CHAPTER 2: Concentration in the audit
11. Concern about concentration of large-firm
audit in the hands of the Big Four, and the impact on competition,
choice, price and quality was our main motive in launching this
How the Big Four evolved
12. It took about 150 years from the beginnings
of modern audit in Britain around 1850 to the emergence of the
Big Four. Some of the founders' names, such as Deloitte, Price,
Touche, Peat and Cooper, are still familiar. In the late nineteenth
and early twentieth century, firms also grew in the United States
and Europe. By the mid-twentieth century, there were large international
groupings such as Deloitte, Haskins & Sells (UK/US, 1957),
KMG (Netherlands/US/Germany, 1979) or Coopers & Lybrand (UK/US,
1957). But with many practitioners of various sizes and nationalities,
including the international networks of the then Big Eight, the
audit market still offered choice.
13. The pace of concentration quickened in the
1980s and 1990s. The first mega-merger was between KMG and Peat
Marwick (1987). In 1989, Deloitte, Haskins & Sells and Touche
Ross came together. The same year, Ernst & Whinney joined
with Arthur Young. In 1998, Price Waterhouse and Coopers &
Lybrand combined. Not all these mergers were tidy, since the international
networks are federations of national partners, some of whom went
their own ways, but the entities they led toKPMG, Deloitte,
Ernst & Young and PwCtogether with Arthur Andersen
became the Big Five which dominated the world market in large
firm audit. The collapse of Arthur Andersen in 2002 after the
Enron scandal, and the absorption of its audit business by the
others, meant that the Big Five became the Big Four. Consolidation
was not impeded by regulatory intervention.
The large-firm audit market in
the United Kingdom
14. In 2010 the Big Four audited 99 of the FTSE
100 leading firms and around 240 of the next-biggest FTSE 250.
They also had about 80% of the FTSE small capitalisation firm
audits. In some important
market segments the degree of concentration is even greater: for
example, only three of the Big Four audit banks in the UK. The
Big Four are all the stronger because the next tier of accounting/audit
firms are so much smaller: the audit revenues of even the smallest
of the Big Four are nearly three times those of the largest second-tier
15. The audit of large firms, in the UK and
internationally, is dominated by an oligopoly with all the dangers
that go with that. The oligopoly's power is underpinned by the
fact that large firms are legally obliged to have their financial
Why did the Big Four become so
16. Witnesses put forward various reasons for
the high degree of concentration in the audit market: Professor Michael
Power, London School of Economics, said: "There is an element
of concentration which may have to do with natural forces of economies
of scale." Mr John
Connolly, Senior Partner and Chief Executive, Deloitte, said:
"The degree of concentration in the audit market has arisen
as a direct result of market forces and, in particular, the demand
from investors for audit quality as well as appropriate capability
to undertake complex audits across the world."
Mr Philip Collins, Chairman of the Office of Fair Trading
(OFT), acknowledging that the OFT had not held a detailed inquiry
into the audit profession, said: "It is a market in which
we have a keen interest but it is not a market in which we felt
it appropriate, in the last seven or eight years, to conduct a
detailed review because other things had been happening."
17. We also heard that a Big Four firm was seen
as the safe choice by audit clients. Professor Power said:
"I think audit committees go by franchise value alone and
do not analyse audit teams."
Mr Timothy Bush, Investment Management Association nominated
representative on the Urgent Issues Task Force of the Accounting
Standards Board, said "there is a regulatory sense that big
is best" and Dr Gunnar Niels of Oxera spoke of "the
reputational advantages of having a Big Four as your auditor".
Mr Jonathan Hayward, Director of Corporate Governance consultants
Independent Audit, said: "No audit committee chairman of
a FTSE property company
is particularly interested in changing
to a medium-sized audit firm because there is lots of downside
and no upside
in doing that."
In some cases reputational considerations have hardened into restrictive
covenants or, as Ms Helen Brand, Chief Executive of the Association
of Chartered Certified Accountants (ACCA) said: "Banks or
organisations themselves are stipulating upfront that they will
only employ a Big Four firm."
18. A self-reinforcing cycle has helped to
consolidate the dominance of the Big Four. Factors include:
i. the internationalisation of business;
ii. the scale of investment and capital required
in an audit firm;
iii. economies of scale in audit;
iv. a semi-captive market;
v. non-interventionist competition authorities;
vi. the perception that big is best;
vii. the reputational assurance of using Big
Four auditors; and
viii. the fall of Arthur Anderson.
Does market concentration limit
competition and choice?
