Chapter 8Competition in the audit sector
Introduction
8.1This chapter considers competition in the audit sector. After providing an overview of views expressed during this inquiry on the current state of competition in the sector, this chapter discusses key risks identified in evidence arising out of the current market structure and the possible impacts on competition that may result from some of the key regulatory reforms proposed during this inquiry.
8.2This chapter concludes with the committee’s views and recommendations.
Current market structure in the audit sector
8.3Deloitte, EY, KPMG and PwC—the ‘Big Four’—have dominated the international audit market since the collapse of Arthur Anderson in 2002. This followed a period of consolidation in the top end of the audit market from the 1980s, when eight companies dominated the sector. In Australia, there are six major firms that provide audit services: the Big Four, as well as BDO and Grant Thornton.
8.4This section canvasses some of the available data on competition and market concentration and presents some of the views presented in evidence on the data as well as the consequences of market concentration.
Data on competition in the Australian audit market
8.5The committee was assisted by recent research undertaken by Dr Sarowar Hossain and Professor Gary Monroe, which was funded by Certified Practicing Accountants Australia (CPA Australia) and Chartered Accountants Australia New Zealand (CAANZ). Professor Monroe and Dr Hossain considered the audit market structure, concentration and competition in Australia between 2019 and 2022. They found that the Australian audit market taken as a whole is ‘competitively structured’ when measured based on the number of clients. According to this research, the market share of the Big Four firms constituted less than 38 per cent of companies listed on the Australian Securities Exchange (ASX) in 2022. In terms of audit fees, however, these firms dominated the market, receiving 83 per cent of audit fees paid by listed companies during the same period.
8.6Dr Hossain and Professor Monroe’s research reinforced the view that the Australian audit market is ‘highly segmented’ with differing levels of concentration and competition across the market based on company size.
8.7Amongst the largest and most complex clients (the top 200 companies listed on the ASX), the Big Four audited approximately 96 per cent of all clients and captured 99 per cent of audit fees in 2022. Amongst the next 300 companies, Big Four firms enjoyed a market share of 76percent, capturing 84 per cent of fees in in the same period.
8.8Big Four firm market share dropped significantly in the medium and small client segments, auditing 31 per cent and 6.2 per cent of clients in these categories in 2022.
8.9Dr Hossain and Professor Monroe noted that overall, the Big Four firms’ market share decreased from 42 per cent in 2019 to 38 per cent in 2022. In contrast, non-Big Four (Grant Thornton and BDO) and medium audit firms increased their market share across the same period. However, with respect to the largest 200 companies, the Big Four audit firms’ market share slightly increased from 95.5 per cent in 2019 to 96.5 per cent in 2022.
8.10Dr Hossain and Professor Monroe made several additional observations:
When rated against the Herfindahl-Hirschman Indices (HHI), the audit market overall is ‘moderately concentrated’ based on audit fees and ‘competitively structured’ when calculated based on the number of clients. However, the audit market for the top 200 companies is ‘highly concentrated’.
Companies in the top 200 switched auditor least frequently, whereas auditor change was most prevalent amongst the medium and small client segments.
Audit firm tenure for the top 200 companies was lengthiest (ranging from 13 to 16 years) and shortest amongst the medium and small client market segments.
Audit fee premiums have seen ‘significant’ increases following the consolidation of the large international firms into the Big Four that currently exist. Dr Hossain and Professor Monroe observed that this may suggest a reduction in competition in the market. However, they noted that this impact was not consistent across all client segments.
8.11Dr Hossain and Professor Monroe’s study extended and updated previous work undertaken by Professor Elizabeth Carson for the Auditing and Assurance Standards Board (AUASB) in 2019. Professor Carson’s report focused on competition in the audit market between 2012 and 2018, finding that during this period, audit market share amongst Big Four audit firms declined from 40.7per cent to 37.7 per cent. Like Dr Hossain and Professor Monroe’s later findings, Professor Carson also observed the segmented nature of the audit market and the differing levels of concentration amongst client sizes. Her report observed that ‘[t]he largest and most complex clients are serviced by the Big Four, whilst smaller clients are serviced by a range of other providers’.
Perspectives on the data
8.12Differing views on the data were emphasised by inquiry participants.
8.13Big Four firms underscored the competitiveness of the Australian sector, with PwC and EY pointing to Dr Hossain, Professor Monroe and Professor Carson’s findings on Big Four market share as a percentage of the overall audit market. PwC highlighted that the Australian audit market ‘is more constrained relative to the growth for other professional services’, noting that the number of companies and organisations requiring audits has only seen minimal growth. It also noted that the market itself is ‘mature’ and the audit product has not changed significantly over recent decades.
