Sunday, May 27, 2018

MBA view: should the Big Four be broken up?

Business school students discuss the future of the accountancy titans

The Big Four accounting firms, Deloitte, KPMG, EY and PwC, have successfully maintained their power and influence, despite repeated crises. But now British MPs have demanded that the Big Four be referred to the competition watchdog for a potential break-up following the collapse of Carillion, a government contractor.

Should the Big Four be split up? We put the question to MBA students from some of the world’s top business schools for their views. Join in the discussion in the comments below.

Breaking up the Big Four will neither increase auditor competition nor restore auditor independence and rigour. The question of “should” is irrelevant. Decreeing a split in these firms is pointless, as it would not solve the root problem. Plus, implementation is impractical as the Big Four’s operations are global and governments can only place restrictions within limited sovereign boundaries. Also, previous attempts demonstrate that “breaking up” the firms is not a lasting remedy for lax auditing.

Audit quality has been compromised over the past half-century by the addition of other revenue-generating services (ie, consulting), the increase in hires with non-accounting backgrounds, and the growing emphasis on maximising revenue. The result: significant cultural change within the firms.

Regulations need teeth. Current regulations are unenforceable and at the core of this issue is a lack of competition

Julie Kellman, Olin Business School
To maintain business, firms are more willing to go along with a client’s desire to avoid the standards rather than take a hard stance on observing them. The latter is a mark of true professional integrity. If we aim to restore the integrity of audits, we should require all professional staff at accounting firms to be certified as public accountants, injecting renewed respect for ethical practices. That is the first step to cultural reform and behavioural transformation.

The Big Four enjoy considerable lobbying power that would be reduced by breaking them up and this may help in stricter repercussions in auditing catastrophes.

However, it would be a mistake to think that simply breaking up the Big Four would be enough. The regulatory framework needs to be fixed soon — unless this barrier to entry is reduced, there will be a vacuum for truly multinational auditing firms that will sooner rather than later be filled up by an oligopoly again.

Breaking up the Big Four firms will not solve the problem arising from audit scandals.

This is because the audit firm and consulting firm fall under the same brand, but operate independently. In fact, in some countries, each practice is a separate entity. When both practices serve the same client, the Big Four firms have ringfencing mechanisms which restrict information-sharing between them. In addition, when the client uses both practices, the contracts are structured separately, as if purchasing from two different vendors.

Since the industry has failed to self-monitor, more effective regulations are necessary. But regulations need teeth. Current regulations are already unenforceable and the lack of competition is the core of this issue. The Big Four should be broken up to encourage competition, allow regulations to be enforced, and correct systemic failures.

The ‘big four’ auditors have life far too easy
What stands out here is the conflicts of interest inherent in professional services. All things considered, the Big Four are comparable. Corporations turn to the Big Four tier for legitimacy (a recognised seal of approval on their numbers) and seek an easy audit process. One way to differentiate is based on ease of client experience, a short-term factor that incentivises firms to sign off on flattering financial figures.

Unfortunately, the numbers have to add up eventually — which is glaringly obvious when suddenly the value of Carillion’s contracts diminished by £1bn .

More competition would allow regulations to act as intended: by penalising and correcting systemic failures as they occur.

I am not convinced a break-up of the Big Four professional service firms, by spinning off the audit functions as standalones, will completely alleviate the conflict of interest problem prevalent in the industry.

Operating with “Chinese walls” is embedded within the operating models but has not prevented companies from engaging in conflicting activities between audit and consulting.

Splitting up the Big Four can provide some temporary structural reforms that could contribute towards solving the conflict of interest problem. However, I believe in order to effectively combat the issue and protect its relatively vulnerable stakeholders, additional regulatory reforms will be required.

A break-up, in addition to regulatory reforms such as statutory rotation of auditors, could help reduce the problem.

If the firms are merely broken up, it will be a matter of time before they find legal and innovative ways to work with their consulting counterparts and we will be back to exactly where we are now.

From the FT 

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