19. We heard conflicting views about the effects
of the Big Four's domination of the market. Their own representatives
argued that it was nevertheless competitive. Mr Ian Powell,
Chairman and Senior Partner, PwC, said that the large firm audit
market was "fiercely competitive" and that each tender
was "ferociously fought" and that competition had affected
prices. Mr John
Griffith-Jones, Chairman, KPMG, acknowledging that FTSE 100 companies
very rarely switched auditors, argued that continuity and a fresh
approach could be achieved by the same audit firm through frequent
rotation of audit staff when new audit teams could still draw
on the firm's corporate knowledge of the client.
Mr Ashley Almanza, Chairman of The Hundred Group (of Finance
Directors of FTSE 100 companies), and Chief Financial Officer
of BG Group, said: "We're content in general terms with the
service provided and the competition that we observe in the market
today." He added:
"Audit firms know that we have a choice and that very often
is all you need to keep their pricing and the quality of their
20. Other witnesses thought the large firm audit
market was not truly competitive and emphasised that tendering
was rare: Mazars recalled research by Oxera published in 2006
by the FRC which indicated that "a FTSE 100 auditor can expect
to remain in place, on average, for a period of 48 years".
Professor Vivien Beattie of the University of Glasgow said:
"Concentration is sometimes even higher at sector level
sometimes in some sectors one of the Big Four has more than 50%
of the market."
Mr Collins said: "We think that the market, as currently
structured, may not operate in a way that works well for users".
Baroness Hogg, Chairman of the Financial Reporting Council (FRC)
said that, despite the efforts of its Market Participants' Group
"to explore ways of getting the market to work better
concentration is as great as ever
the time has come to
consider more radical measures
we would now urge consideration
of further actions at national and G20 level."
21. Some institutional investors believe the
market is not competitive. Mr Paul Lee, Director of Hermes
Equity Ownership Services, said: "The major concern is the
lack of competition". Mr Guy Jubb, Head of Corporate
Governance at Standard Life Investments, said: "It is not
so much the competition issue but it is the lack of choice that
is the area of particular concern
we are no longer comfortable
with relying on market forces to create the resolution
there has to be some regulatory or governmental intervention."
What if Big Four became Big Three?
22. The market for large-firm audit could become
even more concentrated if for any reason one of the Big Four withdrew.
The demise of Arthur Andersen shows it could happen suddenly and
unexpectedly. Legal liability is one area of risk: in the view
of Professor Stella Fearnley, of the University of Bournemouth,
"the risk obviously is a litigation risk."
Professor Power said: "I don't think we can rule out
dramatic loss of franchise value, shock events."
23. Even witnesses comfortable with the present
state of the market saw the prospect of a move from Big Four to
Big Three as a step too far. Mr Almanza said: "Big Four
to Three firms I think would be regarded by most large companies
in the UK, certainly by our company, as an unwelcome change."
The Association of British Insurers (ABI) also suggested that
the remaining Big Four might not in any event have the "necessary
... firepower to absorb a failed Big Four firm".
24. The Big Four themselves oppose any further
concentration. Mr Connolly said: "I would be uneasy
about it going down to three."
Mr Griffith-Jones said: "We need a regulator to prevent
it getting any more concentrated than it is at the moment."
Lord Myners thought that concentration might already have gone
too far and that in the end, if other approaches did not work,
"there should be some action to 'trust bust'" because
"everybody believes that it will be good to have more choice
but nobody seems to be willing to be the first mover."
25. The FRC is clear that a Big Three would not
be acceptable. It emphasises "the need for a clear statement
that the Government/competition authorities would break up a Big
26. Most witnesses believe that the dominance
of the Big Four limits competition and choice in the audit market.
Ethically, audit firms are unable to accept work which would place
them in conflict with other work for the same or other clients.
This is a special problem in the UK banking sector, where only
three of the Big Four are active. Banks' choice of auditor is
sometimes limited by the need to avoid using a firm engaged by
27. All witnesses fear the real possibility
that one of the Big Four might withdraw leaving a Big Three (or
even a Big Two, in the bank audit market). We agree. Loss of one
of the Big Four would restrict competition and choice to an unacceptable
extent. This is one reason for our recommendation of an Office
of Fair Trading (OFT) investigation into the audit market.
3 ADT 24 (FRC). Back
FRC Professional Oversight Board, Key Facts & Trends in
the accountancy profession, June 2010. Back
Q 6. Back
Q 235. Back
Q 174. Back
Q 8. Back
Q 84. Back
Q 80. Back
Q 242. Back
Q 244. Back
Q 292. Back
Q 305. Back
ADT 21. Back
Q 6. Back
Q 170. Back
Q 170. Back
Q 407. Back
Q 5. Back
Q 5. Back
Q 292. Back
ADT 42. Back
Q 238. Back
Q 236. Back
Q 486. Back
ADT 27. Back