8.14Other inquiry participants highlighted the Big Four’s dominance of the audit market for the large ‘Public Interest Entities’. Dr Hossain told the committee that the representation of Big Four firms amongst large listed company audits ‘indicates a lack of competition in the upper echelons of the market’. He stated:
…the dominance of large audit firms, commonly known as the “Big 4,” raises apprehensions about market concentration and potential conflicts of interest, limiting competition and options in the audit market.
8.15The Australian Competition and Consumer Commission (ACCC) told the committee that based on its assessment of some of the submissions (and without inside knowledge), ‘it is clear that for big companies the market does seem reasonably concentrated’.
8.16Deloitte and PwC also acknowledged the segmented nature of the market, and the Big Four’s dominance of the large, listed company sector. Both, however, insisted that competition remains significant.
International comparisons
8.17Professor Monroe and Dr Hossain noted that concerns about market concentration are also present in other jurisdictions. For example, in the United States, the Big Four firms audited more than 45 per cent of public companies and received 82 per cent of audit fees. Similarly, in Europe, Big Four firms received 93 per cent of the audit fees for all listed companies on regulated European Exchanges during the same period.
8.18In the United Kingdom, the Big Four audited 61 per cent of companies listed on the London Stock Exchange and accounted for 96 per cent of audit fees in 2022. In 2019, the Competition and Markets Authority (CMA) observed that the United Kingdom audit market ‘exhibits…high concentration among four big audit firms, resulting in limited choice and a market that is not resilient’.
8.19PwC suggested that market concentration in Australia is not as significant as in other jurisdictions, pointing to Professor Carson’s analysis which stated:
Unlike other jurisdictions where the Big 4 audit more than 70% (United States) or 84% (United Kingdom) of listed companies, in Australia the market share of Big 4 auditors is now less than 40%, declining from 40.71% in 2012 to 37.70% in 2018.
Concerns associated with market concentration
8.20Some inquiry participants argued that the current market structure, and the dominance of the Big Four firms at the top end of the audit market, had consequences for the broader audit market including increased risk and impacts on prices. This section outlines some of the key evidence provided on this issue.
8.21In its consultation paper, Treasury stated:
Some PJC Inquiry submissions identified that regulation of large accounting firms is of greater importance than would otherwise be the case due to the importance of audit to the functioning of capital markets in Australia, and the dominance of the key players in auditing the largest listed companies.
8.22Professor Allan Fels, cited in Treasury’s paper, emphasised the importance of audit to Australia and stated that market dominance ‘is risky for consumers of audit products, but also self-perpetuating’, ‘creates a relaxed climate in which conflicts of interest can be accepted as the norm’ and ‘complicates the regulatory response’.He also asserted that ‘any further reduction in the numbers [of audit firms for large listed companies] will undermine competitive tenders for audits’.
8.23Dr Hossain told the committee that the dominance of the Big Four may also undermine auditor independence and objectivity. Additionally, Professor Monroe and Dr Hossain suggested that the market dominance of the Big Four firms has led to concerns from regulators about whether the lack of competition ‘may have adverse impacts on audit pricing and quality’.Treasury concurred with the view that market concentration and an absence of competition in the auditing sector may lead to higher costs and risks to the economy.
8.24Both Deloitte and PwC suggested that competition in the market has had a downward effect on prices. Deloitte added that benefits in quality and innovation are also being achieved as a result of the current market structure. PwC stated that while a regulatory response would be warranted if market power was being misused, in its view, ‘the outcome of the very competitive [Australian audit] market has often been to put downward rather than upward pressure on price’.
Supporting competition in the audit market
8.25The need and suggestions for supporting greater competition in the audit sector were raised during the inquiry. For example, Professor Fels asserted that the increased risks associated with market concentration ‘would be less if other auditing firms were meaningful competitors for major audit mandates’. He highlighted, however, that so called ‘challenger’ firms have not been able to assume a significant share of the top end of the audit market anywhere in the world.
8.26Treasury also supported greater competition in the sector, telling the committee that:
Without having to debate whether there’s enough competition or not, I think you can always have appetite for more. Moving beyond that the question is: how do you bring that to fruition? That's a more challenging question, but it’s one that we're starting the process of working through.
8.27This section discusses some of the key inhibitors to competition raised throughout the inquiry, referred to as ‘barriers to entry’.
