Audit: the big 4 issue

Audit work in Britain is monopolised by the world's largest accountancy firms. The Gateway asks why, and what the implications are
Commercial awareness

The UK's audit industry is dominated by four international accountancy firms. If you know anything about the accountancy business, they're the ones you'd expect: Deloitte, Ernst & Young, KPMG and PwC, known collectively as the "Big Four".

According to a report on the UK's audit industry issued this March by the House of Lords Economic Affairs Committee, in 2010 the Big Four audited 99 of the FTSE 100 and around 240 of the FTSE 250, as well as the majority of the FTSE 350.

Competition is even more restricted in the lucrative banking audit sector – banks' UK audit business is currently exclusively given to "Big Three" firms, EY not being active in this sector of the audit market.

The problem

Why are these firms so dominant? The House of Lords report identified a sense of complacency in large corporates towards their auditors, drawing attention to research indicating that FTSE 100 auditors remain in place for an average of 48 years (Oxera).

They attributed this general lack of desire for change to "a self-reinforcing cycle", fuelled by the big firms' investment in auditing and their reputations, both of which increase the longer firms keep prestigious clients on their books, and which then discourage these clients from going elsewhere.

Other factors may also be to blame. Many have pointed to a clause often found in loan agreements entered into by banks and big corporates which forbids the borrower from using a non-Big Four auditor.

It has also been suggested that the unlimited liability assumed by auditors for any errors in their work also plays a part, deterring smaller firms from taking on the biggest corporate audit jobs.

Does it matter?

It's easy to make the argument that big-ticket work of this nature should only be taken on by those firms who have the necessary expertise.

But many commentators on the profession say that other top firms in the UK are just as capable of taking on the largest audit jobs – and that letting a small group of firms dominate is bad news for the clients who, as in all sectors with a lack of competition, may face lessened quality and value for money.

That so much of this work is done by just four firms also has implications for the economy as a whole. If one of them were to suddenly collapse, the effect of the disruption of its auditing work could be significant.

This is not just idle speculation: in 2002, accountancy firm Arthur Andersen did just that in the wake of the Enron scandal, causing turmoil in the economically crucial audit business and turning the then "Big Five" into today's Big Four.

The solutions?

The House of Lords report recommended that the Big Four should draw up contingency plans to be put into action should one of them go out of business.

Proactive steps to increase the number of firms in the market were also mooted in the report. Having joint audits, where two firms are required to sign off a company's accounts, was suggested but rejected as inefficient, and because it risked reducing accountability.

Requiring firms to regularly switch auditors was also proposed and, despite the prospect of increased costs for companies and the risk that big corporates would simply switch between Big Four firms, the House of Lords recommended that every FTSE 350 company should be required to hold an audit tender every five years.

The report also suggested that action should be taken on number of relevant issues, including whether investors should be encouraged to take a more active role in auditor selection, and the loan agreement and liability issues mentioned above.

The House of Lords also recommended an Office of Fair Trading (OFT) investigation into the audit industry, which could lead to a referral to the Competition Commission. The OFT recently announced that, in response to the House of Lords report, they are considering whether to investigate the issue.

The government's proposed dismantling of the Audit Commission was also discussed in the report. The disappearance of this organisation, which audits public sector bodies, will open up this audit work to the private sector, potentially increasing the market share of some of the non-Big Four firms. Opinions, however, differ on how to promote fair competition for this work while ensuring that quality and auditor independence are maintained.

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