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Minimising dominance of big firms
November, 30th 2006


The Oxera report has opened a window of opportunity for mid-tier accounting firms in the UK.

Early this year, a report known as the Oxera report was released in the UK, which studied "Competition and Choice in the UK Audit Market". As in other parts of the world, the report looked at the rather controversial issue of domination by certain firms, more particularly, by what is commonly known as the Big Four.

Accounting regulators in the UK did not want to leave the Oxera report languishing and formed what is called as Market Participants Group (MPG) whose task was to look at the 100-odd suggestions to minimise domination by certain firms. The formation of the MPG met with immediate protest, as it appeared that the MPG was funded by the top audit firms and was, thereby, not fully independent.

To fortify the fact that the regulation was not well-intentioned, one argued that the world did not stop when one of the Big Four was banned from new audit business in the US for six months nor when another was banned from audit work in Japan for two months. This debate is interesting as it would make a useful contribution to the international deliberations on these risks.

Interesting debate

One of the propositions states that there would be significant risks to the availability and quality of audits if one of the top firms were to leave the market. This risk could be mitigated if there were increased choice of auditor for public interest entities. Apart from the debate on the lack of choice, the debate also raised issues of liability, competition, regulation and quality.

An overriding thought appears to be that audit quality improves when it is conducted by the top audit firms. There is an impression in some circles that the departure of one of the Big Five firms subsequent to Enron has actually improved audit quality amongst the mid-tier and second-tier firms.

A school of thought states that auditors are chosen not only on the basis of quality, which obviously matters, but also industrial sector knowledge and the chemistry between auditor and company directors.

Mid-tier firms

The Oxera report has opened a window of opportunity for mid-tier firms in the UK. Financial institutions there are now writing to boards of listed companies urging them to consider such firms. The boards should provide a level-playing field for these firms and monitor progress.

A similar issue cropped up in India a few years ago but appears to have died a silent death. While it appears to be natural that one should not impose on anyone and allow the market to decide which firm should be appointed as one's auditor, one cannot deny the fact that a company incorporated in the US would still prefer to keep one of the top audit firms as its auditor. The number of Indian firms registered with the Public Company Accounting Oversight Board (PCAOB) implementer of the Sarbanes Oxley Act is probably in single digit. That the Institute of Chartered Accountants of India (ICAI) recently permitted Indian accounting firms to engage in the business of management consultancy should raise the hopes of mid-level firms that they too can compete with the big boys in the field. Regulation cannot force companies to choose their auditor.

The message to other audit firms could be to compete with the rest of market and share the piece of cake. In the case of corporates, mergers and acquisitions happen almost every day these days companies merge not only because of financial weaknesses in the case of the merged entity but also as a strategic move to thwart competition. It appears that the day is not far off when the same would happen in the case of audit firms too.

Mohan R. Lavi
(The author is a Hyderabad-based chartered accountant.)

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