No evidence of "tacit coordination" among Big Four

by Richard Crump

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25 Sep 2012

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Big Four

THE WATCHDOG investigating competition issues in the UK audit market has found no evidence of collusion among the Big Four.

In a working paper as part of its investigation into the Big Four's dominance of the FTSE 350 audit market, the Competition Commission said that although conditions conducive to "tacit coordination" appear to exist, it found no evidence that such activity takes place.

According to the paper, significant barriers to entry and the Big Four's stable market share and high concentration of clients were all conditions that supported tacit collusion, whereby firms implicitly agree to limit their rivalry.

The Competition Commission said that because the appointment of auditors is made by the audited companies, tacit coordination on price is less likely than some form of implicit collusion with regard to geography or industry sector.

"The latter would arise if firms choose not to compete for certain customers or if they decide not to enter the audit market in specific sectors," the commission said.

Mid-tier firms, frustrated by their inability to win FTSE 350 audit clients, have argued the market is too concentrated among PwC, Deloitte, KPMG and Ernst & Young. According to the Commission, between 2002 and 2010 the Big Four consistently carried out the audits for more than 90% of the FTSE 350 companies and accounted for more than 95% of audit fees.

In its submission to the Competition Commission, Grant Thornton argued that the Big Four's high market concentration made it easier for them to monitor the behaviour of their competitors and "there were significant barriers to entry" for mid-tier firms.

BDO, the only firm outside the Big Four to audit a FTSE 100 company, urged the commission to scrutinize audit pricing to compare audit prices over time following a competitive tender, "as research had found that the Big 4 put their prices up within three years of winning a competitive tender", and to consider whether this was indicative of tacit coordination.

The working paper's findings, published ahead of the results of the Competition Commission's wider investigation due in November, will be welcomed by the Big Four, who have argued that the market is competitive.

In their own submissions, the Big Four argued they had a strong incentive to compete to win tenders because of the longevity of client relationships, the infrequency with which FTSE 350 audits came up for tender and coordination was also said to be unsustainable given "the uncertain pay-offs from not competing aggressively for a particular engagement".

The findings also appear to support PwC's claims that the market for listed company audits is "fiercely competitive". In September, PwC's lawyers Norton Rose said there were more than 130 instances of FTSE 350 companies switching auditor between 2001 and 2011.

PwC said the evidence-based data, which represents a rate of approximately one switch a month, dispels the widely held view that the audit market is static and uncompetitive.

"The research shows the market is anything but static. We have every incentive to compete on every piece of work we get," says Pauline Wallace, head of public policy at PwC, adding there would be no benefit from collusion with others.

"We are dealing with a group of very sophisticated companies that are very different from each other. The notion that you would not want to bid aggressively for work is very hard to get your head around.

"Having an audit is a very stable income stream."

The commission said its position "would change" if its ongoing investigation came up with new evidence or evidence of "any mechanisms in place to enhance the possibility of coordination".

The counterpoint view, expressed by on mid-tier partner, is that the question of collusion is of little importance to the overall inquiry and that issues such as pricing, and a lack of innovation should take precedence.

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