The audit market for the biggest listed

The concentration battle Big Four audit market concentration has been identified as a problem by regulators in recent times but are mid-tier firms prepared to provide more competition? Nick Huber investigates how concentration varies across markets and where the mid-tier is looking to break down Big Four dominance The audit market for the biggest listed companies in many Western countries is like an exclusive club. Plenty of accounting firms want to join the elite Big Four accounting firms (PwC, Deloitte, KPMG and Ernst & Young) but, to their great frustration, find that the market does not always perceive their credentials as being good enough to join the big players beyond the velvet rope. In the UK, for example, the Big Four audit all but one company in the FTSE 100 share index and dominate audits of FTSE 350 companies. Now, however, the Big Four market share in audit is under growing international scrutiny. There are concerns the Big Four have become too dominant and the collapse of one of these firms would cause major disruption to the economy. Regulators are considering reforms to dilute the Big Four s dominance and improve competition in the audit market (See box, page 9). In the UK, mid-tier firms insist that they have the scale, experience and skills to handle many FTSE 100 audits. But is the mid tier ready to take on the Big Four in audit markets outside the UK particularly in fast-growing economies like China, India and Latin America? Recent research into audit markets for large listed companies worldwide (See pages 7, 8 and 10), confirms the dominance of the Big Four firms in the biggest Western economies. But in many fast-growing emerging economies, audit markets are more open. The research, published last year by Grant Thornton, looked at audit firms share of listed companies with a FTSE-350 equivalent market capitalisation. It found that Big Four firms had an 84 percent share of audits in G8 countries and 70 percent worldwide. The Big Four dominate most of Europe s largest economies, scrutinising 100 percent of top-350 listed companies in the Netherlands and 97 percent in Italy. The only big European economy where the mid-tier firms have a sizeable chunk of largecompany audits is France, where joint audits are mandatory. Here the Big Four s market share is 58 percent. Outside Europe, however, audit markets are more fragmented. In India and China, for example, the Big Four share is only 41 percent and 14 percent respectively. The majority of companies are audited by firms other than the Big Four or mid-tier, many of them national firms. In Russia, the Big Four has a 52 percent market share. Senior partners at the bigger mid-tier firms admit that unless regulators intervene in European audit markets to force more competition n DUAL AUDIT Auditor concentration in listed companies Dual audit Big4: Big4 FTSE 350 equivalent market cap Big4: Other Other: Other Denmark 7 3 4 0 France 234 70 132 32 market cap > 100m Denmark 9 4 5 0 France 289 78 161 50 market cap > 50m Denmark 16 6 9 1 France 391 84 208 99 Sources Factset, Hemscott, Bloomberg, Grant Thornton (for example by introducing mandatory joint audits), there is little scope for mid-tier firms to unlock the Big Four s stranglehold on the top 350-company audit market. The Big Four s dominance in Western markets is due to three main factors: the Big Four firms are well established and company boards often stick with the same auditor for decades or even longer; only the Big Four firms have the global scale, skills and experience to audit the largest 20 or so companies in the FTSE 100; and restrictive banking covenants, which require companies to use a Big Four auditor. In response, the mid-tier 4 n Concentration barometer The audit markets with the highest and lowest Big Four concentration 100 % 80 60 40 20 0 Czech Republic Estonia Hungary Iceland Netherlands Italy Notes: Applies to companies with market cap > 100. Portugal Ireland Finland Slovenia G8 EU 27 G20 Indonesia Greece France Russia India Cyprus Lithuania Luxembourg Malta China Source: Factset, Bloomberg and Hemscott 6 y May 2011 www.internationalaccountingbulletin.com