Barriers to entry in the audit market
8.28In its consultation paper, Treasury identified as a potential issue for consideration barriers to entry into the audit market, which may have the effect of limiting competition, entrenching existing dominant players and reducing the resilience of the audit services market. In its submission, Treasury highlighted three factors identified by Professors Roger Simnett and Ken Trotman in a 2022 research report that are cited by companies when appointing new auditors:
the reputation of the firm, including their credibility, size, global and industry standing;
the quality of the lead engagement partner, including their capability and industry experience; and
the quality of the audit team.
8.29The first of these, reputation, was identified by a number of inquiry participants as a major barrier to entry for non-Big Four or ‘challenger’ firms seeking to compete in the top end of the audit market. While disputing the accuracy of this belief, Professor Graeme Samuel gave evidence that large audit clients will seek out the services of the Big Four firms because of notions that these firms provide credibility.
8.30Reflecting the second and third factors identified in Treasury’s submission, capability was another major barrier to entry identified in evidence. Professor Monroe stated that the size, complexity and often global operations of the largest companies go beyond the capability and resources of small auditors. PwC expressed a similar sentiment, stating that large, listed companies often ‘require a firm with global reach, access to a range of skills in the audit…as well as the capital to be constantly investing in the latest technology and processes’.
8.31Professor Monroe noted concerns about perception issues amongst audit clients about potential signals that might be sent by retaining a non-Big Four firm. He stated:
Those firms want to pick a big four auditor because everyone else in that group is picking a big four auditor, so what does it signal if they pick somebody else? Are they signalling that they have lower-quality financial reports because they're picking what might be perceived as a lower-quality auditor, a non-big-four?
8.32He also explained that gaps in available data hinder the ability to determine whether small firms bid for auditing jobs in large firms and are rejected in favour of a Big Four firm or are simply not bidding for these types of jobs at all due to a lack of capacity.
8.33Treasury identified other factors that may be barriers to entry for challenger firms, including:
the often-longstanding relationships between companies and their audit firms, which limit turnover and hinder the ability of smaller firms to provide services to these clients; and
the small size of the pool of large audit firms. Companies often use one of the largest firms as their auditor and two of other firms to provide non-audit services. This can lead to a tendency for companies to select auditors from a small pool and may pre-dispose firms to remain with their current auditor and not tender for new audit contractors.
8.34In the United Kingdom, the CMA identified similar barriers to entry for challenger firms. It further noted the difficulties for challenger firms in hiring suitably experienced staff and scaling up capabilities to compete for and undertake complex audits. The Australian Financial Reporting Council shared similar reports, stating that some non-Big Four audit firms in the United Kingdom have expressed reluctance to make the requisite significant investments in training and systems to provide such services for a small number of audits.
8.35Professor Fels argued in favour of government intervention in Australia, stating that the current market concentration at the top end of the audit market would continue in the absence of positive action by government and regulators.
8.36In the United Kingdom, the CMA recommended that major (FTSE 350) companies be required to appoint joint auditors, with at least one being a non-Big Four firm. This recommendation was aimed at improving choice and resilience in the audit sector by breaking down barriers that prevent challenger firms from auditing large companies. The Australian Financial Reporting Council told the committee that this recommendation has not been implemented in the United Kingdom to date.
Potential impacts of regulatory proposals
8.37In addition to the impact of competition on the current audit market structure, the effect of regulatory reforms proposed during this inquiry (such as structural or operational separation to address conflicts of interest arising from the multidisciplinary structure of the Big Four firms discussed in Chapter 3) was also considered as part of the broader conversation about competition in the audit sector.
8.38While acknowledging that proposed regulatory reforms may have some impact on competition, the ACCC told the committee that the nature and extent of this impact is ‘a little hard to predict’. It explained:
…[I]f you’ve been audited by firm A and you can’t use A for consulting services, then what might have been four options could be restricted to three, if you’re talking about the big four. So, there could be a flow-on impact to competition. Whether it’s significant or not is very hard to judge. I think it would depend on, for example, whether there are other options outside of the big four for some of that consulting work.
8.39While not expressing a view as to what form of separation should be implemented, Dr Hossain emphasised that the influence and dominance of the Big Four firms in the upper echelons of the audit market make it ‘imperative’ that clear boundaries between audit and consulting services be established. He explained:
This separation is necessary to ensure that auditors remain unbiased and vigilant in detecting any irregularities or conflicts of interest that may arise when their audit firms also provide consulting services to their clients.
8.40Professor Samuel told the committee that his proposal for change, which would prohibit one company providing both audit and consulting services to the same client (operational separation), ‘should simply result in advisory mandates being redistributed amongst the accounting firms’. In his view, the dominance of the four major firms is unlikely to change. Despite this, Professor Samuel emphasised the importance of imposing ‘the right disciplines’ on the audit sector, such as his suggested regulatory reform and greater transparency around reporting on audit quality.
