Accounting firm EY is considering a voluntary spin-off of its global audit and advisory business. This is an astonishing about-face, given the Big Four’s unwavering public opposition to structural reform. Splitting audit or consulting units of companies so that they are completely separate companies is, as the Financial Times has written, the most risky, disruptive and expensive of the remedies suggested for conflicting management. interests of the sector. Still, if EY can pull off structural reform against all odds, it could pay off big.
Reform is certainly needed to improve audit quality, to stimulate competition between auditors, to quell the conflicts that can proliferate in multidisciplinary firms and, ultimately, to avoid the bankruptcies of companies, such as Wirecard (which has been audited by EY).
Auditors challenge management; consultants help him. Proponents of structural reform argue that professional services firms can never properly align these two competing philosophies under one roof, especially when auditing is often the poor cousin of more lucrative consulting work.
It is too early to pass firm judgment on EY’s plans. The precise nature of a split is still being worked out. It is likely that the audit would remain a partnership while EY would place the advisory business under separate ownership, possibly through a public listing or sale of a stake. National EY member firms around the world should vote on such a radical change. That would be no small electoral feat: EY currently has 312,000 employees, including nearly 13,000 partners, operating in more than 150 countries.
Regulatory approval in these different countries could not be taken for granted. Structural separation by itself does not guarantee better audits – as the Big Four have argued. They argued that smaller audit firms could become too dependent on large corporate clients. However, coupled with other reforms – such as mandatory rotation – dependency can be mitigated.
Companies also argued that abandoning consultancy work would hamper the recruitment of the best graduates or specialists. They often sign up for auditing as relays before moving on to better paid advice. A simple solution could be to increase the salaries of auditors. Companies counter that higher wages mean higher fees charged to customers. If it leads to better audits, maybe that’s a price to pay.
Meanwhile, over the whole fiscal year looms the possibility that if the EY plan fails, the Big Four could still shrink to three. This would aggravate, not alleviate, the problems of dependency, poor quality and lack of competition.
Despite these questions, EY deserves praise for trying to get ahead of the problem, and to understand it must try to implement a split on a global scale. His plan puts pressure on rivals PwC Deloitte and KPMG to follow suit – or explain to regulators and clients why they can’t. Also, contingency planning for a split makes sense in case governments and regulators force the issue.
EY’s plans go beyond the operational separation mooted by the UK, which will release its latest audit overhaul announcement on Tuesday but has dragged its feet on legislating change. The European Commission has promised proposals by the end of 2022. EY could focus on the United States, which caused the last major overhaul of accountancy firms after the Enron bankruptcy in 2001. The Securities and Exchange Commission would concerned about the growth of business consultancy work. with respect to the audit, and indicated that it will examine the conflicts of interest and the independence of the auditors. A review is in progress. EY may simply feel that leading and influencing change is better than fighting it.