Live from the archives: Thoughts on competition between the largest global audit firms
My legacy site re: The Auditors is being re-branded and I still have a lot of boxes to unpack here in Philadelphia, so I'm sharing some evergreen thoughts on the Big 4 oligopoly.
I am more or less done with my move to Philadelphia — anyone an expert on getting an old LG flat screen to sound right? — and my official duties as a full-time Wharton Lecturer will start on July 1. I’ve got several newsletters in the hopper but, in the meantime, I thought we could spend some time thinking about the hot topic of monopoly concentration in the context of the Big 4.
If you want to keep up on the latest in antitrust regulatory and legislative activity I have two strong recommendations: 1) Follow Matt Stoller on Twitter and subscribe to his Substack newsletter, Big; 2) Get connected with the Stigler Center and its blog ProMarket.
I wrote a series of three posts about the Big 4 and the lack of competition between the largest global firms for the ProMarket blog as my deliverable for my time as an inaugural Journalism Fellow at the Stigler Center in 2017. In one post I did a manual calculation of the HHI index for the largest audit firms. No one had done it lately. At Wharton I hope to use the automated tools of a big school to look at this subject with more precision.
The bad news is that the Public Company Accounting Oversight Board (PCAOB), which checks auditor quality via an inspection process, looks at smaller audit firms—those that audit fewer than 100 issuers—only every three years, and there are so many more of them to review than larger audit firms.
That means there’s some reason to be glad that there is concentration among auditors for the largest public companies. Audit work at those firms—Deloitte, KPMG, EY, and PwC—is inspected by the PCAOB every year and the inspections are rigorous.
If only we could be sure about that…
But way back in 2006, and then in republished form in 2013, I wrote for my legacy blog re: The Auditors on the list of reasons why the accounting/audit industry should be on any list of industries that should be more competitive. What’s the harm? Auditors are the last stop before public dissemination of financial information via SEC filings, financial statements provided to banks for loans, and information to investors in private companies. If auditors, and their firms that provide consulting and tax services, too, operate with impunity because of a “too few to fail or jail” pass, you’re going to get poor quality, compromised financial reporting or worse: none at all like at Theranos and Ozy Media.
When the Biden Administration published its Executive Order target list in July 2021 , the accounting industry was not mentioned. I was told that most have thrown up their hands. Everyone likes to talk about the power and the conflicts of Big 4 but no one knows what to do about it so the policy is “hands-off” because now there are “too few to fail”.
There is nothing much that’s changed about most of what I wrote below at retheauditors.com ~15 years ago. In fact it’s gotten much worse in terms of collaboration, collusion, domination, and concentration. Just ask the audit regulator, the PCAOB, snookered by one of the Big 4 firms in a big way. KPMG’s top audit partners encouraged former and current PCAOB professionals to commit criminal acts of regulatory subversion that led to guilty pleas and guilty verdicts and now the PCAOB has a long row to hoe back to credibility.
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Competition – Some Thoughts
September 2, 2013
This was originally posted on November 9, 2006. The more things change the more they stay the same. For more recent research on audit market competition and the consequences of another firm exit see “The Problem Of An Audit Firm Market Exit: New Research From University of Chicago Booth School of Business”.
The GAO research for their report, A Mandated Study on Consolidation and Competition, was conducted in Chicago, Illinois, New York, New York, and Washington, D.C., from October 2002 through July 2003. (Sarbanes-Oxley was passed in July of 2002.)
The report, although thorough, was completed very early in the cycle after the passing of Sarbanes-Oxley and while firms were still reorganizing and mobilizing to respond to the dramatic events that occurred. Although a similar study has been completed recently in the UK, with even more dramatic concerns expressed, it is time for an update in the US.
Challenge to big four auditors grows
By Barney Jopson, Financial Correspondent, Financial Times
Published: September 11 2006 03:00
A movement to challenge the dominance of the big four auditors is gaining momentum with confirmation from regulators that many in the City back action to tackle the risks it has created…The Institute of Chartered Secretaries and Administrators suggested the top firms sign a memorandum of understanding agreeing not to poach staff and clients from rivals when they face a crisis of confidence linked to an accounting scandal.From the July 2003 GAO Report entitled, “PUBLIC ACCOUNTING FIRMS, Mandated Study on Consolidation and Competition.”
The audit market for large public companies is an oligopoly, with the largest firms auditing the vast majority of public companies and smaller firms facing significant barriers to entry into the market.
Collusion refers to a usually secret agreement among competing firms (mostly oligopolistic firms) in an industry to control the market, raise the market price, and otherwise act like a monopoly. While overt collusion involves an explicit formal agreement among the firms, under tacit collusion each firm seems to be acting independently with no explicit agreement, perhaps each responding to the same market conditions, but ultimately the result is the same as it is under an explicit agreement.
