The latest recommendation to break up the Big Four accountancy firms from the two U.K. parliamentary committees investigating the collapse of construction firm Carillion is hardly a new idea. But is it even possible? What authority does parliament, or the Competition and Markets Authority (CMA)—the agency given the job of considering the breakup—have to affect such an outcome?

The last time the CMA’s predecessor organisation—the Competition Commission—investigated the audit market, its main recommendation was to ensure that companies put out their audit for new tender every 10 years. But, according to data from proxy advisory firm Manifest, this had the effect of increasing the Big Four’s stranglehold on external audit, and they now audit 99 percent of FTSE 100 companies and 97 percent of the FTSE 250. In addition, limits on the amount of non-audit work a firm can do for a company it is already auditing do not seem to have had any impact.

It also seems that they are too big to investigate. The fall of Arthur Andersen in 2005 created an even smaller market out of an already small one, and the U.S. attorney general decided not to prosecute KPMG over the sale of fraudulent tax products because it might have resulted in a Big Three. This has created what the Financial Times recently referred to as a “too few to fail” regime.

As to the novelty of the idea of breaking up the Big Four, there have been several calls for such action just this year. Stephen Haddrill, chief executive of the Financial Reporting Council (FRC), who is also currently under investigation, in January called for an inquiry into whether KPMG, Deloitte, PwC, and EY should have to spin off their U.K. audit arms into separate businesses; he did so again in March. The new CMA chair, former Conservative MP and chairman of the Treasury Select Committee, Andrew Tyrie, appeared in April before the Business, Energy, and Industrial Strategy (BEIS) Committee, which is now making the recommendation along with the Work and Pensions Committee, and argued that “something needed to be done” about the audit market.

Carillion report recommendation

We recommend that the Government refers the statutory audit market to the Competition and Markets Authority. The terms of reference of that review should explicitly include consideration of both breaking up the Big Four into more audit firms and detaching audit arms from those providing other professional services.

But what does the industry think of a potential breakup? 

“I have a real fear that we won’t have an audit profession worthy of the name in 20 years’ time if we don’t act decisively to sort these problems out now,” said Michael Izza, CEO of the Institute for Chartered Accountants of England and Wales (ICAEW).

He tempered this concern, however, with a statement that shows the Institute is against a breakup: “I strongly believe that helping additional competitors break into the market is a much more constructive way forward than breaking up the Big Four, or creating audit-only firms.” But successive regulations that have attempted to do this have failed spectacularly, and Izza offers no silver bullet that might succeed this time.

A comment on his blog, however, offered one potential solution. It suggests that the ICAEW should amend its regulations to stipulate that no firm that employs any of its members as partners may act as auditor to more than 15 FTSE 100 companies and 40 FTSE 250 companies. “Right there you create the need for 7 audit firms, and give them the incentive to invest and compete,” said the respondent, without evincing any great confidence that such a regulation would be adopted. As the Carillion report notes: “The market for auditing major companies is neatly divvied up among the Big Four firms. It has long been thus, and the prospect of an entrant firm or other competition shaking up that established order is becoming ever more distant.”

It was symptomatic of a market which works for the members of the oligopoly but fails the wider economy. Waiting for a more competitive market that promotes quality and trust in audits has failed. It is time for a radically different approach.
Carillion report


The report’s summary of the situation at Carillion, where no single Big Four firm was unconflicted, is a clear demonstration that new accountancy firms, or expanded second-tier firms, are very much needed. 

While none of the Big Four firms emerges unscathed from the report, KPMG, as the auditor for the last 19 years, comes off worst. “KPMG’s long and complacent tenure auditing Carillion was not an isolated failure,” says the report. KPMG hurriedly responded to the report’s recommendation, saying, “It is clear there is a need for us to look closely at our business model. This isn’t just contingency planning, it’s constant re-evaluation of what we do so we continue to deliver what investors, companies, and society as a whole require from the audit profession.” The statement, however, continues in much the same vein as Izza, saying that “Multi-disciplinary firms deliver many clear benefits to audit quality” through investments in technology that can only be made as a global firm with comprehensive expertise.

Statements from Deloitte and EY run along similar lines. EY’s says: “A multidisciplinary model provides the structure, breadth, and depth of technical skills and industry expertise necessary to deliver high-quality audits.” And it again points to investment in technologies. Deloitte says, “Our multidisciplinary model enables Deloitte to invest significantly in systems, processes, and technologies—and to tap into increasingly critical skillsets such as data science, cyber and IT—that help drive high-quality audits in the public interest for complex global companies.” 

Deloitte’s statement also points to the improvements made by Sarbanes-Oxley in the United States, but those regulations are inapplicable in the United Kingdom, so the improvement in audit quality attributed to them is not relevant. PwC did not respond to requests for comment.

The economy needs a competitive market for audit and professional services which engenders trust. Carillion betrayed the market’s current state as a cosy club incapable of providing the degree of independent challenge needed.
Carillion report

So, what will the CMA’s actions be? As the MPs’ recommendation is so new, the CMA has not opened a live study or investigation into the sector. Its existing position was described by a CMA spokesperson: “We are working closely with the Financial Reporting Council, whose role is to regulate the quality of U.K. company audits, to see what more needs to be done to drive up standards. As part of this, we are actively monitoring the impact of the remedies put in place following the Competition Commission’s inquiry.”

But if the CMA does find that there is a problem with the market, what are its possible remedies and powers? Apparently quite wide-ranging; its guidance on market studies and investigations says: “When a competition problem is identified, a wide range of legally enforceable remedies are available, aimed at making the market(s) more competitive in the future.” But it is necessary to turn to an earlier set of guidelines from the Competition Commission, the CMA’s predecessor, to find out what these might be. 

Among the four remedies is divestiture. According to the Commission, “This may be done by either creating a new source of competition through disposal of a business or assets to a new market participant, or by strengthening an existing source of competition through disposal of a business or assets to an existing market participant that is independent of the divesting party (or parties).” So, clearly, it is within the CMA’s power either to force the Big Four to sell off their audit businesses as standalone businesses or force them to sell those assets to other accountancy firms. If the Big Four do not have contingency plans to address this potential outcome, it might be time to develop them.

Head of Corporate Governance for the Institute of Directors Roger Barker does not see a simple hive off of the audit functions as a solution. 

“Then you’ll just still have four audit firms,” he said. “A more viable way to increase competition and choice would be to split each firm into two; then you’d have eight separate entities by reducing the maximum size allowed, a classic antitrust approach.” 

This also is an approach within the CMA’s powers to recommend. And, as Barker pointed out, the U.K. arms of each of the Big Four would be the only ones affected. “They are not unified companies like, say, Barclays Bank; they’re really networks of companies branded together, but independent entities in each jurisdiction. This is something they have engineered, as they did not want issues arising in one market to create liabilities for partners in another.” 

Had they been unified organisations, then strict audit requirements in Singapore or the United States, say, would have applied globally, and Carillion might not have been allowed to implode.