Special report: Market concentration Major economies auditor concentration in listed companies with FTSE 350 equivalent market cap G8 982 1,072 1,102 1,297 84% 140 89 601 5,282 G20 1,438 1,327 1,508 1,633 68% 231 161 2,385 8,682 EU27 384 363 320 285 83% 29 33 210 1,623 EEA 402 379 331 302 84% 29 34 215 1,691 All 1,570 1,476 1,613 1,724 70% 233 177 2,390 9,183 Argentina x 11 3 4 2 87% 3 23 Australia x 86 63 31 56 85% 4 11 27 278 Austria x x 4 20 8 6 86% 1 1 4 44 Belgium x x 8 12 17 9 79% 1 2 9 58 Brazil x 28 29 64 31 80% 12 12 15 191 Bulgaria x x 0% 3 3 Canada x x 112 102 92 58 87% 13 6 37 420 China x 83 37 53 64 14% 54 39 1,346 1,676 Cyprus x x 2 40% 3 5 Denmark x x 14 10 14 3 1% 2 0 5 46 Estonia x x 1 100% 0 1 Finland x x 19 19 3 11 90% 6 58 France x x x x 57 62 76 78 58% 10 2 55 128 468 Germany x x x x 57 59 18 34 82% 5 8 25 206 Greece x x 10 5 4 4 55% 9 1 9 42 Hungary x x 3 2 4 100% 0 9 Iceland x 1 1 100% 0 2 India x 68 17 66 38 41% 5 270 464 Indonesia x 17 5 12 34 70% 1 28 97 Ireland x x 8 9 3 1 91% 1 1 23 Italy x x x x 31 19 30 36 97% 2 2 120 Japan x x 63 302 302 353 86% 21 1 144 1,186 Latvia x x 0% 1 1 Lithuania x x 2 33% 4 6 Luxembourg x x 3 4 4 3 64% 8 22 Malta x x 1 33% 2 3 Mexico x 21 6 25 18 88% 4 6 80 Netherlands x x 15 25 13 16 100% 0 69 Norway x 17 16 10 17 91% 1 5 66 Poland x x 7 18 7 14 71% 10 9 65 Portugal x x 6 3 11 2 96% 1 23 Romania x x 0% 8 8 Russian Federation x x 25 19 19 14 52% 6 64 147 Saudi Arabia x 12 6 19 23 71% 1 1 22 84 Slovak Republic x x 1 1 2 100% 0 4 Slovenia x x 1 4 2 1 89% 1 9 South Africa x 41 25 32 15 85% 4 1 15 133 South Korea x 67 57 64 40 85% 1 40 269 Spain x x 17 11 43 15 87% 2 11 99 Sweden x x 37 32 12 21 94% 7 109 Turkey x 22 7 36 15 76% 6 7 12 105 UK x x x x 111 80 88 60 97% 5 6 0 350 US x x 554 460 515 703 85% 91 59 237 2,619 Notes: International network audits of listed companies with a market cap above the lower level of the FTSE 350 as at 30 June 2010. At the close of trading on 30 June 2010, Connaught plc was the lowest-ranked constituent of the FTSE 350 index, with a market cap of 161.17 million ( 263.7 million). Data sourced from Factset, Bloomberg and Hemscott (UK) as at 30 June 2010 for qualifying companies listed in the G8, G20, EU27 and EEA regions. Joint audits (mandatory in France; voluntary in Denmark) are treated as a separate mandate for each auditor in the aggregate. Sources: Factset, Hemscott, Bloomberg, Grant Thornton. www.internationalaccountingbulletin.com May 2011 y 7

Major economies auditor concentration in listed companies with market cap greater than 100m G8 1,171 1,300 1,346 1,570 80% 214 135 960 6,694 G20 1,708 1,601 1,818 1,965 66% 323 223 3,140 10,776 EU27 517 459 429 394 79% 64 70 337 2,269 EEA 543 478 442 418 80% 64 71 345 2,360 All 1,873 1,760 1,936 2,085 67% 326 248 3,159 11,387 Argentina x 12 3 4 2 88% 3 24 Australia x 104 75 42 77 79% 12 16 52 378 Austria x x 4 22 8 7 84% 1 1 6 49 Belgium x x 10 13 21 11 77% 1 3 12 71 Brazil x 31 34 68 32 79% 14 14 16 209 Bulgaria x x 0% 8 8 Canada x x 137 130 110 69 82% 14 7 78 545 China x 92 40 58 71 14% 58 45 1,549 1,913 Cyprus x x 2 33% 4 6 Denmark x x 17 11 15 4 1% 4 1 9 58 Estonia x x 1 2 1 1 100% 0 5 Finland