The announcements of the planned mergers between Coopers & Lybrand and Price Waterhouse and between Ernst & Young and KPMG have alarmed the clients of the firms involved and aroused public concern.
Anxiety has been expressed about the degree of concentration, already high, which would result from the proposed unions.
The implications for the audit services market of greater concentration include the enhancement of oligopoly, the resulting potential for price fixing arrangements, a reduction in consumer choice, an escalation in conflicts of interest and a potential failure of self-regulation.
These last two issues have attracted discussions in the press. If the mergers take place, self-regulation by the profession might not be appropriate because the resulting merged firms might dominate the profession and the self-regulatory process. The public would doubt whether the merged firms could regulate themselves in an unbiased fashion.
An escalation in conflicts of interest is also likely to arise because the same audit firm might provide consultancy services to two competing client companies. How can a company ensure its auditors will not release useful information to its competitors in return for consultancy fees?
There are good reasons to fear the undesirable consequences of the proposed mergers involving four of the current Big Six.
A commonly used measure of market concentration is the market share held by the largest four companies in an industry (the C4 ratio). In the audit services market, market share is usually measured by reference to either the number of audits acquired or the amount of audit fee income derived from clients.
Previous mega-mergers include Ernst & Whinney and Arthur Young in 1989, and Coopers & Lybrand and Deloitte, Haskins & Sells in 1990. Research study, by Vivien Beattie of Stirling university and Stella Fearnley of Southampton university, showed that, as a result of the two mega-mergers and other smaller mergers between accountancy firms, the C4 based on number of audits increased from 45% in 1988 to 59% in 1990.
They concluded: ‘Audit concentration in the UK market for listed company audit services has now almost reached the limit of a tight oligopoly, which is a market structure characterised by few rivals, stable market shares and medium to high entry barriers.’
The present proposed mergers would increase further the degree of concentration in the audit services market. Based on a sample of 1,331 UK listed companies in 1995, the four firms currently involved in merger negotiations, held a staggering 61% of the total number of audits and collectively earned 80% of the total audit fees.
If the two proposed mergers go ahead, the C4 ratio (based on these firms plus Deloitte & Touche and Arthur Andersen) will increase to 76%, as measured by the total number of audits and 93% by the total audit fees. That smacks of an oligopoly in the audit services market.
Table 1 shows that the degree of concentration brought about by the proposed merger between Coopers and PW would be particularly marked in several sectors. These represent the industries where the potential for oligopolistic pricing and conflicts of interest are more likely as a result of the proposed merger.
Of 37 industrial categories, a merged Coopers-PW firm would gain a market share, based on number of audits, of 30% or more in 22. The combined firm would also capture 40% or more of the market in nine categories: extractive industries, chemicals, diversified industrials, spirits, electricity, water, merchant banks, insurance and life assurance.
Industries where there would be significant changes in auditor concentration include building materials and merchants, engineering, healthcare, pharmaceuticals, leisure and hotels, media, support services, other services and business, and water (Table 3).
A significant change here means that the resulting market share, based on number of audits and audit fee income, of Coopers-PW would be at least 50% higher than that of either Coopers & Lybrand or Price Waterhouse.
Similarly, a merged E&Y-KPMG firm would gain a market share, based on number of audits, of 30% or more in 22 of the 37 industrial categories (Table 2). The combined firm would also capture 40% or more of the market in extractive industries, oil (integrated), oil exploration and production, chemicals, engineering, engineering (vehicle), pharmaceuticals, transport, gas distribution, telecommunications and retail banks.
Potential conflicts of interest
Industries where there would be significant changes in auditor concentration as a result of a merger include building materials and merchants, engineering (vehicle), paper, packaging and printing, textiles and apparel, food producers, food retailers, electricity and other financial (Table 4).
Christopher Pearce, FD of Rentokil Initial and head of the One Hundred Group, considers the proposed Coopers-PW merger ‘reduces competition and increases the potential for conflict of interest’. He is not satisfied that giving up self-regulation would be enough. ‘Our concerns about the reduced choice and competition for major companies in choosing auditors and in due diligence acquisition remain unchanged,’ he says.
The evidence suggests that such fears may be grounded, and in some sectors more than in others.
Chris Pong FCCA is lecturer in accounting and ICAEW Fellow in the department of accounting and business method at the University of Edinburgh
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