Australian observers are becoming increasingly concerned that large corporates often have little choice of external audit provider, prompting fears that a big four accounting firm failure could leave some companies without an auditor.
While there is no immediate concern of a failure, the issue is up for debate in the G7 economies.
In the UK, the debate over big four dominance has attracted a slew of ideas on how to improve matters. The UK Financial Reporting Council (FRC), which regulates accountants, said that because of the big four’s omnipotence – in the UK the big four audit 99 of FTSE100 companies and 97 per cent of the FTSE250 – and auditor independence rules, many large firms have a choice of less than four auditors.
This has prompted fears that if one of the big four exits the market due to failure, acquisition or otherwise, some large corporates would be unable to find an auditor capable of auditing on a large scale.
In Australia, the situation is being exacerbated by the dominance of three firms – KPMG, PricewaterhouseCoopers and Ernst & Young. According to data obtained by Risk Management from the Australian National Centre for Audit and Assurance Research, Deloitte has about 10 per cent of the listed market as external audit clients, while the other three are all approximately the same size in terms of client numbers, with PwC and KPMG leading in terms of fees. Overall, 87 per cent of all ASX listed companies are audited by the big four.
According to Professor Keith Houghton, Dean and Professor of business administration, College of Business and Economics at the Australian National University, regulations designed to make external auditing a more transparent process following the collapse of Enron and Andersen Consulting in 2001 are exacerbating the situation.
“The choice is more difficult and much more problematic now because of independence threats,” he said. “If you’ve got PwC as a tax consultant, then it really limits your choice for picking an auditor to probably two firms. That is starting to get into very limited choice sets. That is becoming a challenge for boards of directors. That’s not to say that having two isn’t enough to choose from, but it starts to become problematic if you don’t feel as if you get quite the right mix of partners and staff that are being proposed for your audit.”
A case in point, according to a source close to the situation who spoke on condition of anonymity, was National Australia Bank’s search for an external auditor after US regulations on auditor independence forced it to drop its existing auditor, KPMG, in 2004.
“With the National Australia Bank, when they decided to leave KPMG because of the independence issue, they effectively didn’t have much of a choice at all because of existing connections with two of the other big four firms,” the source said. “It was effectively a choice between Deloitte and Ernst & Young and if you want it large scale, maybe Deloitte isn’t the one. Is there adequate choice? No. In this market, even Deloitte struggles with a proposal as big as NAB because they are seen as the fourth of four and markedly different. However, Deloitte does have some very substantial icon non-listed companies, so there is plenty of expertise in the engine room, but not if you are counting heads on ASX companies.”
Some non-big four auditors, meanwhile, privately admit they do not have the capacity to provide audit services to the big end of town, and the barriers to entry are relatively high, experts said. However, Matt Adam-Smith, partner and head of corporate assurance services at second-tier auditor Grant Thornton, said part of the problem for non-big four firms in Australia is perception.
“The largest multinationals need the size of a big four firm to resource them,” he said. “In Australia, less than 75 of the largest companies in the ASX aren’t capable of being audited by firms other than the big four. But if you look at the stats of the ASX200, more than 90 per cent are audited by the big four.
“Why is that the case? Some of that is down to perception – a lot of the directors around town feel more comfortable with the big four brand and that’s a challenge for firms like us.”
In the UK, the debate is well advanced. The Association of British Insurers (ABI) weighed into the debate recently suggesting the big four be forcibly separated from some of their clients through regulation. Other suggestions have involved forced rotation of big four firms around clients, establishing a state-backed audit firm, reversing the merger that created PwC and loosening ownership restrictions on audit firms.
However, according to Houghton, who is also part of an Australian Research Council funded project looking at the future of audit, market-based, rather than radical regulatory solutions, may hold the key to resolving the audit choice issue. “I have little doubt that those market reactions will, and indeed are, occurring in Australia,” Houghton told Risk Management. “We observe that the liquidation type practices of the bigger firms are tending to split off because the market doesn’t want the two sorts of practices together, so we are seeing firms evolve in response to market pressures.”
He added that in the US, market forces are already challenging the status quo. “The amount of choice at the upper end is pretty tight, but what’s happening in the US is that some smaller firms are styling themselves as audit-only firms and picking off particular industries, for example, pension funds,” he said. “So there is a market response to the current pressures that show small, but high prestige niche market-type firms are emerging and capturing important parts of the US audit market.”