x x 21 20 3 16 91% 6 66 France x x x x 64 74 93 87 55% 15 2 60 183 578 Germany x x x x 64 66 24 49 77% 4 14 44 265 Greece x x 12 7 5 7 55% 11 4 10 56 Hungary x x 4 2 4 100% 0 10 Iceland x 1 1 100% 0 2 India x 82 19 76 47 39% 6 350 580 Indonesia x 17 6 15 39 62% 3 44 124 Ireland x x 9 9 3 1 92% 1 1 24 Italy x x x x 38 21 39 39 96% 2 4 143 Japan x x 84 358 381 445 84% 25 2 223 1,518 Latvia x x 0% 2 2 Lithuania x x 2 29% 5 7 Luxembourg x x 3 4 5 3 58% 11 26 Malta x x 1 17% 5 6 Mexico x 22 6 26 18 86% 4 8 84 Netherlands x x 18 27 14 21 99% 1 0 81 Norway x 25 19 12 24 90% 1 8 89 Poland x x 9 18 14 16 66% 13 16 86 Portugal x x 8 3 12 3 93% 1 1 28 Romania x x 0% 10 10 Russian Federation x x 26 21 20 16 50% 6 78 167 Saudi Arabia x 12 6 22 26 63% 1 2 35 104 Slovak Republic x x 1 1 2 80% 1 5 Slovenia x x 2 5 2 1 91% 1 11 South Africa x 44 31 36 15 84% 6 1 17 150 South Korea x 90 71 84 53 78% 2 82 382 Spain x x 23 11 45 17 83% 2 18 116 Sweden x x 42 35 14 26 90% 1 12 130 Turkey x 31 10 41 15 72% 6 7 24 134 UK x x x x 195 147 153 119 87% 34 27 30 705 US x x 595 520 572 789 81% 129 76 381 3,062 Notes: International network audits of listed companies with a market cap over 100 million ($164 million) as at 30 June 201. Data sourced from Factset, Bloomberg and Hemscott (UK) as at 30 June 2010 for qualifying companies listed in the G8, G20, EU27 and EEA regions. Joint audits (mandatory in France; voluntary in Denmark) are treated as a separate mandate for each auditor in the aggregate. Sources Factset, Hemscott, Bloomberg, Grant Thornton 8 y May 2011 www.internationalaccountingbulletin.com

Special report: Market concentration 4 are looking East and South to pick up multibillion dollar audit clients. The gap between the Big Four and mid-tier firms in audit markets in some developing economies is often narrower than in the West. However, getting mid-tier firms to name some of their trophy clients is surprisingly tricky. Of a handful of mid-tier accountants contacted by for this feature, most declined to comment. None were able to name large audit clients outside the UK and Europe. One thing is clear, however, the most attractive market for mid-tier auditors is China the world s fastest-growing economy. The single most important [audit] market is China, says Jeremy Newman, chief executive of BDO International, the fifth largest accounting network. In the past two-and-a-half years, we have invested more money, effort and time in China than in anywhere else. BDO is about two-thirds the size of the smallest Big Four firm in China, and about half the size of the largest Big Four firm, Newman says. BDO s strategy in China is to build its roster of blue-chip Chinese firms in contrast to the Big Four, which, Newman says, typically audit the Chinese subsidiaries of global companies. Our hope is that when our Chinese clients expand we will be able to pick up the audits of their subsidiaries rather than the Big Four. But given that large companies in Western economies have typically chosen Big Four firms as markets matured, why should China be any different? Newman says that his dealings in China have convinced him the government is wary of an audit market dominated by only four firms and is keen to encourage competition. Edward Nusbaum, global chief executive of Grant Thornton, says the audit market for the top 350 to 2000 listed companies is a priority for his firm because the Big Four are less dominant there. There has been a huge shift in the marketplace over the past five years, he says. There was an assumption that the vast majority of listed companies would be audited by the four largest firms, but this assumption has shifted dramatically. Audit committees