Tuesday, October 11, 2005

The Threat of Big Four Consolidation

Concerns around the long-term prospects of KPMG to get out of the government’s sights have renewed the discussion of auditor concentration in the accounting industry. The collapse of Andersen did not result in the promotion of Grant Thornton to the Big Five. Instead, the activities of Andersen’s former clients and employees demonstrated that there would only be a Big Four.

Is that enough?

The marketplace, of course, has cast its vote. The collapse of Andersen did not result in a flight to smaller firms, and it is likely that the loss of one of the remaining Big Four would have a similar result. This trend toward concentration merely has accelerated a trend that began as consolidation – featuring such monstrous mergers as Pricewaterhouse with Coopers Lybrand and Deloitte Haskins and Sells with Touche Ross.

What’s next?

Certainly, the rapid growth of smaller audit firms is unlikely. While public companies lament the lack of options, they are really unanimous in voicing the insufficiency of smaller audit firms to meet their complex needs. Joining the chorus is the investment banking community, which has an overwhelming bias toward the services of the Big Four.

The only alternative to audit firm concentration appears to be a forced break-up of the Big Four. Would we see the return of such forgotten partners as Haskins, Marwick, and Lybrand? Could Fidelity wind up selecting Touche Sells as its auditor?

The possibilities are endless, while the plausibility is not.

The problem of how to decompose the Big Four firms would represent the preliminary problem. Regional divisions would make little sense given the broad domestic and global reaches of even smaller public companies. Could you put Deloitte on the East Coast and Touche on the West Coast? Give Coopers the Midwest, Price the Deep South, and Waterhouse Texas and Oklahoma?

The easier option would be to divide the Big Four firms along business lines. This would entail different firms for tax, audit, and consulting services. Maybe Deloitte could resurrect Braxton after all!

The problem with dividing the Big Four along business lines is that it would do nothing to reduce audit concentration. There would be four big audit firms, four big tax firms, and four more big consulting firms.

Did PwC’s sale of its consulting practice to IBM do anything to audit services? KPMG’s spinoff and eventual IPO of BearingPoint? Of course not.

The government cannot do anything to unwind an industry consolidation that has evolved over two decades. The cure would be far worse than the disease. Instead of worrying about audit concentration, the PCAOB and SEC should focus on effective, clear auditing standards to ensure effective, thorough, consistent audits – instead of trying to shape market forces.

By Tom Johansmeyer


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