Can Big Four Go to Big Five and Prevent Big Three?

The audit industry has responded to a Financial Reporting Council consultation paper on auditor choice in the UK public company market. The FRC oversees public company audit in the UK. The demise of Arthur Andersen has meant that only four firms of a similar size globally now remain to audit the financial statements of public companies. The remaining Big Four dominate the audit market in the UK and indeed globally. A number of critical issues arise due to the current situation, one of which is whether the Big Four can ever again become the Big Five, and conversely, how to prevent a withdrawal of a firm that would lead to the Big Three.

The view of the Big Four is that the current market for audits is highly competitive in price and quality. There is also the view that global companies demand auditors with a global presence, and that only the Big Four have sufficient global resources to satisfy this need.

There is also a consensus on the view that unlimited liability is the way the Big Four can become the Big Three. Thus, the Big Four strongly support the pending UK Company Law Reform bill that would allow auditors and client companies to agree, subject to shareholder approval, on limitations on liability. KPMG noted that the Big Four do not have sufficient capital to deal with a single catastrophic claim or indeed a series of lesser claims. Ernst &Young said that meaningful auditor liability reform must go beyond the UK and include the US and EU as well in order to be effective.

Ernst & Young viewed the main issue as being one of preventing the withdrawal of one of the Big Four from the audit market. If the Big Four were reduced to three, posited E&Y, there is a real risk that the entire profession would be put at risk since it would be unlikely that firms would be able to retain enough talented people to consistently deliver a quality audit product.

There was some pessimism that the Big Four could become the Big Five any time soon. According to KPMG, the issue of concentration of audits in the Big Four is a global issue and the appropriate solution can only be arrived at on a global basis taking account of market forces. The solution is likely to involve the merger of mid-tier firms, which would require significant investment. There are two critical changes that have to happen before such a merger could occur. First, there must be liability reform in all major economies where there is currently an unlimited liability regime. Second, there must be much faster progress towards convergence of accounting and auditing standards.