8.41Some inquiry participants suggested that structural separation, which would require audit functions of a multi-service firm to separate from the non-audit functions, may have a limiting effect on small business. Treasury stated that in larger firms, structural separation ‘might result in the simple redistribution of consulting work amongst the firm, so they’re not providing consulting services to audit clients’. However, the impact on smaller firms might be more significant. It explained:
For a smaller firm, that might become more of a question of their viability. For a smaller firm that survives on providing both consulting and audit services, it might be that the cross-subsidisation of those activities is important to their existence.
8.42BDO also expressed concern for the potential impact of structural separation on small businesses. It asserted that establishing separate audit-only firms would be ‘uneconomical’ for a large number of smaller accounting firms. In its view, such a requirement would lead to a decline in market competition ‘as smaller firms exit and the pool of providers diminishes’.
8.43Another regulatory intervention, mandatory audit firm rotation, may also impact competition in the sector. In the United Kingdom, companies are required to change audit firms every 20 years. While describing this intervention as ‘necessary’, the CMA acknowledged that this measure had had a flow-on effect on competition because it removed access to one company where the market is dominated by the Big Four.
8.44Both the CMA and Professor Fels highlighted the importance of preventing further consolidation in the market where mandatory audit firm rotation exists. Professor Fels explained:
Auditor firm rotation in a market dominated by the Big Four means however that the pool of bidders for the work on rotation is three at most. That is before firms, in their current audit and non-audit conglomerate form, consider whether an auditing contract is not worth bidding for, given the amount they are earning from the company from non-audit work.
Imagine now what happens if the Big Four become the Big Three. With the departing auditor eliminated from a tender there would be two firms at the most in many tenders. Sometimes, possibly often, there would be no competitive tender at all.
8.45As a general observation, Treasury highlighted the importance of ensuring that any regulatory intervention is appropriately balanced. It stated:
In designing specific interventions, the potential benefits should be weighed against potential costs for the community, such as higher prices, lower quality services and slower economic growth. For example, the imposition of regulation can create barriers to entering an industry that reduce competition, increase concentration and create dominant firms.
8.46EY told the committee that it would welcome an inquiry from the ACCC into competition in the audit market that ‘addresses any concerns the Committee may have’. The ACCC told the committee that it had not received a formal suggestion that it conduct an inquiry into the audit market. It added that its compulsory information-gathering powers ‘are only activated when the ACCC is directed to undertake an inquiry under Part VIIA of the Competition and Consumer Act by a Treasury portfolio Minister’, and ‘are not available where the ACCC self-initiates a market study’. It noted that whether such a direction is made ‘is a matter for the Government’.
Committee view
8.47Relative to jurisdictions such as the United States and the United Kingdom, it appears that Australia enjoys a greater degree of competition in its audit sector, particularly in the medium and small company sectors. However, the data reveals that in the large and very large, listed company sector—amongst the ‘public interest entities’—the Big Four have a significant and entrenched stranglehold on the market.
8.48There are clearly concerns about the impact of this dynamic on the sector, including the risks of conflicts of interest and the ability of regulators to intervene to address poor conduct. Further, the barriers to entry for challenger firms are substantial and appear to require significant intervention to overcome. Evidence to this inquiry provided some insight into these concerns, but further analysis is required.
8.49Any future reforms must occur in a way that does not negatively affect competition—we must tread carefully to avoid inadvertently creating unintentional consequences in seeking to remedy other concerns. For this reason, the committee strongly recommends that the government direct the ACCC to conduct an inquiry into competition in the audit sector. This inquiry should consider the key themes of this chapter, including:
the current state of competition in the audit market, including the impact of and concerns associated with market concentration;
mechanisms for supporting competition in the market, including addressing barriers to entry; and
the implications of broader regulatory reform proposals, including operational or structural separation from tax and other consulting services.
8.50The committee is of the view that this inquiry should be commenced at the government’s direction pursuant to Part VIIA of the Competition and Consumer Act 2010 so that the ACCC may have the benefit of its compulsory information gathering powers.
8.51The committee notes that in the United Kingdom, the CMA recommended that major (FTSE 350) companies be required to appoint joint auditors, with at least one being a non-Big Four firm. The committee considers that such an approach has merit and recommends that a similar approach be taken in Australia.
8.52The committee recommends that the Australian Government consider mechanisms to increase competition within the audit sector. This may include mandating tendering, mandating firm rotation for auditors, and mandating public interest entities be subject to joint audits which include smaller firms.
Senator Deborah O'Neill
Chair
Labor Senator for New South Wales