The Big Four accounting firms got that way for a reason; they may stay that way

THE talk around town that global Big Four accounting firm EY could be looking to split its auditing and consulting practices has an all-too-familiar ring to it. Some might remember the Enron debacle at the turn of the century, which forced the collapse of its auditor Arthur Andersen — then one of the world’s Big Five accounting firms.

The resulting tide of mistrust then pressured the other accounting firms to spin off their consulting work from their audit functions. But, over the years, these business lines have found their way back together again — and all the Big Four have both auditing and consulting practices under the same roof once more.

So, who’s to say this break-up-and-get-back-together cycle won’t happen again (assuming the split even takes place, to begin with)? Should we pay the current chatter any heed?

Perceived conflict

The push for public accounting firms to hive off their more lucrative consulting businesses is one that emerges time and again — and not without good reason.

The impetus typically comes from a concern that accounting firms — believed to be eager to please their existing consulting clients, or win new ones — might compromise their professional integrity when it comes to carrying out their compliance duties.

Enron was a good case in point. The energy giant was a stock-market darling that managed to successfully conceal its mountains of losses, debt and toxic assets via fake holdings (special purpose vehicles) and highly manipulated accounting entries.

Arthur Andersen was seen as being complicit in such fraud, because it signed off on Enron’s financial statements as the company’s auditor. The firm was accused of being reckless in its audits because of a conflict of interest over the significant consulting fees it earned from Enron.

Arthur Andersen collapsed in the wake of that debacle, and the remaining Big Five accounting firms felt pressured to sell, spin off or deactivate their consulting businesses to regain public trust.

In the years that followed, however, such concerns diminished. And the accounting firms began to rebuild their consulting businesses via acquisitions, organic growth or the hire of relevant staff.

By 2014, Gartner estimated that the Big Four held the biggest share of global consultancy income — with a combined 40 per cent of the market. A more recent report noted that the Big Four’s consulting practices are now several times larger than those of the top consulting firms of McKinsey, BCG and Bain.

Although concerns have diminished from their height 2 decades ago, they have not altogether disappeared. Regulators, in particular, are always mindful that the threat of a perceived conflict could turn into an actual one — an especial worry, given the impressive size and clout of each of the Big Four firms. Such concerns naturally escalate, along with the expectations that regulators will act, when the number of accounting scandals increase, as they have in recent years.

Regulatory pressure — or not?

The growing number of high-profile accounting scandals in recent years may have catalysed the belief that some accounting firms are contemplating splitting their audit and non-audit businesses, but it is unclear if the firms have actually been impelled to split as a result of them.

In the United Kingdom, reports of big accounting failures at construction group Carillion and retail chain BHS spurred a review of the entire industry. The country’s audit regulator, the Financial Reporting Council (FRC), in 2020 issued a set of guidelines for the Big Four to split their audit and non-audit businesses there by 2024.

But, in the face of a reported backlash from private businesses, the latest proposals issued have far less bite: The government’s consultation paper is still proposing to limit the “unhealthy dominance” of the Big Four, but suggests this be done through stipulations that listed companies carry out at least some of their audits with another provider.

Over in the United States, the Securities and Exchange Commission (SEC) was reported by The Wall Street Journal (WSJ) in March to be probing conflicts of interest at the Big Four accounting firms: asking them whether the consulting and other non-audit services they sell undermine their ability to conduct independent reviews of public companies’ financials. Seeking such assurance is, however, quite different from pushing the firms to split their businesses.

Value proposition

Still, such developments may have fuelled the most recent speculation that some Big Four firms are contemplating hiving off their non-audit services.

The Financial Times (FT) had reported last month that EY is planning to split its audit and advisory operations worldwide. The firm has since represented that no such decisions have been made, though it is evaluating options to improve audit quality.

Some weeks after, WSJ reported that another Big Four firm, Deloitte, is exploring a plan to split its global audit and consulting practices, and that it had reached out to investment bankers at Goldman Sachs after news broke of rival EY’s potential world-wide split. Deloitte has denied plans to split, saying it remains committed to its current business model.

This is an important point to note: the current business model is one that works for the accounting firms.

To take EY as an example: the firm’s audit revenues grew 27 per cent between 2012 and 2021, compared to a 93 per cent growth in the rest of its business for the same period. Last year, revenues for its audit business totalled US$13.6 billion while consulting, tax and deals advice operations brought in US$26.4 billion.

Not only are non-audit services additional revenue generators, they are also profitable. They expand the firm’s client base and reach, as well as its expertise. And there are economies of scale to having such business lines housed under the same roof — not only does this make the firm a one-stop shop for clients, but it also enables the firm’s own staff to make use of the expertise available in-house. Combining both services under one roof also helps the firms hire and retain talent, which many are struggling with.

The Big Four accounting firms have spent significant amounts in recent years to grow their consulting prowess, which naturally builds on their existing expertise in tax and auditing. It makes little business sense for them to now hive off these services in the absence of certain factors.

Not happy ever after

The consulting and non-consulting divisions have not always co-existed in harmony in public accounting firms; it’s well known that both sides have different goals, approaches and work cultures — and earning power.

Going back to Arthur Andersen: In the decades preceding the Enron debacle, the accounting firm’s consulting arm, then called Andersen Consulting, was growing at a much faster rate than its auditing and tax practices; and the consulting partners felt they were being held back.

The burgeoning acrimony — mostly due to the displeasure felt by the consultants over having to share their much-larger profits with Arthur Andersen — eventually led to Andersen Consulting being awarded its independence, after which it was rebranded Accenture. (In a stroke of luck, Andersen Consulting jettisoned itself from the global entity and brand just before the Enron scandal erupted.)

So, in some cases, an inability to get along can impel the spinning off of one business into a separate entity. But, the impetus would have to be very strong.

FT’s article quoted an unnamed senior partner at a Big Four firm as saying a split would create “a low-growth boring (audit) business next to a high growth consulting business”.

That’s not to say that it won’t happen; just that a firm’s non-consulting partners are unlikely to vote on a move that would leave them with the short end of the stick.

Some have said that an accounting firm might be compelled to split its audit arm from its other operations if its auditing division ends up being embroiled in enough accounting scandals and resulting lawsuits that would cause it to be better off as a separate legal entity — shielding the rest of the business from litigation, regulatory action and reputational damage.

But separating a business is no easy task. It takes months (sometimes, years) of work, including approvals from partners involved, to bring it about. This is not a decision typically taken lightly or made easily by the businesses involved, and is unlikely to be the impetus for any of the Big Four.

So, that means...

Where does that leave us? In the absence of another massive scandal on the scale of Enron, or firm and decisive moves by the regulators to break up the Big Four firms, or an overwhelming need by a consulting division of any firm to strike out on its own, I would say we are very likely to remain in status quo — and that talk of a possible split in one or all of the Big Four firms might stay just that.

The writer was a former tax accountant with Arthur Andersen