The Historical Changes of the World Biggest Audit Firms

1. Introduction

This article presents in detail the history， evolution and reorganization of the Big Four along with presenting the future of the firms. As we all know， the Big Four is the name given to the top four professional consultancy firms of the world namely PwC （PriceWaterhouse Coopers）， KPMG， Ernst and Young and Deloitte. These firms provide audit， accounting， taxation， financial and other professional consultancy to the clients （being businesses and companies）. The discussions below is the history of these firms including the reason of formation of the Big Four and their journey towards being big four.

2. The History of the Big Four – The Big Eight

This name was given to the eight top most audit and accounting firms of the world in the beginning of the twentieth century. Before their evolution as the Big Four， the Big Eight comprised of the following accounting and auditing firms （Mattera 2002）：

a） Arthur Andersen

It was an international professional services firm founded in the year 1913 and went out of business in the year 2002 because of the major ethical and business scandal involving Enron Corporation （as discussed below in detail）. The firm majorly provided consultation services， assurance services， taxation services， corporate finance and legal services to its clients. It operated in around 84 countries. In 1989 this firm was ranked as the worlds second-largest accounting and auditing firm and United States biggest accounting and auditing firm. （Gaines and Cohen 1989）

b） Arthur Young and Company

The firm had its headquarters in the New York， United States and was ranked as the sixth largest auditing and accounting firm in the world in 1980s （Gaines & Cohen， 1989） Arthur Young was established in the year 1906 by a Scottish professional Arthur Young along with his brother Stanley. The company gained huge success in the field of providing accounting and auditing professional services and consultancy services to the corporate clients with the passage of time.

c） Coopers and Lybrand

It was formed in the year 1974， this firm was based in Paris， France. The company offered numerous accounting， auditing and book keeping services （including consultancy services） to companies and individuals. During the 1980s it was ranked as the fourth largest accounting and auditing firm in the world and was competing neck to neck with Ernst and Whinney for third place （Gaines & Cohen， 1989）.

d） Deloitte Haskins and Sells

Deloitte was founded in the year 1845 in London， and subsequently after a series of mergers and acquisitions， Deloitte， Haskins and Sells （2002） came into being in the year 1959. The company had its headquarters in the city of New York， United States and was involved in providing the financial and auditing services to many Corporate and non-Corporate clients.

e） Ernst and Whinney

It was incorporated in the year 1978 in England and Wales （Company Check 1979） and came to the fourth position among the Big Eight in the year 1924 through a series of mergers and de-mergers to survive in the growing and competing market and continuous hard work and dedicated services.

f） Peat， Marwick， Mitchell

It was formed in the year 1911 by the merger of William Barclay Peat & Co. and Marwick Mitchell & Co. （Nndb.com 2008） The Company had its headquarters in London， United Kingdom and was involved in providing auditing and accounting services to a variety of Corporate and non-Corporate clients. The firm was considered to be the world leader in the 1980s （Gaines & Cohen， 1989）

g） Price Waterhouse

Having headquartered in London， it was established in the year 1865 by the merger of Price， Holyland and Waterhouse and was named as Price Waterhouse in the year 1874. The firm was ranked as seventh largest accounting and auditing firm in 1980s （PricewaterhouseCoopers 2013）.

h） Touché Ross

Being the eighth largest accounting and auditing firm in the world in the 1980s， the firm was head quartered in New York， United States and was formed in the year 1900 by George Touché.

3. Journey from Big Eight to Big Six to Big Five and then to Big Four

History of the Big Eight reveal that the firms ranked as the top eight in the world became such huge enterprises by continuous mergers and de-mergers and constant provision of quality services to all the clients on a timely and effective manner. All of the firms forming a part of the Big Eight have a history of mergers with small firms as well as affiliations with some small global firms to increase their market share and to target vast and diversified markets worldwide.

In order to continue with the professional oligopoly in the market and increase their market share constantly the Big Eight adopted a lot of professional methods and techniques. Till the 1970s this cannot be achieved through advertisement or illegal poaching of clients as it was banned by the accounting bodies and law setting agencies. But with the start of the 1980s these practices were adopted by the Big Eight to diversify their client base and increase their market share （Mattera 2002）.