and management teams are becoming more sophisticated and are analysing the marketplace more thoroughly and are looking for alternatives to all their suppliers. Grant Thornton and other mid-tier firms have done a lot to elevate their reputation and image in the marketplace. Regulatory reviews around the world on audits of listed companies have come back at least as positive as other firms and sometimes better. Nusbaum singles out India and China as key markets although he explains the Indian audit market is very fragmented and unpredictable. No one knows how that marketplace will evolve, he says. Nusbaum is cautiously optimistic Grant Thornton can expand in these markets. It s possible to become a top-four audit firm for large companies in India or China, although probably not for five or 10 years, he says. After all, companies in industries with a seemingly unassailable lead can be overtaken, Nusbaum argues citing the example of the automotive industry where Ford was overtaken by Toyota in the space of 30 years. In developing economies such as India, one way for mid-tier firms to grow their share of audit markets is to partner with national accounting firms, says Sunil Poshakwale, professor of international finance at Cranfield School of Management. There are a good number of well-known accounting firms in India which could pose stiff competition for mid-tier firms, he says. So the strategy for [global mid-tier firms] should be to develop ways of collaboratively working with accounting firms in India. Big Four look East and South Audit markets in Asia may be more open than in Europe and America, but mid-tier firms still face fierce competition from Big Four firms that are well established and growing fast. Last year, Deloitte said Asia-Pacific had been its fastest growing region over the past five years. The firm is investing heavily in the BRIC countries and also the Middle East and South-East Asia. Other Big Four firms are expanding in audit and consultancy markets in the East and South in an effort to counter declines in the West. PwC s Asian revenues grew by around 8 percent in the year to June 2010, and jumped 12 percent in South and Central America. In contrast, revenues in Western Europe slipped by 0.6 percent and by 1.7 percent in North America and the Caribbean. Mid-tier accounting firms are having more success in picking up large listed audit clients in fast-growing economies such as China and Latin America, although they are unable or reluctant to provide examples of blue-chip clients. The Big four firms maintain a comfortable lead in these audit markets but have yet to achieve the dominant position they have in the West partly due to the strength of national accounting firms. Fragmentation in these markets gives mid-tier auditors around five or 10 years to impress large listed companies and become a serious alternative to the Big Four. < See table Auditor concentration in listed companies with market cap over 50m on p10 n Intervention Regulatory reviews of audit market and Big Four The European Commission is considering making potentially major changes to the audit market, including mandatory rotation of auditors and a cap on advisory fees. It has yet to publish its conclusions. In the UK, the Office of Fair Trading (OFT) is considering whether to investigate parts of the UK audit market to consider concerns over the dominance of the Big Four firms. The OFT was due to give an update on the situation as the International Accounting Bulletin went to press in May. Any investigation would focus on the use of legal clauses in bank lending agreements that require companies to use a Big Four auditor, and whether they