Monopolistic Complacency and the Big Four

A couple of “industries”, audit and management consultancy, which have deliberately entwined themselves round each other and called themselves ‘professional services’, have developed strongly monopolistic tendencies. The degree of industry concentration is truly remarkable: the four leading firms employ around 650,000 people, earn revenues of over US$100 billion, and take around 80% of the global market for large and medium businesses, plus a huge involvement in public sector consulting.

The big four ceased to be truly competitive decades ago. They now exist for the benefit of their own people, rather than their customers. It’s a carve up comparable to the various cartels and closed shops which existed in the City of London prior to the ‘big bang’. It seems unlikely to last much longer.

There is no reason why audit and management consultancy should combine, other than to screw the customer. The essential task of audit is to confirm that the picture presented to the outside world in the company’s annual statement and accounts is both ‘true and fair’. Management consultancy has no role in that assessment. The essence of audit is its independence and objectivity as well as its professional competence. Being employed by the audited firm as a management consultant, doesn’t just raise conflicts of interest, it compromises the whole audit process.

The big four have become so immersed in this compromised process that an audit certificate signed off by any members of PricewaterhouseCoopers, Deloitte, Ernst & Young, or KPMG, might appear to be not worth a great deal. They are probably worth no more than the late Arthur Anderson’s audit of Enron. That certainly seems to be the case with PwC, whose chairman echoes Arthur Anderson’s complacency with his message that if an auditor was required to certify the accounts as really true and fair, then they would have to be paid a whole lot more than thy are at present (Guardian 16.12.11). Is he suggesting the current generation of PwC audit certificates are not to be taken seriously? Are Deloitte and the others any different?

Traditionally the audit function was carried out by an appropriately qualified accountant working for a professional partnership, with partners personally liable for the quality of its work. The 21st century saw the introduction of the limited liability partnership (LLP) which enabled bad advice to be given and mistakes made, without any liability being born by the partners. This is the context for the PwC chairman’s contemptuous attitude to audit certification.

As pointed out elsewhere on this site, the LLP is not a taxable entity. Moreover, partners are enabled to register as domiciled for tax purposes wherever their payments might be minimised. Not surprisingly, a substantial slice of the big four’s income is derived from advice on how to avoid paying tax.

The European Commission’s scrutiny of this industry has raised some interesting challenges. They proposed, yet again, that professional services companies must break themselves up so as to separate audit operations from all the other functions, and that companies must also, to preserve audit independence, change their external auditors at least every six years. Not surprisingly, the big four have never liked these ideas and have always previously managed, with support from the ‘madmen in authority’ and their City clients, to avoid them being enacted. Ironically, the UK’s newly detached relationship with the EU might result in more progress being made this time.

However, the real solution is in the hands of companies themselves. If a company was concerned for its annual report and accounts to have real credibility, it should, unlike Enron, be able to demonstrate the independence of its external auditors. That would be achieved by choosing to use either a big four firm’s audit, or its advisory services. But never both.

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