Lack of Competition in the Large Company Audit Market - Essay Example

Audit Concentration- lack of competition in the large company audit market Introduction Big 4 audit firms in the world include Deloitte, KPMG, Ernst & Young, and PricewaterhouseCoopers. It is believed that on an average more than 90% of large firm audit work is concentrated with these Big 4 accounting firms. Larger listed companies in UK find no choice other than Big 4 so far as qualitative auditing is concerned. There may some benefits of concentration but concerns about high audit costs, lack of competition, and risks of destabilization of capital markets may prove fatal if emergent measures are not taken. Theses issues of audit concentration have been discussed in depth in this write up with recommendations to reduce the concentration as far as possible. The extent of concentration Audit concentration with big 4 is a globalised issue. An “analysis of auditor concentration among G8 economies revealed a high of 99% in Italy, followed by UK (98%), the US (97%), Canada 96%, and Russia (90%). Japan revealed a lower auditor concentration of 84%- while the reasons are unknown, increased activity is occurring in the Japanese audit market owing to PwC winding down their affiliates earlier this year. Relatively lower concentration in Germany (83%) cannot be attributed to any particular cause, whereas G8’s lowest concentration levels in France (61%) are largely due to the implementation of French joint- auditing regulations which were imposed in 1966. Across G8 the Big 4 firms accounted for an average of 91% of the market.” (Grant Thornton LLP, 2008)1. The 98% concentrated UK large audit market can further be divided into two segments; first segment is of FTSE 100 and FTSE 250 companies, and the other segment is of smaller listed companies. The concentration of large audits is evidenced by the fact that segment of “FTSE 100 and FTSE 250 are supplied audit services almost exclusively by Big Four, which audit all but one FTSE 100 companies, and 242 FTSE 250 companies. The other segment of market- smaller listed companies- is supplied by both the Big Four and mid- tier firms. Even here, the Big Four individually have significantly higher market shares than mid- tier firms.” (Oxera, page iv)2 Quantum wise larger audit assignments are only a small portion of total audit market in UK, and 98% of this section of total pool of audit work is concentrated with Big 4 firm. The Big four (Ernst & Young, KPMG, PricewaterhouseCoopers, and Deloitte) have an advantage because “the reputation and depth of resources of big firms put them in a strong position to mitigate the agency and costly contracting costs that are increasingly significant for larger companies largely (Kevin McMeeking, 2006)3 Looking from a broader perspective the concentration of larger audit with Big 4 is a matter of concern when issue is looked from the point of smaller and mid- tier from; but on few issues the concentration is also proving to be the only way out to extend audit services to that elite section of larger companies from pool of audit customers. Though merits of audit concentration are few, but those are worth consideration. Firms with larger share in audit market have two direct advantages. “First, audit firms with larger market shares are able to spread industry- specific training costs over more clients, producing economies of scale that are not easily duplicated by small market share firms. Secondly, large market share firms are able to develop more industry- specific knowledge and expertise, thereby enabling them to provide higher quality services than small market share firms.”(Goliath, September 2003)4 Past experience have shown that audit firms with larger market shares seek transnational partnerships and affiliations and that has resulted into international brand names for such big audit firms. This internationalization of Big 4 has enhanced the competitive position of certain other audit firms that are mid- tier accounting firms or may be smaller firms joining hands in individual nations with Big 4 to execute audits under some affiliation arrangements. In this way big 4 are providing some advantage of concentration to other audit firms, but all this is happening in nations where there are legal entangles to provide audit services directly by Big 4. Causes of concern with concentration of audits Larger companies seeking audits from Big 4 are paying higher costs of such audits and researches reveal that such costs will rise further. It is notable that once the concentration of audits with Big 4 comes down the audit fee will also decrease accordingly. It is reported by an information body of the Big Four Trade Union that a “research commissioned by BDO Stoy Hayward and conducted by London School of Economics reveals audit fees are certain to escalate should one of the Big four firms exist the audit market, leaving only big three in control. The report demonstrate the reduction from big five to big four in 2002, following the collapse of Arthur Anderson, fuelled a 2.4% jump in the average audit fees paid by listed companies, excluding other factors such as change in regulations. Audit fee growth has continued every year since then. The research also shows that a drop of just 10 percentage points in the market share the big four hold at present could lead to the annual audit fee paid by UK’s listed and private companies easing by 7%.” (I Love Big 4, May 6, 2008)5 Oligopoly created by Big 4 is a great impediment to healthy competition emerging from audit experts associated with audit firms other than Big 4. The legacy of concentration of power is that it creates a non- competitive atmosphere. Who cares for the audit observations of Big 4 when others are not provided platform to challenge their competitive capabilities. They might be right professionally but they have not provided room to themselves to be more professionally alert and competitive. Why don’t larger