Break-up or audit only? Can the big four firms survive the UK regulators?
‘Whining don’t get the hay in’ was an article of faith for the family farms of my youth on the prairie of agricultural America. Surviving, staying alive to plant another year’s crop, required clear-eyed acceptance of the facts as found, and strategies that were realistic and achievable.
It’s different these days in London, where the model for audits of the world’s large public companies faces a storm of perfervid criticism. The latest is a chapter in the full-throated screed, released on 16 May 2018, by two committees of the British Parliament, broadcasting blame far and wide for last January’s collapse of Carillion.
The report (page 85) would refer ‘the statutory audit market to the Competition and Markets Authority. The terms of reference of that review should explicitly include consideration of both breaking up the big four into more audit firms, and detaching audit arms from those providing other professional services.’
The MPs link arms with an entire chorus line of the like-minded – the competition authority’s own Andrew Tyrie, CEO Stephen Haddrill of the Financial Reporting Council, and City grandee Sir John Kingman as nominee of government itself – all abetted by the shrill voices of enthusiastic commentators.
What is conveyed in passion, however, is lacking in demonstrated comprehension of the target – that is, recognition of the limited ability of government to act in a benign and beneficial way.
Possibly – and in no way as apologist for the big four or their accountability – well-informed information users in the capital markets may truly desire the continued vitality of the current ‘big audit’ model, and the traditional single ‘pass/fail’ audit opinion on the consolidated financial statements of global companies, even if all the qualifiers loaded into that assumption should be taken with deep scepticism.
If so, consider the misguided requirement of mandatory audit tendering, imposed by the FRC in 2012, ostensibly for pro-competition reasons. The resulting cost, disruption and continued concentration have instead now driven Grant Thornton, the fifth-ranked firm in the UK, to foreswear future tendering for FTSE 350 audits – joined this week by BDO’s reported readiness to do the same if forced to shed its practice in ancillary non-audit services.
Demonstrably disruptive on the downside, the UK regulators have the power to kill a big four firm, or indeed the entire model, through failure to recognise the continued application of the law of unintended consequences. What their limited vision and authority shows no ability to achieve is a positive contribution to the stability of big audit.
Splitting up the big four in the UK would be ineffective on a global scale, because failing to reach the dozens of foreign jurisdictions where 75% of the revenue of UK-based FTSE 100 companies is derived. Neither would such a move add any new competition. Instead, the newly created smaller organs would each be partial in scope and limited in industry expertise and resources, hobbled by formidable cost inefficiencies in re-building duplicative infrastructure, and severely weakened in their financial ability to withstand the shocks of litigation and liability exposures that already threaten the stability and very survival of the big four.
As for attempts to force the firms into ‘audit only’ structures, the issues of financial weakening and global impracticality apply no less. More importantly, reverting to the sceptical questions as to the dubious value of the current commodity-valued ‘pass/fail’ report, the rapidly evolving environment of big data in all its various permutations means that every element of the assurance model that was invented in and survives anachronistically from the Victorian era will inevitably evolve as well.
Providers of that service in a form fit for future purpose will require precisely the skills residing in the advisory capabilities of the big four – and elsewhere, to be sure. This means that the deployment by the UK regulators of a ‘neutron bomb’ that would annihilate the big four’s ancillary services would achieve only one dramatically consequential result: after several years of sifting through the radioactive rubble of the disintegrated big four, new species of assurance providers would evolve from the wreckage, emerging out of the surviving niches and other consultancies capable of building the competencies and expertise to provide value in response to the needs of information users.
Asked in 2005 what he and his fellow regulators would do in the event of another Andersen-like failure, Public Company Accounting Oversight Board chairman William McDonough was candid to say: ‘None of us has a clue.’
With the current whining, finger pointing and blame mongering that threaten the availability of assurance in the form that users profess to want, McDonough’s reality check remains a cautioning guide.
Jim Peterson, author of ‘Count down: the past, present and uncertain future of the big four accounting firms’
(www.jamesrpeterson.com)
Break-up or audit only? Can the big four firms survive the UK regulators?