Another major change came with the beginning of the ‘merger wave. Although Big Eight were formed by a series of mergers， but this wave includes the merger of one big and established firm with another such firm， resulting in an even bigger firm / entity. The Big Eight came to the opinion that they had reached a point of market saturation and in order to further increase their market share， they need to either increase their client base or to merge with already established firms to occupy an unbeatable status in the market， as well as to target new and untouched markets （Mattera， 2002）.

Big Eight proved to be strong competition and many firms were forced to merge with it in order to preserve their business. The biggest example of such a merger was that of Spicer& Oppenheim a second tier reputable London based firm that merged with Big Eight partner Touche Ross to stay in business （Faulkner et al.， 2012）.

Mergers helped the Big Eight as the size of the company increased， so did its ability and efforts to conduct research and indulge in political activities. Most of the partners of the Big Eight firm were on the professional bodies committees that determined and issued accounting guidelines （Faulkner et al.， 2012）. The research done and opinions were than published and sent to both established and potential clients to raise the reputation and profile of the firm. These activities added to the reliability of the firm and gained the trust of potential clients. The Big Eight built their reputation on their size， research publications， quality of services and distinction in standard settings； these factors built a positive feedback loop and the Big Eight came to be known as a firm that attracted and recruited the best talent and the biggest and most prestigious clients （Faulkner et al.， 2012）.

The mergers not only made the auditing firm bigger but gave it power to influence the mergers as well. For instance Price Waterhouse an important part of Big Eight made sure that its clients merged with other clients on its list and not with other non-clients.

Mergers were also used by Big Eight as a pressure building tactic. The first of this series was the formation of KPMG Peat Marwick in 1987 due to the merger of Peat， Marwick， Mitchell with the American affiliate of Kleinveld Main Guerdeler KMG a European firm （Faulkner， Teerikangas & Joseph， 2012）. Although the American affiliate itself was small in size but its association with Kleinveld Main Guerdeler （KMG） meant it had the support of a strong European network. A merger with Peat， Marwick， Mitchell made KMG Peat Marwick the biggest international auditing network and at the same time put pressure on the competing firms to expand their international exposure （Faulkner et al.，2012）.

To consolidate the firm further， two more mergers took place in the Big Eight in 1989 when Ernst & Whinney and Arthur & Young merged together to form Ernst & Young and Touche Ross and Deloitte， Haskins & Sells merged resulting in the creation of Big Six.

As a result of this merger In the U.S.， Ernst & Whinney being the fifth largest firm in the world having revenues of $2.15 billion and Arthur Young being the sixth largest firm in the world with revenue of $2.05 billion， a new firm was produced in 1989 that surpassed the world leaders KPMG-Peat Marwick （which had 1988 revenue of $3.9 billion） and Arthur Andersen & Co.， （the second- largest accounting firm in the world and the largest in the United States） （Gaines & Cohen， 1989） .

In September 1997， Price Waterhouse and Cooper &Lybrand announced plans to merge followed by merger plans of KPMG and Ernst & Young in October 1997. This move was severely criticized as the other firms believed that it would lead to oligopoly. Price Water/Cooper &Lybrand went ahead with their merger plans thus creating the biggest firm in the world （Faulkner et al.， 2012）. The merger plans of KPMG and E&Y could not materialize due to competition issues， client hostility and costs. The regulators were also not in the favour of further mergers as in their opinion the industry was quite concentrated. Only 1% of the services were provided by non-Big Five firms； the rest were handled by the Big Five with Ernst & Young providing 19% of the auditing services and KPMG， 13% of auditing （Faulkner et al.， 2012）.

In 2002， Arthur Andersen collapsed because of unethical practices with its audit of Enron. The employees and clients of the firm were absorbed by the four remaining partners. Big Four emerged stronger than before following this unintended consolidation with Price Waterhouse Cooper being the strongest firm handling 34% of the auditing and KPMG being the smallest with 18% auditing.

In the year 2002 the accounting world was hit by the biggest scandal of the century， the Enron Scandal！ The firms employees and accountants admitted of its involvement in the forgery of the books of Enron Corporation which led to the bankruptcy of the company and sinking of the investments of stake holders worth billions of dollars （Mattera 2002）.

The scandal and the firms acceptance of its involvement in the forgery， led to the rise of millions of questions about the integrity of the audit and accounting firms and the established ethical principles and practices governing this profession （Mattera， 2002）. Following the involvement of Arthur Andersen in the Enron scandal， ethics has become the focal point of the accounting industry （Wetfeet， 2008）.

