Accounting Firm Choices
The most observable impact of consolidation among accounting firms appeared to be the limited number of auditor choices for most large national and multinational public companies if they voluntarily switched auditors or were required to do so, such as through mandatory firm rotation. Of the public companies responding to our survey to date, 88 percent (130 of 147) said that they would not consider using a smaller (non- Big 4) firm for audit and attest services. See appendix II for survey
questionnaires and responses. In addition, our analysis of 1,085 former Andersen clients that changed auditors between October 2001 and December 2002 suggested that public companies (especially large companies) overwhelmingly preferred the Big 4. Only one large public company with assets over $5 billion that was audited by Andersen switched to a smaller firm. See appendix III for a detailed analysis.
For most large public companies, the maximum number of choices has gone from eight in 1988 to four in 2003. According to our preliminary survey results, a large majority (94 percent or 137 of 145) of public
companies that responded to our survey to date said that they had three or fewer alternatives were they to switch accounting firms. All 20 of the audit chairpersons with whom we spoke believed that they had three or fewer alternatives. Of the companies responding to our survey, 42 percent (61 of 147) said that they did not have enough options for audit and attest services. However, when asked whether steps should be taken to increase the number of available choices, results revealed that 76 percent (54 of 71) of public companies responding to our survey to date said they would strongly favor or somewhat favor letting market forces operate without government intervention.
We also found that client choices could be even further limited due to potential conflicts of interest, the new independence rules, and industry specialization by the firms—all of which may further reduce the number of available alternatives to fewer than three. First, the Big 4 tend to specialize in particular industries and, as our preliminary survey results indicated, public companies that responded often preferred firms with established records of industry-specific expertise, which could further reduce a
company’s number of viable choices.18 For example, 80 percent (118 of 148)
of the public companies responding to our survey to date said industry specialization or expertise would be of great or very great importance to
them if they had to choose a new auditor.19 When asked why they would not
consider an alternative to the Big 4, 91 percent (117 of 129) of public companies responding to date cited technical skills or knowledge of their industry as a reason of great or very great importance.
As figure 7 shows, in selected industries, specialization can often limit the number of firm choices to two—in each case, two firms accounted for well over 70 percent of the total assets audited in each industry in 2002. As a result, it might be difficult for a large company to find a firm with the requisite industry-specific expertise and staff capacity. Figure 7 also shows the impact of the Price Waterhouse and Coopers & Lybrand merger and dissolution of Andersen on industry specialization and associated client choice. While two firms also dominated the four selected industries in 1997, this concentration became much more pronounced by 2002, as illustrated in figure 7. See appendix IV for a detailed discussion of industry
specialization and further industry-specific examples and limitations of this type of analysis.
18
Historically, firm consolidation in particular industries was often driven by the fact that a few largre companies dominated certain industries. Accounting firm “industry
specialization” can be captured by a firm’s relatively high market share, in terms of client assets or cllient sales, in a given industry. The observation that a few accounting firms audit the vast majority of company assets in a given industry does not necessarily indicate that they audit many companies in that industry—in fact, these few “specialists” may audit only a few very large companies. While firms that are not considered to be specialists in a given indusry may audit a large number of smaller companies, they may not have the requisite excess staff capacity or technical expertise necessary to handle the larger clients in that industry, which is implied by the term specialization. Industries conducive to specialization would tend to preclude other firms from easily entering the market and challenging specialist firms’ market share.
19
Industry specialization or expertise ranked third in importance behind quality of services offered (99 percent) and reputation or name recognition (82 percent).
Figure 7: Percentage of Assets Audited in Selected Industries, 1997 and 2002
Source: Who Audits America, 1997 and 2002.
Petroleum and coal products (1997) Petroleum and coal products (2002)
0.1% Other
1.0% Deloitte & Touche
4.3% KPMG
Price Waterhouse Coopers & Lybrand
Arthur Andersen Ernst & Young
0.0% Other
3.1% Deloitte & Touche
2.2% KPMG
Ernst & Young
Pricewaterhouse- Coopers 11.1% 21.9% 28.5% 33.2% 18.2% 76.4% 61.7% 94.6%
General building contractors (1997) General building contractors (2002)
0.6% Other
0.6% Price Waterhouse
3.3% KPMG
Deloitte & Touche
Coopers & Lybrand
Arthur Andersen Ernst & Young
1.6% Other
3.3% KPMG
Deloitte & Touche
Ernst & Young
PricewaterhouseCoopers 13.3% 17.7% 31.6% 32.9% 15.0% 19.4% 60.7% 64.5% 80.1%
Note: Selected industries presented for illustrative purposes, and additional examples are included in appendix IV.
Transportation by air (1997) Transportation by air (2002)
Nondepository institutions (1997) Nondepository institutions (2002)
0.0% Coopers & Lybrand
0.1% Other
0.3% Price Waterhouse
Ernst & Young
1.4% Deloitte & Touche
Arthur Andersen KPMG 0.4% Pricewaterhouse- Coopers 0.1% Other KPMG
Deloitte & Touche
Ernst & Young
20.8% 37.5% 39.9% 13.4% 37.4% 48.7% 2.8% Other 2.8% Price Waterhouse KPMG
Deloitte & Touche
0.9% Coopers & Lybrand
Arthur Andersen
3.6% Ernst & Young
2.9% Other
3.8% Pricewaterhouse-
Coopers
Deloitte & Touche
KPMG
3.8% Ernst & Young
8.9% 8.3% 72.8% 28.4% 59.5% 77.4% 86.1% 81.7% 87.9%
Industry specialization, as captured by a relatively high market share of client assets or client sales in a given industry, may also be indicative of a firm’s dominance in that industry on a different level. As a hypothetical example, consider a highly concentrated industry, with several very large companies and numerous smaller companies, in which a single accounting firm audits a significant portion of the industry assets. This firm’s
interpretation of accounting standards specific to the industry could become the prevailing standard practice in that industry due to the firm’s dominant role. If, subsequently, these interpretations were found to be inappropriate (by some influential external third party, for example), the firm as well as the companies audited by that firm could be exposed to heightened liability risk, which could potentially have a severe negative impact on that industry as a whole as well as the firm.
Finally, the new independence rules established under the Sarbanes-Oxley Act of 2002, which limit the nonaudit services firms can provide to their audit clients, may also serve to reduce the number of auditor choices for some large public companies. As a hypothetical example, suppose that a large multinational petroleum company that used one Big 4 firm for its audit and attest services and another Big 4 firm for its outsourced internal audit function wanted to hire a new accounting firm because its board of directors decided that the company should change auditors every 7 years. In this case, this company would appear to have two remaining alternatives if it believed that only the Big 4 had the global reach and staff resources necessary to audit its operations. However, one of the remaining two Big 4 firms did not enter a bid because its market niche in this industry was small companies. Consequently, this company would be left with one realistic alternative. Although hypothetical, this scenario spotlights another concern that focuses on the potential exercise of market power, as it is highly probable the remaining firm would be aware of its competitive position. Conceivably, there are other scenarios and circumstances in which such a company would have no viable alternatives for its global audit and attest needs.