firms have departments dealing with smaller audits? Problems that smaller businesses face in rationalizing their accounting systems might not be there with larger companies. In a way Big 4 and other larger audit firms are loosing opportunities of presenting professional excellence that are provided by smaller audits or professional assignments It is a two way traffic. If smaller firms do not have experience of larger audits, then Big 4 and other larger accounting firms also do not have experience of difficulties faced by smaller auditors on their way to emerging as larger companies. It must not be forgotten that difficult scenarios are exceedingly available with smaller professional assignments. Competition can become acute only when there exist mixtures of larger as well as medium and smaller size professional assignments. That is why “Grant Thornton LLP CEO Edward Nussbaum called for an auditor concentration study in the U.S., recognizing that more accounting firm means greater competition and increases quality and lowers costs to end users” (SmartPros, April 26, 2007)6 Concentration of larger audits with big four in UK also represents a potential risk to the confidence of larger firms. What will happen when the expertise provided by Big 4 suddenly get interrupted as there are no second line of experts to carry on the larger audits on lines Big 4 are conducting. Though there may be different opinion on this issue but the opinion cited in a discussion paper by National audit office (NAO) of UK clearly illustrates the present risky scenario. As per NAO “the concentration of expertise amongst the Big 4 firms exposes the market to risk should one of these firms leave the market for whatever reasons.” (Martin Sinclair, 8th August 2006)7 NAO also has apprehensions when it stated in the discussion paper that “it is unclear that changes to the existing situation can be brought about by without regulatory intervention. The market as it exists in current form, has evolved over the last 10 years or so due to various mergers amongst the top firms to create current Big 4 firms that exists.” Then there is a tendency among larger firms to appoint only one of Big 4 as auditor. These larger industries have perhaps this perception that association of Big 4 as auditors with the industry will create a healthy impression about the firm amongst investors, lenders and financial institutions the firms are associated with. What will happen in the capital market when they get disassociated from Big 4 auditing. So “the key issues concern not only with availability of the supply of audit services from non Big 4 firms, but also buyer behavior which is sometimes based on perception rather than a true understanding of the quality and choice available.”(Grant Thornton News, 15 June 2007)8 Recommendations to reduce concentration Time and again it is stated that larger companies have few or rather no choice for selecting efficient and competitive auditing firm except one of Big 4 as that is specific- industry specialized. There may not be a ready specialized audit firm to take over the job because of gap between Big 4 and next best auditing firm. But Kevin McMeeking9 has ably suggested that “this gap would be reduced if large numbers of medium sized firms agree to merge. Competition could also be improved if the government introduced tax or other incentives to encourage the mid- tier auditors to grow. Mergers and tax breaks might allow the non Big firms to gain more of a foothold in the market by targeting the audit committees of FTSE 250. However, the medium sized accounting firms do not have the motivation or resources to undertake this form of growth overnight.” These suggestions can really bring some results provided some sort of motivation is created amongst the mid- sized audit firms to face competition in order to reduce the concentration of audit with Big four. There is an impression that smaller or mid tier audit firms lacks the capacity and technical expertise to execute large audit assignments. There may be some truth in these allegations, but capacities can be enlarged in any professional firm in anticipation or actual availability of larger professional assignments. Why should an audit firms enlarge its resources and capacities unless they hope to get larger assignments? Like Big 4 firm they have also to keep cost- benefit correlation for survival. In fact the atmosphere in the professional audit market is so vitiated with concentration that smaller and mid- tier firms do not even keep hopes of getting larger assignments. Under such situations the reason of lack of specific industry specialized technical expertise holds no ground for not allotting larger audits to firms other than Big 4. A chartered accountant in UK or an audit professional in other countries has to undergo rigorous pre- qualification audit training before he/she emerges out as member of respective institute. Accounting is the only profession in the world that has reputation of instilling high class competitive professional attributes among its members. It is true that audit professionals associated with small and mid- tier firm might be lacking in experience. But experience cannot be inherited even in larger audit firm. It is gained by handling more and more audit assignments. If the experience could be inherited there would not have been accounting firm failures of Big audit firm like Andersons that rocked the financial world in a very recent past. There is no law in any country that compels larger companies to get their audit performed compulsorily by Big 4 firm. Conclusion Audit concentration problem is grave and solutions are not easily available. What is required is the determination on part of regulatory and government authorities to introduce regulations and legislations to reduce such concentration. Audit committees of larger companies can also play part by shedding the inhibition of getting associated with Big 4 only. References Read More