4. Advantages and Disadvantages of the Evolution of Big Four

The establishment and concentration of the auditing firms from Big Eight to Big Four has led to many pros and cons for the accounting and auditing service industry， the concerned clients， stake holders and public at large.

The biggest issue that has raised many doubts and question marks on the quality of the services provided by these firms is the growing trend of unethical practice in the accounting and auditing field. As audit is an independent examination and done on sampling basis there is an inherent risk of making mistakes in the opinion. But certain unethical an amoral practices may also arise as an attempt to increase revenues or retain big clients （Mattera 2002）.

After the Enron Corporation scandal many laws and regulations were imposed on the public practitioners. But the oligopoly and market penetration achieved by the Big Four through this process of mergers have led these big enterprises immune to many such governing rules and regulations （Mattera 2002）.

Another drawback associated with the evolution of the Big Four is the market oligopoly created and maintained by such firms. This market leadership has made these firms less accountable and more confident in their dealings， whether right or wrong （Mattera， 2002）. In the world of accountancy size does matter； the size of the smallest Big Four firm is still greater than the size of all second-tier firms combined. Therefore because of the mergers， Big Four enjoys competitive advantage globally and at the same time also restricts any change in the industry its competition may bring about （Faulkner et al.， 2012）.

The benefits include， among other things， diversification of the services provided by the firms. Two firms with entirely different speciality merge to form a single firm having two specialities. This has greatly improved the level of services and has contributed in providing one stop solutions to the clients （Mattera 2002）.

Another benefit is the increased areas of operations， many firms operating in different areas come under the umbrella of big four by forming alliances and networks. This has led to the fulfilment of the requirement of the multinational clients. This also helps in transferring the widely accepted and recognized accounting and auditing techniques and methodologies to underdeveloped areas of operations and improving the quality of the profession worldwide （Mattera 2002）.

The evolution of Big Four has also led to the increased number of publically traded clients with each individual firm. Firms formed as a result of merger of two or more firms also increase the clientele. Further， new clients are captured in new areas of operations （Mattera 2002）.

5. The Existing Industry and Business of the Big Four

As discussed and explained that the Big Four auditing and accounting firms comprise of the network of top four world renowned auditing and accounting service providers. Comprising of the PwC， KPMG， Deloitte and EY， these organizations have a history of struggles， constant mergers and affiliations and diversification of the offered services to reach the position they now hold. （Mattera 2002）

6. Business and Industry Concentration

Oxera Consulting Limited conducted a detailed research on the Big Four and their concentration in the audit and accounting industry in the United Kingdom for the Financial Reporting Council. （Financial Reporting Council FRC UK 2006）

The research was based on 67 audit firms and clients （including other stake holders）. The research also included responses from 50 Audit Committee Chairs telephonic interviews. The research also analysed the data from 700 companies and the FTSE 100 to evaluate the results as well as the barriers to entry in the audit market. （Financial Reporting Council FRC UK 2006）

The research concluded various aspects of the current businesses of the Big Four， as explained below.

a） Existing Clientele ship：

The Big Four audit 99 （ninety nine） companies of the FTSE 100 companies （that is only one company from this list is audited by some small firm）. 99% of the audit fees paid by the FTSE 350 are paid to the Big Four， and the remaining 1% to other firms. （Financial Reporting Council FRC UK 2006）

This shows the concentration of the audit towards the Big Four and the oligopoly maintained by these entities.

b） Switching of the service providers：

The switching or shifting of the audit firms by the clients among the Big Four or out of the Big Four is quite rare and the switching percentage of the clients is 4% for all the listed and public companies and 2% on average for the FTSE 100 companies. （Financial Reporting Council FRC UK 2006）

