And if one big auditor should accidentally fall…

The top end of the accountancy market was never a crowded place, but since the late 1980s the number of audit firms dominating the scene in the world’s leading economies has been halved. Mutterings of discontent at the alleged closed shop operated by the remaining ‘big four’ are particularly audible in the City of London, where there is increasing clamour for a regulatory solution to the problem.

It was in 2002, the year that Arthur Andersen was blown out of the water for its role in the Enron scandal, that five finally became four. Since then, questions have been raised about audit quality and about potential conflicts of interest arising from the provision of audit services, which could reasonably be described as a public duty, with other, non-audit services. Frustratingly, it is the excellent reputation enjoyed by all four companies - PricewaterhouseCoopers, Deloitte, KPMG and Ernst & Young - that has led to the present state of affairs.

Tony Brommel, head of accountancy markets and ethics at the Institute of Chartered Accountants in England and Wales, says that audit committees will usually plump for one of the big four over mid-tier firms because it simply "looks more grown up that way". The main barrier to opening up the market is, he says, nothing more complex than the perception of quality offered.

Between them, the big four currently audit 99% of FTSE 100 companies and 97% of FTSE 250 companies. According to a study commissioned by the UK government this year, it has become practically impossible for small and mid-sized rivals to gain a foothold in the blue-chip auditing market.

In an effort to demolish the myth surrounding the four, the Association of British Insurers (ABI), a trade association representing investors that own roughly one-fifth of the UK stock market, issued a statement in June encouraging companies to consider all options when selecting an auditor. These types of measures, rather than regulatory solutions, says Brommel, are preferable to regulatory action.

"Regardless of whether you think there’s a big problem or not, it’s better to concentrate on market-based solutions," he says. "We do agree with the view that information dissemination measures are best, whereas regulatory measures can backfire. Regulatory intervention has a cost and often unintended consequences."

In a later statement released in August, the ABI counselled extreme caution, warning that a market-based approach to audit competition and choice should be "backed up by heightened vigilance on the part of the competition authorities at both EU and national level". It highlights the threat of "regulatory capture", a state of affairs where "large firms could determine the shape of regulation by threatening to withdraw from the audit market".

The failure of the big four to reassess their priorities, preferably restraining their profit-seeking instincts in the interests of audit quality, as ordered by the UK watchdog the Financial Reporting Council last year, has raised further questions on the appropriateness of the current market structure. According to Brommel, ideas on how to tackle the situation currently flying around the City of London include the introduction of limits on the number of audits the big four are allowed to conduct and joint audits.

Following a public consultation, the UK regulator is examining potential remedies ranging from increasing the capacity of mid-tier firms to minimising the risks of another Enron scenario where four might become an unacceptable three. "There is one point on which everyone agrees," says Henri Olivier, secretary- general of the European Federation of Accountants. "That is if one of the major players disappears from the scene, then there will be a real problem."

In the US, many fear that the litigation for alleged negligence might bring down one of the big four. To what extent should auditors be liable for failing to spot a company’s accounting errors or malpractice? The US Chamber of Commerce warned this week that the system was "on the edge of disaster".

Aware of the fallout that could result from another collapse of one of the main accountancy firms, the European Commission has commissioned a study, due in the coming weeks, to assess the need for introducing EU-wide caps on auditor liability. "These big firms have legitimately cornered the expertise in many areas," says Internal Market Commissioner Charlie McCreevy, himself a former accountant who is still a paid-up member of the Institute of Chartered Accountants in Ireland. "It’s not simple to solve this particular problem, so I’d like to see further work [done] on it."

The eighth directive on company law, which came into effect earlier this year, introduced mandatory rotation of key audit partners (every seven years) in an attempt to improve standards. The idea is to prevent an auditor developing too close a relationship with the auditee. But stronger proposals on mandatory rotation of firms, as practised in Italy, were scrapped during the directive’s passage through Parliament. Olivier does not consider rotation of firms to be an acceptable solution. "My view is that rotation is a bad answer to what could be a real problem," he says. "Rotation of firms can be bad for audit quality."

Whatever the effect on quality, if one of the big four collapses, the rotation of firms would become well-nigh impossible.

The top end of the accountancy market was never a crowded place, but since the late 1980s the number of audit firms dominating the scene in the world’s leading economies has been halved. Mutterings of discontent at the alleged closed shop operated by the remaining ‘big four’ are particularly audible in the City of London, where there is increasing clamour for a regulatory solution to the problem.

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