Should the Big Four Be Broken Up?

The Big Four Accounting firms are under renewed scrutiny. Audit is a low growth industry with 3% organic growth. Subsequently, the Big 4 have moved into consulting and advisory work which has had a growth rate of 44% since 2012. This is viewed as fertile ground for conflicts of interest.

The Wall Street Journal raised the issue in a recent report.

The UK regulators have even suggested that the Big Four Accounting firms should be broken in order to split up auditing and consulting work.  In essence, you would create a market of “audit only” firms.

Naturally, the accounting industry has countered this argument.

But the industry says it helps to have auditing and consulting under the same roof. That setup gives the auditors easier access to technology and expertise about their clients’ businesses. It “provides the structure, breadth and depth of technical skills and industry expertise necessary to deliver high-quality audits,” said Mark Weinberger, Ernst & Young’s global chairman.

Creating audit-only firms, by contrast, “would undermine significant progress made to strengthen audit quality,” Deloitte said in a statement.

When Arthur Anderson collapsed due to the Enron scandal, there was a plea to save the company by separating audit and consulting work.

In the U.S. there was some interest in the matter six years ago.

In 2013, James Doty, then chairman of the U.S. Public Company Accounting Oversight Board, expressed interest in looking at the growth of the audit firms’ consulting practices, but the PCAOB hasn’t taken any public action since.

What has hurt the accounting profession are recent scandals. The largest recent scandal was furniture retailer Steinhoff that was audited by PWC.

They also allege that Steinhoff made loans to these entities, allowing it to book interest revenue that was never likely to be translated into cash. This, they argue, went hand in hand with “round-tripping”, in which large blocks of business were moved off the books and only the profitable bits were then brought back on. The firm has not commented in detail on the analysis, though it has denied impropriety.

Every time there are major accounting scandals the Big Four faces an existential threat.

I suspect that there may be more scandals to come. The debt issuance in the U.S. corporate sector has been at extreme levels for a couple of years. There was investor demand for higher yielding securities and the cost of debt issuance was relatively low to due to low global interest rates. Subsequently, the corporate sector levered up the balance sheet and bought back shares.

If the tide goes out on this trend there will a wave of corporate bankruptcies. The “fall guy” will be the accounting firms and you will most likely see a concerted push to break up the Big Four.

Similarly, on a macro level, there appears to be more appetite to bring up anti-trust concerns. Rumblings about breaking up tech giants such as Google, Facebook and Amazon have surged in recent months. A similar sentiment could develop against the Big 4 accounting firms in the wave of a new debt crisis.