unfairly restrict competition. In its March Budget, the UK government said it wanted the OFT to examine the issue. Mid-tier firms welcomed the government s call for the review. Steve Maslin, chair of Grant Thornton UK s Partnership Oversight Board, said: The government has recognised that excessive concentration in the FTSE 350 audit market is not in the interests of listed companies, their investors and the market as a whole. Restrictive banking covenants, which limit the choice of companies to appoint suitably experienced auditors of their own choosing, are anti-competitive and a major factor preventing other audit firms from building their position in the market, he also claimed. However, Big Four firms argue that their success is simply due to market choice. The use of large audit firms by large international companies is a result of market choice and reflects capability and quality, said Joachim Schindler, global head of audit at KPMG. KPMG delivers on the requirements of these global businesses by considerably investing in the quality of our people and the quality of our network. Hence, in addition to the technical and industry expertise, we put people with a truly global mindset in front of our clients. Global mobility is an opportunity for our people and benefits our clients. < www.internationalaccountingbulletin.com May 2011 y 9

Major economies auditor concentration in listed companies with market cap over 50m G8 1,360 1,561 1,605 1,871 75% 305 198 1,658 8,548 G20 2,010 1,939 2,176 2,353 63% 429 308 4,316 13,521 EU27 620 567 506 494 63% 101 112 615 3,006 EEA 653 591 520 524 73% 101 114 637 3,131 All 2,211 2,123 2,309 2,501 64% 429 353 4,393 14,319 Argentina x 13 4 7 2 79% 7 33 Australia x 123 94 51 103 73% 18 24 94 507 Austria x x 4 24 9 8 79% 1 3 8 57 Belgium x x 11 14 25 12 73% 1 3 19 85 Brazil x 33 40 71 32 76% 15 16 26 233 Bulgaria x x 0% 12 12 Canada x x 171 164 133 85 74% 18 11 161 743 China x 100 46 67 78 14% 59 51 1,614 2,015 Cyprus x x 2 20% 8 10 Denmark x x 21 15 21 4 1% 4 2 15 80 Estonia x x 1 2 1 1 83% 1 6 Finland x x 28 24 3 21 90% 8 84 France x x x x 71 93 105 108 48% 22 2 77 304 782 Germany x x x x 77 79 26 65 69% 9 20 91 359 Greece x x 17 9 6 9 52% 13 8 17 79 Hungary x x 5 1 2 5 93% 1 14 Iceland x 1 1 67% 1 3 India x 108 25 96 59 36% 7 506 801 Indonesia x 18 8 20 47 56% 4 68 165 Ireland x x 9 13 3 2 93% 1 1 29 Italy x x x x 48 28 49 48 93% 2 11 186 Japan x x 119 438 504 562 79% 39 4 387 2,053 Latvia x x 0% 3 3 Lithuania x x 2 15% 11 13 Luxembourg x x 3 4 5 6 60% 12 30 Malta x x 1 11% 8 9 Mexico x 22 8 33 19 85% 4 1 10 97 Netherlands x x 18 30 15 23 97% 3 0 89 Norway x 32 24 13 30 81% 2 21 122 Poland x x 10 19 18 22 50% 1 21 46 137 Portugal x x 10 3 15 3 89% 2 2 35 Romania x x 0% 13 13 Russian Federation x x 26 23 21 16 43% 7 107 200 Saudi Arabia x 12 8 26 27 54% 2 2 58 135 Slovak Republic x x 1 1 2 67% 2 6 Slovenia x x 2 5 2 1 59% 1 6 17 South Africa x 47 37 41 16 80% 10 2 24 177 South Korea x 138 97 114 82 68% 2 205 638 Spain x x 26 12 50 19 73% 3 37 147 Sweden x x 55 46 15 34 84% 2 27 179 Turkey x 36 11 45 17 63% 7 10 46 172 UK x x x x 235 192 186 151 82% 58 43 65 930 US x x 648 590 633 890 75% 170 110 645 3,686 Notes: International network audits of listed companies with a market cap over 50 million ($82 million) as at 30 June 2010. Data sourced from Factset, Bloomberg and Hemscott (UK) as at 30 June 2010 for qualifying companies listed in the G8, G20, EU27 and EEA regions. Joint audits (mandatory in France; voluntary in Denmark) are treated as a separate mandate for each auditor in the aggregate. Sources: Factset, Hemscott, Bloomberg, Grant Thornton 10 y May 2011 www.internationalaccountingbulletin.com