Which Big 4 practices may be construed as tacit collusion and where do the Big 4 have opportunities for tacit collusion, potentially leading to overt collusion?
1) Recruiting of new graduates as well as experienced hires
Use of Mercer Human Resources Consulting by all Big 4 firms for salary benchmarking info
(When I worked in Latin America, I often thought that partners from competing firms in particular countries must be agreeing on salaries for their staff, in order to not have a bidding war and raise overall costs for all the firms and therefore reduce their partner profits. The partners in professional services firms in any developing country are a distinct population who all know each other, having grown up in the elite class and having attended the same schools, belonged to the same country clubs, lived in the same areas, for the most part.
Even though many of these firms grew and became more sophisticated during the 80’s and 90’s, starting salaries for staff never changed much and significant changes in earnings were only available when a professional reached the pinnacle of the firm, a sort of golden ticket. Most left for industry before getting anywhere near the partnership, a model that still exists in the US.)
Agreements between Big 4 during times of crisis to limit poaching of professionals from other firms (When Andersen was flailing there was an agreement in place. During the KPMG tax shelter issue, all the firms issued these communications, formally or informally, to discourage recruiting from KPMG until the matter was resolved. Who’s idea was this? And how would it have seemed if major energy firms had gotten together while Enron was imploding and decided to give it a better chance of survival by not recruiting its employees until the dust settled? Seems to me to be anti-competitive from the perspective of an open labor market. fm note: How many other times have the Big 4 agreed to avoid recruiting during a time of crisis for one firm? Didn’t a tech company get prosecuted for that monopsony behavior? )
Limited movement of partners between firms. (fm note: That’s changed a bit but partners still have very restrictive agreements on this subject.)
Strict adherence to lists of approved universities for recruiting.
2) Informal roundtables and meetings are being held amongst Big 4 leadership, in particular regarding regulatory initiatives, independence compliance, diversity hiring and quality assurance/ risk management initiatives at forums such as the CAQ and Davos.
3) Peer reviews, still required by many states, even after Sarbanes Oxley mandated inspections by the PCAOB give the firms an opportunity to look inside each others’ operations. The GAO (and other state and federal agencies) utilize the Big 4 to conduct peer reviews of their own operations and hire the Big 4 for special studies of agencies, programs and other activities.
4) Solicitation of new audits/resignation from current audits, including establishment of rates
Understandings/agreements regarding re-distribution of AA clients in 2002.
The new independence rules established under the Sarbanes-Oxley Act of 2002, which limit the non-audit services firms can provide to their audit clients (especially consulting services and internal audit outsourcing) and which require partner rotation, may also serve to reduce the number of auditor choices for some large public companies.
Conceivably, there are scenarios and circumstances in which audit firms would discuss amongst themselves who will do what work for which clients over what periods in order to avoid competition, bidding down of rates and conflicts.
–The most observable impact of consolidation among accounting firms appeared to be the limited number of auditor choices for most large national and multinational public companies if they voluntarily switched auditors or were required to do so, such as through mandatory firm rotation. Of the public companies responding to the GAO 2003 survey to date, 88 percent (130 of 147) said that they would not consider using a smaller (non-Big 4) firm for audit and attest services. (From GAO 2003 Study)
5) Strategic alliances with vendors such as SAP, Oracle, Microsoft, American Express Travel Services that also require a delicate balance between business need and independence conflicts.
6) Industry conferences and other gatherings (AICPA, IIA, ISACA, etc) provide an opportunity for informal meetings and information sharing between firm leaders.
fm note: This was the way one SEC official met with KPMG officials, in one instance, to discuss PCAOB scrutiny without PCAOB officials present. The CAQ is the lobbying organization of the public company auditors, affiliated with the trade association the AICPA.
US Attorney for SDNY Amanda Kramer: What was the purpose of your email on July 14, 2015, to these heads of national offices?
Former SEC Deputy Chief Accountant now head of PwC’s US audit practice Wes Bricker: The purpose was to let them know that I would be attending a CAQ symposium -- CAQ stands for Center for Audit Quality symposium -- and that I anticipated having time for a discussion to listen on matters of interest or concern.
Q. Let's take a look at the email in the center of the page that starts out with the word "Wes." Who sent this email?
A. Dave Middendorf.
Q. What did he say?
A. He said that he also would be at the CAQ symposium. It would be great to introduce himself. He'd also spoken with Mark Northan who is a KPMG partner, and offered to provide views on the allowance for loan loss issues.
Q. Did you in fact meet him that Sunday?
A. I did.
Q. Where did you meet him?
A. We met at the CAQ symposium after the normal agenda for the symposium was over.
(USA v. Middendorf and Wada, 2019, p. 172.)
© Francine McKenna, The Digging Company LLC, 2022