I like to spend some time talking about the market for audit services because many people believe the competitive environment affects audit quality. There is wide disagreement, however, about whether the current market for large company audits is too competitive or not competitive enough.
Some critics complain that audit quality suffers because of cutthroat competition among the big accounting firms. Partners are afraid to stand up to clients for fear of being replaced. Clients engage in “opinion shopping” to find the most permissive auditor. Auditors submit “low-ball” bids to win new clients and then reduce testing to make a profit.
Other critics complain that audit quality suffers because the “Final Four” auditing firms comprise a collusive oligopoly. Clients, especially those in specialized industries or located in smaller cities, have difficulty replacing a deficient auditor. The remaining firms have become “too big to fail” and no longer fear indictment from a Justice department that does not want to create a “Big Three.” PCAOB chairman William McDonough once called the question of splitting up the Big 4 “the single most difficult issue in public policy in this area” (“SEC Weighs a Big Three World,” Wall Street Journal, 6/22/05).
“Advisory Services Rise Again at Large Audit Firms,” R. Mithu Dey, Ashok Robin & Daniel Tessoni, CPA Journal (August 2012). The Big Four are rebuilding their consulting divisions, selling services to private-equity firms and non-audit clients.
“Second-Tier Auditing Firms: Developments and Prospects,” R. Mithu Dey & Ashok Robin, CPA Journal (June 2011). This article discusses the revenues, growth, productivity, and industry specialization strategies of second-tier firms Grant Thornton, BDO Seidman, Crowe Horwath, and McGladrey & Pullen.
“Financial Reform and the Big 4 Audit Firms,” Bernard Ascher & Albert Foer, American Antitrust Institute Working Paper No. 10-01 (January 2010). Because of their importance to the capital markets, the Big 4 have become “too big to fail.” This paper describes how structured divestitures could be used to reduce industry concentration.
“Audit Committees Rubber-Stamp Management Choice,” Edward Teach, CFO.com (October 24, 2007). Interviews with 30 Big Four managers and partners reveal that client management – not the audit committee – is the “driving force” in appointing and dismissing auditors.
“Firms’ Auditor Choices Dwindle,” Diya Gullapalli, Wall Street Journal (June 21, 2005): C1+C3. More than half of large corporations employ two or more of the Big Four accounting firms. Clients in smaller cities or specialized industries have difficulty switching auditors.
“We Need More Than the Big Four,” Edward Nusbaum, Wall Street Journal (January 25, 2005): B2. Chief executive of Grant Thornton discusses the dangers of industry concentration in public accounting.
“Small Firms Exit Auditing,” Carrie Johnson, Washington Post (August 27, 2003): E1. Small accounting firms resign from public clients rather than comply with Sarbanes-Oxley.
“GAO Warns on Future Problems From Audit-Industry Mergers,” C. Bryan-Low & J. Weil, Wall Street Journal (July 31, 2003): C11. GAO report warns that industry consolidation could limit clients’ choices and lead to higher audit fees. Difficult to discipline accounting firms without hurting clients.
“Big Accounting Firms, Striving to Cut Costs, Irritate Small Clients,” Lee Berton, Wall Street Journal (April 21, 1994): A1-A5. This article is a bit dated, but provides a good reminder that public accounting is a service business and auditors must keep the client happy.