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More on the ‘tipping point’ for Big 4 firms

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Image courtesy of Adobe Stock.

Image courtesy of Adobe Stock.

If you casually pay attention to what is going on in the land of Big 4, a world far, far away from most of us in the accounting world, you might have interest in two recent articles from Jim Peterson, pondering the survivability of the huge firms. I will summarize what I think are a few highlights.

2/13 – Jim Peterson at Re:Balance – If the Big Four Went “Ex-advisory” – Deja Vu? Or Worse? – Regulators don’t like the huge consulting practices in the Big 4 and the partners in the Big 4 consulting arms don’t like the constraints on their growth, opportunities, and compensation from being tied to the audit & tax practices.

Article speculates on the impact if the consulting work were to be spun off, as happened back in 1998 through 2001.

A few of the speculated impacts would be an even lower capacity to absorb the financial loss of a huge litigation or regulatory hit. Another ramification would be the loss of all the specialists that help out on audits. That would make it far more difficult (and I’ll guess more expensive) to complete a complex international audit.

For context, Deloitte’s Advisory revenue was $3.5B larger than audit in 2016; audit and tax were just over 50% of total revenue.

To refresh our memories, the article describes the previous spin offs from 4 of the Big 5:

  • 2/2000 – EY – sold to CapGemini
  • 2001 – KPMG – spun off into BearingPoint
  • 7/2002 – PriceWaterhouse – sold to IBM
  • 1998 started and 1/2001 finished – Arthur Andersen – spun off into Andersen Consulting

Delloitte kept their consulting.

Article provides current estimates of the world-wide practices for audit and tax only:

  • $24.4B – PwC
  • $20.4B – Deloitte
  • $19.0B – EY
  • $15.7B – KPMG

Article discusses the limited ability to absorb a catastrophic loss in a world which now shows these kinds of settlements:

  • $22.5B – VW’s settlement in just the US
  • 0.7B Euros – Rolls-Royce settlement of two decades of bribery
  • $6B – hit to BT Group’s market capitalization the day irregularities were disclosed

Audit and tax only firms would have less ability to absorb a serious financial hit. Consider the impact on each firm’s “tipping point.”

What is a “tipping point”? Glad you asked…

1/26 – Jim Peterson at Re:Balance – A Fresh Year, Fresh Problems, And a Fresh Look at the Big Four’s “Tipping Points” – His theory is that the dollar threshold which could cause the collapse of another Big 4 it not the size of a judgment that would sink the firm.

Instead, a far smaller loss would create a wide-spread loss of confidence amongst partners, who would leave in fear, taking their capital with them. Carry forward that thought process and you know that panicked partners would likely take a few clients and some staff with them as well. A contagion of fearful departures would collapse a firm.

The tipping point at the world-wide level, according to the article, is somewhere in the range of $4B to $6B.

Since the Big 4 are actually an operating group of national firms, the analysis (if you wish to pursue this concept) needs to be scaled down to the breakup number of a national firm. The US is the focus here since it is the largest market. The US also has the highest likelihood of a catastrophic award at trial.

Mr. Peterson estimates the tipping point for US firms is in the range of a billion dollars.

Check out the article for a discussion of the severe financial risk from the Taylor Bean & Whitaker litigation against PwC.

When I have a lot of time, there is much I’d like to dive into on that case – there is unpleasantness to discuss from the publicly available information that came out of the trial.

The collateral consequences of one firm failing are severe. Currently, it would be difficult for many large companies to find another auditor that is independent. That issue is made more severe by several other factors. Quoting from the article:

The present four-firm structure is irreducible, given the uneven concentrations of their personnel, market share and industry expertise around the world, and the politically imposed restrictions on auditor choice due to outmoded concepts of independence.

That sentence would require a full length article to explain. If you pay much attention to the Big 4 world, you can think through the implications yourself.

As just one illustration of the issues, there are many industries with a heavy concentration in one of the firms. The impact on that industry would be devastating if the leading firm were to be hit. Not enough capacity exists to handle the transition. Yes, partners, staff, and all the subject matter experts would move somewhere else, but replacing the capacity would take a lot of time, and there are 10-Q deadlines and audit filing deadlines that would have long since passed by before the capacity could ever be rebuilt.

If you’ve read this far in my post, you really ought to check out both of the above articles.

Written by Jim Ulvog

February 17, 2017, 9:30 am at 9:30 am

Posted in Audits, Pondering

Tagged with ,

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