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January 14, 2008

A question of choice

There is no need to interfere in the increasingly concentrated upper echelons of the US audit market, according to a Government Accountability Office report. Arvind Hickman speaks with Crowe Chizek audit partner Rick Ueltschy about the report’s findings.

A US government watchdog has cast doubts on whether a lack of choice in the US audit marketplace warrants external intervention by regulators. A new report, ‘Audits of Public Companies: Continued Concentration in Audit Market for Large Public Companies Does Not Call for Immediate Action’, which surveyed a large sample of US listed companies, found that although the market is extremely concentrated at the higher end, concentration is not having an adverse effect on audit fee pricing.

The report will be welcome news to the Big Four, which dominate the large listed US companies in the Fortune 1000. However, some conclusions raised received a mixed response from mid-tier firm Crowe Chizek, which accepted some of the findings but challenged the conclusion that firms of its size are not equipped to audit big companies of up to $2 billion in revenue.

The Government Accountability Office (GAO) surveyed a random sample of nearly 600 large, medium and small public companies about their experiences with auditors. The watchdog also interviewed the Big Four and surveyed all other firms that audit at least one public company.

No ill-effects Although 60 percent of companies say competition was insufficient, the watchdog concluded there is a lack of consensus on how to reduce concentration and there do not appear to be any significant adverse effects from the current situation.

The report revealed that nearly all companies (98 percent) with revenues in excess of $1 billion were audited by the Big Four in 2006, which was also the case in 2002. In the next bracket of companies, with revenues between $500 million to $1 billion, 92 percent chose the Big Four in 2006, although this is a 3 percent decline compared to 2002. At the other end of the scale, only 22 percent of companies with revenues of under $100 million say they were audited by the Big Four, a large drop from 44 percent in 2002.

These findings clearly illustrate there is a very high level of concentration at the upper end of the US audit market. Despite this, the GAO report found no compelling reason to take immediate action to improve choice. It explained that concentration had not affected audit quality and was not a significant factor in rising audit fees. Rising fees are due to additional work associated with increasingly complex accounting and auditing standards, as well as more demanding oversight requirements and staffing difficulties. The report also concludes that there are capacity problems, or a lack of interest, among mid-tier firms in auditing large listed clients.

Perception problems

Crowe Chizek audit partner Rick Ueltschy tells TA the report sums up the market fairly well, although it further highlights perception problems within the marketplace.

“First of all, I would state that the larger non-Big Four firms are capable of doing work above the $1 billion in revenue mark. So it’s not intuitively obvious that it was the right break point to call companies [above this revenue mark as] ‘the largest’,” he says. “We feel very comfortable about our ability to audit companies in the manufacturing and retail space well into a couple of billion dollars worth of revenue that would have a few worldwide locations, and there are a lot of companies that are profiled like that.

“I think that the concentration of the Big Four continues in spite of the fact that the mid-sized firms could handle the work of a large, large portion of those companies very capably. So the report’s overall conclusions about competitiveness are generally accurate except for that particular point, which I don’t think the report drew out.”

Ueltschy believes the report accurately describes drivers of cost in the marketplace, however he claims that fees could be reduced significantly if more companies in the $500 million to $1 billion category looked beyond the Big Four. “They would likely find that they would have the opportunity for significant cost savings,” he remarks. “It differs meaningfully depending on the nature of the client, but it would not be unusual for us to be 25 percent or more lower than a Big Four firm in industries with which we have familiarity.”

Another contentious conclusion of the report is that mid-tier firms have little interest in auditing larger entities that are typically the domain of the Big Four. Ueltschy contends that although Sarbanes-Oxley legislation has made it difficult for firms such as Crowe Chizek to drastically expand resources, larger mid-tier firms are attempting to wrest more market share from the Big Four.

“It is certainly our desire to expand our public company presence and it is our desire to continue to therefore expand our capacity. From time to time we feel like we’re kind of getting at the edge of capacity but we have not yet faced a point at which we did not have the capacity to handle the opportunities for new work,” he says.

“We would like to continue to expand the portion of the public company audit market that we can play in. That doesn’t necessarily mean that we feel the need to be able to get to the size where we could audit General Electric… We want to continue to improve our capabilities, expand the universe of companies that we are able to audit, both in size and the number of specialised industries, and be more of a broad competitor with the Big Four.”

US percentage of companies audited by the Big Four in terms of company size, 2002-2006

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