However， due the quality and independent concerns the legal and regulatory bodies are taking an interest in this aspect and are now implementing laws and regulations to set out time limits for changing the auditor. （Financial Reporting Council FRC UK 2006）

c） Tendering for the clients：

The research conducted also concluded the fact that competitive and merit based tendering for the clients that leads towards the switching of the firm by the client， is also a rare circumstance. Therefore， the Big Four do not doubt their market share and seldom put efforts to maintain the existing market share. （Financial Reporting Council FRC UK 2006）

d） Reputation of the Big Four and their selection：

The research conducted for FRC also highlighted this most important factor which contributes greatly to the current position and success of the Big Four， and that is the selection of Big Four by many reputed organizations because of their reputation. The research presented the fact that ‘reputation is an important driver of choice and this criteria favours the Big Four as many of the FTSE 350 companies select Big Four as their auditors or consultants because of their reputation to deliver quality value added services and insurance against reputational risks. （Financial Reporting Council FRC UK 2006）

e） Concentration in the audit market：

Oxera， through the research conducted for FRC， also found out that the above reasons have led to the concentration/accumulation of the majority of the clients with the Big Four and because of this concentration the audit and consultation fee charged by the Big Four has increased dramatically. Apart from the concentration， increase in audit fee charged by the Big Four is also because of the increase in costs because of strict rules and regulations imposed on auditing and accounting service market and industry. （Financial Reporting Council FRC UK 2006）

The research presented the fact that there is a huge gap between the Big Four and the mid-tier firms and the gap cannot be easily filled or removed. （Financial Reporting Council FRC UK 2006）

f） Reason for selecting Big Four：

Although the audit fees charged by the Big four has dramatically increased in the past few years， but this does not change the fact that the Big Four is the top most choice of many of the Corporate clients because of their reputation and quality and the Audit Committees of many companies consider quality and reputation as the most important factors for selection of auditors and consultants rather than cost of services. （Financial Reporting Council FRC UK 2006）

g） Need to select Big Four because of lack of choice：

Oxera also concluded in their research that a few of the FTSE 100 have no choice in selection of auditors （especially statutory auditors）. And because of the high concentration， auditor independence rules， expertise needs and lack of qualitative supply of the services， they have to make a forced selection of Big Four as their auditor. This lack of choice gives the upper hand to the audit firm and they can easily exploit the client. （Financial Reporting Council FRC UK 2006）

h） Decreasing competition：

The increased concentration and the reduced number of the top tier firms have led to decrease in the competition and it is not working in the same manner as it was during the 1980s. That is the existing competition is not yielding the same positive results in the form of improved and quality services. （Financial Reporting Council FRC UK 2006）

The research conducted by Oxera for FRC also highlighted the major concerns and policy issues regarding the audit market. The concerns include increased concentration in the audit market after two major mergers in the year 1989 and formation of the Big Six from the Big Eight.

Further merger of Price Waterhouse and Coopers and Lybrand in the year 1998 and dissolution of Arthur Andersen， because of the Enron Corporation scandal， in the year 2002 have increased this concentration. As per the research this increasing concentration has adversely affected the service quality. （Financial Reporting Council FRC UK 2006）

7. Summary

To sum up， this article illustrate how the Big Four grew from the Big Eight during the 20 years time. The section explains the journey of the world toppest audit firms reorganisations and competitions from 1980s till now in detailed. Moreover， through the financial factors description， it can be seen that the Big Four are quite successful in the audit industry and have a significant positions.

References：

[1]Allen，D.G.（1993）.Accounting for Success：A History of Price Waterhouse in America，1890-1990.UK：Harvard Business Press.

[2]Faulkner，D.，Teerikangas，S.&Joseph，J.R.（2012）.The Handbook of Mergers and Acquisitions.UK：Oxford University Press.

[3]Financial Reporting Council FRC UK.（2006）.Competition and choice in the UK audit market.[report]Oxford：Oxera Consulting Limited.

[4]Gaines，S.and Cohen，L.（1989）.Ernst-Arthur Young Merger Expected.Chicago Tribune，[online]19th May，1989.

[5]Mattera，P.（2002）.Lack of Accountability：The Enron/Arthur Andersen Scandal and the Future of the Accounting Business.[e-book]Washington，D.C.：The Corporate Research Project.Available through：The Corporate Research Project.

[6]Nytimes.com.（2011）.The New York Times.[online]Available at：http：//www.nytimes.com/2011/10/28/business/longing-for-the-days-of-the-big-eight.html？_r=4&[Accessed：13 Aug 2013].

作者簡介：靳珊（1989.4-），女，汉族，陕西西安人，现任职于西安外国语大学财务处，国际金融学硕士，本科毕业于西安外国语大学会计学（ACCA）方向，从事财务管理等相关工作。