirable or beneficial.
The position was blared to the skies: Labour MP Rachel Reeves, on her own and as chair of Parliament’s select Business, Energy and Industrial Strategy Committee, the Competition & Markets Authority as then led by Sir Andrew Tyrie, the FRC itself in its strategic plan of March 2018, and the Labour party’s shadow chancellor John McDonnell.
Generously read, Moriarty’s fresh perspective can be taken for recognition that the challenges of auditor scale, geographic coverage, and distribution and accessibility of industry and other expertise – all left unaddressed by the cited critics as they kept silent on the means by which the mooted market disruptions might be accomplished - mean the end of the threats to displace the Big Four tetrapoly any time soon.
Or viewed slightly aslant, the persistent lack of political will, official energy and legislative attention to the accounting profession – manifest in the passage of nearly six years of inaction post-Carillion, and the acknowledged retreat by the government of Rishi Sunak from attempts to overhaul either the audit sector itself or its regulator – has intersected with the dawning realization that officialdom simply lacks the tools by which to re-shape the Big Four’s share of FTSE 350 audits.
In the months after Carillion’s demise, I addressed the vigorous hostility aimed at the auditors. A series of blog posts (here to here) came together in my short book, DOA: Can Big Audit Survive the UK Regulators? (Amazon 2019). There I laid out in detail the impossibility of re-distributing large company audits, whether by forced participation of smaller firms in joint engagements or in actual re-allocation of full-fledged lead auditor execution and responsibility.
In summary, the data starkly demonstrate the limits of the smaller firms – most succinctly captured in their global revenues:
- Although increasingly trailing its brethren, KPMG as it pushes toward $ 40 billion is still three times larger than BDO, at $ 13 billion the largest of the so-called “challenger” firms.
- And at $ 65 billion at the top of the table, Deloitte is some fifty to one hundred times larger than the firms implausibly included in the “challenger” roster.
My central points of four years ago were straightforward:
- “Concerns over the suitability of the Big Audit model cannot be addressed by attempted forcing of shrinkage on the large firms” (page 36).
- “Conceding the legitimacy of the concerns over audit quality, these will not be addressed by moving either clients or personnel from the Big Four to the smaller firms” (page 38).
- “The challenges of scale – geographic coverage, depth of expertise, personnel demands and financial resources – represent barriers to the emergence or creation of new players of Big Four size that are both natural and insurmountable. Those limitations – definitive on the prospects for either market share re-distribution or imposition of joint auditors with the involvement of the challengers – are no less conclusive on the question of ‘split up’” (page 49).
- “The demands of complex multi-country engagements will outstrip the capabilities of networks oriented to serve a small-country client base with limited personnel resources” (page 43).
- “The impact of scale is critical. No number of hours at the controls of a single-engine airplane can qualify its pilot, however skilled, to command a wide-body jet – much less a helicopter or a stealth drone or a space shuttle” (page 41).
- “No network smaller than the Big Four has a prayer of achieving the scale and resources to clamber into a competitive position” (page 37).
Looking back, what matters now is not the arrival of relief after years of Cassandra-like messaging, against a wall of denial, ignorance, and animus toward the Big Four. Rather, it’s what is to come. From the foreword of DOA:
“Outbreaks of financial malfeasance and scandal are nothing new. They are both cyclical and inevitable in the operation of the capital markets – functions of the frailties and cupidity of human nature and the pendulum effects of less-than-efficient market mechanisms.”
Nor should the views here be taken as advocacy for the immunization of the Big Audit model from either criticism or the forces of change:
“The question is not whether the Big Four can survive in a form still fundamentally similar to that invented by their Victorian namesakes. It should be plain that under the combined public, regulatory and legal exposures, they cannot. The large firms have no inherent right to the preservation of their franchise in its current form – they are no more immune to the inevitable forces of evolution than were the dinosaurs or the steam locomotives.”
What deserves present recognition – although unlikely to be officially registered or acted upon – is that fresh financial scandals are gestating even now within the darker corners of the capital markets, only awaiting the conditions for their delivery. When the turn of that next predictable cycle does come, as it will with the certainty that has marked its predecessors for decades, the howls of public protest will sound as if fresh, “Where were the auditors?”
- The still-emerging impacts of the COVID pandemic and the dramatic uplift in interest rates are combining to put stresses on companies struggling to survive. They foreshadow a dramatic increase in company failures and bankruptcies, with resort by the unscrupulous to manipulations and chicanery aimed at evading reality, and with painful impact on investors and other sources of capital.
- Increasing numbers of auditor changes are the result of both adjustments of their client rosters by the larger firms and the expansionist ambitions of the smaller firms – all in the context of history’s lesson that problems in audit quality and performance are most frequently seen in the early years of a replacement auditor’s engagement.
- The current disengagement of the regulators from the basic issues will assure that the unlearned lessons available from the recent past will be sprung as if newly-invented when they befall a fresh generation of inexperienced bureaucrats.
To conclude – Richard Moriarty’s recognition of the structural imperative of the Big Four – under the current model – is a helpful and welcome step.
But there’s a basis for the emphasized qualifier. What Moriarty has achieved should not be over-stated. Critical concerns remain over both the value and the sustainability of the Big Audit model. And all the warnings remain vital and relevant.
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