‘Whining don’t get the hay in’ was an article of faith for the family farms of my youth on the prairie of agricultural America. Surviving, staying alive to plant another year’s crop, required clear-eyed acceptance of the facts as found, and strategies that were realistic and achievable.
It’s different these days in London, where the model for audits of the world’s large public companies faces a storm of perfervid criticism. The latest is a chapter in the full-throated screed, released on 16 May 2018, by two committees of the British Parliament, broadcasting blame far and wide for last January’s collapse of Carillion.
The report (page 85) would refer ‘the statutory audit market to the Competition and Markets Authority. The terms of reference of that review should explicitly include consideration of both breaking up the big four into more audit firms, and detaching audit arms from those providing other professional services.’
The MPs link arms with an entire chorus line of the like-minded – the competition authority’s own Andrew Tyrie, CEO Stephen Haddrill of the Financial Reporting Council, and City grandee Sir John Kingman as nominee of government itself – all abetted by the shrill voices of enthusiastic commentators.
What is conveyed in passion, however, is lacking in demonstrated comprehension of the target – that is, recognition of the limited ability of government to act in a benign and beneficial way.
Possibly – and in no way as apologist for the big four or their accountability – well-informed information users in the capital markets may truly desire the continued vitality of the current ‘big audit’ model, and the traditional single ‘pass/fail’ audit opinion on the consolidated financial statements of global companies, even if all the qualifiers loaded into that assumption should be taken with deep scepticism.
If so, consider the misguided requirement of mandatory audit tendering, imposed by the FRC in 2012, ostensibly for pro-competition reasons. The resulting cost, disruption and continued concentration have instead now driven Grant Thornton, the fifth-ranked firm in the UK, to foreswear future tendering for FTSE 350 audits – joined this week by BDO’s reported readiness to do the same if forced to shed its practice in ancillary non-audit services.
Demonstrably disruptive on the downside, the UK regulators have the power to kill a big four firm, or indeed the entire model, through failure to recognise the continued application of the law of unintended consequences. What their limited vision and authority shows no ability to achieve is a positive contribution to the stability of big audit.
Splitting up the big four in the UK would be ineffective on a global scale, because failing to reach the dozens of foreign jurisdictions where 75% of the revenue of UK-based FTSE 100 companies is derived. Neither would such a move add any new competition. Instead, the newly created smaller organs would each be partial in scope and limited in industry expertise and resources, hobbled by formidable cost inefficiencies in re-building duplicative infrastructure, and severely weakened in their financial ability to withstand the shocks of litigation and liability exposures that already threaten the stability and very survival of the big four.
As for attempts to force the firms into ‘audit only’ structures, the issues of financial weakening and global impracticality apply no less. More importantly, reverting to the sceptical questions as to the dubious value of the current commodity-valued ‘pass/fail’ report, the rapidly evolving environment of big data in all its various permutations means that every element of the assurance model that was invented in and survives anachronistically from the Victorian era will inevitably evolve as well.
Providers of that service in a form fit for future purpose will require precisely the skills residing in the advisory capabilities of the big four – and elsewhere, to be sure. This means that the deployment by the UK regulators of a ‘neutron bomb’ that would annihilate the big four’s ancillary services would achieve only one dramatically consequential result: after several years of sifting through the radioactive rubble of the disintegrated big four, new species of assurance providers would evolve from the wreckage, emerging out of the surviving niches and other consultancies capable of building the competencies and expertise to provide value in response to the needs of information users.
Asked in 2005 what he and his fellow regulators would do in the event of another Andersen-like failure, Public Company Accounting Oversight Board chairman William McDonough was candid to say: ‘None of us has a clue.’
With the current whining, finger pointing and blame mongering that threaten the availability of assurance in the form that users profess to want, McDonough’s reality check remains a cautioning guide.
Jim Peterson, author of ‘Count down: the past, present and uncertain future of the big four accounting firms’
(www.jamesrpeterson.com)
