This was originally posted here on November 9, 2006. The more things change the more they stay the same. For more recent research on audit market competition and the consequences of another firm exit see “The Problem Of An Audit Firm Market Exit: New Research From University of Chicago Booth School of Business”.
The GAO research for their report, A Mandated Study on Consolidation and Competition, was conducted in Chicago, Illinois, New York, New York, and Washington, D.C., from October 2002 through July 2003. (Sarbanes-Oxley was passed in July of 2002.)
The report, although thorough, was completed very early in the cycle after the passing of Sarbanes-Oxley and while firms were still reorganizing and mobilizing to respond to the dramatic events that occurred. Although a similar study has been completed recently in the UK, with even more dramatic concerns expressed, it is time for an update in the US.
By Barney Jopson, Financial Correspondent, Financial Times
Published: September 11 2006 03:00
A movement to challenge the dominance of the big four auditors is gaining momentum with confirmation from regulators that many in the City back action to tackle the risks it has created…The Institute of Chartered Secretaries and Administrators suggested the top firms sign a memorandum of understanding agreeing not to poach staff and clients from rivals when they face a crisis of confidence linked to an accounting scandal.
The audit market for large public companies is an oligopoly, with the largest firms auditing the vast majority of public companies and smaller firms facing significant barriers to entry into the market.
Collusion refers to a usually secret agreement among competing firms (mostly oligopolistic firms) in an industry to control the market, raise the market price, and otherwise act like a monopoly. While overt collusion involves an explicit formal agreement among the firms, under tacit collusion each firm seems to be acting independently with no explicit agreement, perhaps each responding to the same market conditions, but ultimately the result is the same as it is under an explicit agreement.
What practices may be construed as tacit collusion and what opportunities do the firms have for tacit collusion, potentially leading to overt collusion?
1) Recruiting of new graduates as well as experienced hires
-Use of Mercer Human Resources Consulting by all Big 4 firms for salary benchmarking info
(When I worked in Latin America, I often thought that partners from competing firms in particular countries must be agreeing on salaries for their staff, in order to not have a bidding war and raise overall costs for all the firms and therefore reduce their partner profits. The partners in professional services firms in any developing country are a distinct population who all know each other, having grown up in the elite class and having attended the same schools, belonged to the same country clubs, lived in the same areas, for the most part. Even though many of these firms grew and became more sophisticated during the 80’s and 90’s, starting salaries for staff never changed much and significant changes in earnings were only available when a professional reached the pinnacle of the firm, a sort of golden ticket. Most left for industry before getting anywhere near the partnership, a model that still exists in the US.)
-Agreements during times of crisis to limit poaching of professionals from other firms (During the KPMG tax shelter issue, all the firms issued these communications, formally or informally, to discourage recruiting from KPMG until the matter was resolved. Who’s idea was this? And how would it have seemed if major energy firms had gotten together while Enron was imploding and decided to give it a better chance of survival by not recruiting its employees until the dust settled? Seems to me to be anti-competitive from the perspective of an open labor market.)
-Limited movement of partners between firms.
-Strict adherence to lists of approved universities for recruiting.
2) Informal roundtables and meetings are being held amongst Big 4 representatives, in particular regarding independence compliance, diversity hiring and quality assurance/ risk management initiatives.
3) Peer reviews, still required by many states, even after Sarbanes Oxley mandated inspections by the PCAOB give the firms an opportunity to look inside each others’ operations. The GAO (and other state and federal agencies) utilize the Big 4 conduct to conduct peer reviews of their own operations and hire the Big 4 for special studies of agencies, programs and other activities.
4) Solicitation of new audits/resignation from current audits, including establishment of rates
-Understandings/agreements regarding re-distribution of AA clients in 2002.
– The new independence rules established under the Sarbanes-Oxley Act of 2002, which limit the non-audit services firms can provide to their audit clients (especially consulting services and internal audit outsourcing) and which require partner rotation, may also serve to reduce the number of auditor choices for some large public companies. Conceivably, there are scenarios and circumstances in which audit firms would discuss amongst themselves who will do what work for which clients over what periods in order to avoid competition, bidding down of rates and conflicts.
–The most observable impact of consolidation among accounting firms appeared to be the limited number of auditor choices for most large national and multinational public companies if they voluntarily switched auditors or were required to do so, such as through mandatory firm rotation. Of the public companies responding to the GAO 2003 survey to date, 88 percent (130 of 147) said that they would not consider using a smaller (non-Big 4) firm for audit and attest services. (From GAO 2003 Study)
5) Strategic alliances with other vendors such as SAP, Oracle, Microsoft, American Express Travel Services.
6) Industry conferences and other gatherings (AICPA, IIA, ISACA, etc) provide an opportunity for informal meetings and information sharing between firm leaders.