Are Highly Concentrated
Another key statistical measure that is used to assess the degree to which a market is dominated by relatively few firms also shows that the public company audit market is highly concentrated. The Hirschman-Herfindahl Index (HHI) is one of the concentration measures used by government agencies, such as DOJ and the Federal Trade Commission, to aid in the assessment of market structure and potential market power. An HHI for a market is calculated using the various market shares of the firms
3
Data on audit revenue from the Public Accounting Report include revenue from audits of both public and private companies. Unless otherwise noted, market shares and other concentration measures in this report are based on audits of public companies only.
competing to offer goods or services within it.4 According to merger guidelines issued by DOJ, an HHI below 1,000 indicates a market that is predisposed to perform competitively and one that is unlikely to have adverse competitive effects. An HHI between 1,000 and 1,800 indicates a moderately concentrated market, while an HHI above 1,800 indicates a highly concentrated market.
As shown in figure 12, the HHI in 2006 for the overall market for public company audits—as determined based on the audit fees collected by accounting firms auditing public companies—was 2,300, a level considered to be significantly concentrated. This represents a slight decline since 2002, when the audit market’s HHI was around 2,390 after it peaked following the dissolution of Arthur Andersen.5
4
HHI calculated based on Audit Analytics audit fee database by summing the squares of the individual market shares of all the firms within a given market. For example, a market consisting of five firms with market shares of 35 percent, 30 percent, 20 percent, and 10 percent has an HHI of 2625 (352 + 302 + 202 + 102). The HHI reflects both the market shares of the top firms and the composition of the market outside of the top firms, whereas the four-firm concentration ratio does not.
5
A study by London Economics in 2006 for the European Commission found that the audit market HHI in the UK and member countries of the European Union varied widely but were generally higher than the HHI threshold of 2000 used by the European Union as indicating a market where a merger could create competitive concerns. See London Economics in association with Ralf Ewert, “Study on the Economic Impact of Auditors’ Liability Regimes,” Final Report to EC-DG Internal Market and Services (Frankfurt am Main, Germany, September 2006) and Official Journal of the European Union, “Guidelines on the assessment of horizontal mergers under the Council Regulation on the control of concentrations between undertakings,” 2004/C31/03 (May 2, 2004).
Figure 12: Hirschman-Herfindahl Indexes, 2000-2006
Note: HHI figures based on total audit fees.
We also found that analyzing the audit market by region and industry reveals that many industries were similarly highly concentrated and that concentration also exists across six major geographic regions of the country.6 We segmented the market into distinct economic sector (industry) audits and distinct regional audits. As figure 13 illustrates, all industries are above the threshold for significant market power and have generally shown some improvement since 2002, but some sectors are significantly more concentrated than others. A number of these industry- specific markets would not only be considered tight oligopolies but would also be considered dominant firm markets (one firm holding over 60 percent of the market with no significant competitors). For example, Ernst
6
This does not imply GAO advocates defining the audit market this way, rather this segmentation suggests some differences that might be relevant for analyzing choice and other competition-related matters. Only if we can define industry-specific markets and regional markets as unique audit market sectors of the economy is such a characterization appropriate. Evidence suggests that some sectors have particularly complex audits and sector-specific expertise is an important determinant of auditor choice. This should be viewed in light of the fact that many companies are involved in activities that cut across multiple industries. 0 500 1,000 1,500 2,000 2,500 2006 2005 2004 2003 2002 2001 2000 HHI
Source: GAO analysis of Audit Analytics data.
Year
Highly concentrated Moderately concentrated Unconcentrated
& Young accounts for 77 percent of all audit fees collected in the
agricultural sector while, the second largest firm only holds 12 percent of the market.
Figure 13: Hirschman-Herfindahl Indexes, Markets Segmented by Industry
1,500 2,000 2,500 3,000 3,500 4,000 4,500 5,000 5,500 6,000 6,500 Agricultureb
Utilities Educational Services Health care and social assistance Other services Warehousinga Construction Manufacturing: Food processing and textiles Mining Real estate, rental and leasing Manufacturing: Wood, petroleum, minerals, chemical products Management: Companies/Enterprises Information Transportation Traditional retail Accommodation and food services Manufacturing: Durable Miscellaneous retail All sectors Finance and insurance Administrative and support and waste management and remediation Wholesale trade Professional, scientific, and technical Arts, entertainment, and recreation
HHI
2002 2006
Source: GAO analysis of Audit Analytics data.
Notes: Industries defined by two digit North American Industry Classification System codes. a
b
The agriculture sector has fewer than 30 companies.
Similarly, we found regional markets in the United States such the Mid- Atlantic and the Midwest to be somewhat more concentrated than the Western regions, although all were highly concentrated.7