It’s not every day that the chairman of a major business says that he can’t deny, that he and the other three biggest players in the sector are an “oligopoly”. Yet that’s what the UK chairman of KPMG, Bill Michaels, told Financial News recently.
The big four audit firms have been in the spotlight recently, notably after the fall of Carillion, with many now calling for a break-up of their dominance. The big four are KPMG, Deloitte, EY (previously Ernst and Young) and PwC, previously PriceWaterhouseCoopers. There are concerns that they have conflicts of interest and that their dominance of the audit market has led to a lack of competition.
The four have not covered themselves in glory in recent times, with the collapse of Carillion after years of satisfactory audits, provoking the Government into a review of the audit performance of the big four and their market dominance.
Meanwhile, just below the big four, sits Grant Thornton, whose audits failed to uncover serious accounting irregularities at Patisserie Valerie, including an apparent black hole of £20m. Which firm has been called in to investigate? PwC, one of the big four. Before this latest development, Grant Thornton told the FT that it didn’t think splitting up these firms would be effective. Their public pronouncements may be a little more muted for a time.
The Carillion audits featured KPMG as the external auditor, and Deloitte as the internal auditor, with PwC and EY providing consulting at various stages. Parliament has asked the competition watchdog to investigate, using words such as “cosy club” to indicate its belief that the accountancy firms did not offer a truly independent challenge to the firms they audited.
How would a Break-up Happen?
There are two possible scenarios for a break-up. Each business could be forced to divide itself into two smaller businesses, providing a range of business services. Alternatively, all four businesses could be forced to divest themselves of their consultancy arms, creating businesses that only carried out audit work. This is complicated by the fact that these are international businesses but all four have been considering how they could make this kind of restructuring work.
Accountancy firms get plenty of criticism but it has to be said that they are fully aware of the uncompetitive position in which they find themselves and realistic about the likely courses of action. The chairman of KPMG in the UK is Bill Michael. He revealed that he thought the business model currently being used by the Big Four, particularly as it concerned consultancy, wasn’t sustainable.
Harsh noises from the Labour party may have increased the Big Four’s openness to a restructuring of their businesses. John McDonnell, the Shadow Chancellor, has decided to instigate a radical review of the issue, citing Carillion’s collapse as a symptom of “catastrophic” inadequacy in regulatory systems. And back in May, MPs also called for the Competition and Markets Authority to investigate the big four.
The bill for administering the Carillion collapse and winding up the company is expected to reach £150m. This was revealed in response to a Freedom of Information request from the Unite union. The settlement of redundancy payouts is expected to be £65m. Accountants and other professionals liquidating the services and construction companies are going to be paid around £70m. The other £15m is for other expenses.
Other public money has had to be spent on taking over contracts for construction projects, such as the Royal Liverpool Hospital. Labour’s is arguing that shareholders should foot these bills since they were rewarded in the good years.
The Carillion collapse could well be the final catalyst for the breakup of the big four. On 1st March 2017, Carillion’s accounts appeared to allow a £79m dividend to be declared. £55m of this was paid on June 10th 2017. Yet massive profit warnings followed in July and September and by January 2018 the company was in liquidation. KPMG came in for heavy criticism for having taken earnings of £29m for auditing the company over a period of 19 years. Deloitte and EY were also criticised for their poor consultancy advice.
Patisserie Valerie isn’t a business on the same scale. But the fact that it too has faced sudden problems after apparently satisfactory audits, couldn’t have come at a worse time for the big four.