COMPETING FOR EMERGING CORPORATE CLIENTS: A STUDY OF INDEPENDENT AUDITOR CONCENTRATION.Abstract In recent years competition among the largest public accounting firms has intensified in·ten·si·fy v. in·ten·si·fied, in·ten·si·fy·ing, in·ten·si·fies v.tr. 1. To make intense or more intense: as the so-called so-called adj. 1. Commonly called: "new buildings ... in so-called modern style" Graham Greene. 2. Big 8 CPA (Computer Press Association, Landing, NJ) An earlier membership organization founded in 1983 that promoted excellence in computer journalism. Its annual awards honored outstanding examples in print, broadcast and electronic media. The CPA disbanded in 2000. firms have consolidated into the "Big 5" firms. With audit fees being dependent to a large extent on client size and profitability, growth minded independent auditors Independent Auditor An external auditor with a certified public accounting designation that qualifies him or her to provide an auditor's report. Notes: These auditors aren't affiliated with the company being audited. are engaged in competition for the largest corporate clients as well as emerging corporate clients. The purpose of this research effort is to generate an understanding of independent auditor competition for emerging corporate clients represented by "Forbes Forbes , B(ertie) C(harles) 1880-1954. American publisher and businessman who founded and edited (1916-1954) Forbes magazine. His son Malcolm Stevenson Forbes 200 Best Small Companies in America America [for Amerigo Vespucci], the lands of the Western Hemisphere—North America, Central (or Middle) America, and South America. The world map published in 1507 by Martin Waldseemüller is the first known cartographic use of the name. " and for major corporations listed in the "Fortune 500." The study provides and analyzes independent auditor market shares utilizing a series of market concentration ratios. The results indicate that market concentration has increased in both the "Forbes 200" and "Fortune 500" audit markets. As a consequence, the differences between the "Big 5" and smaller independent auditors are being accentuated. The smaller independent auditors are increasingly unable to compete with the largest firms for the largest and most desirable corporate clients. Competing for Emerging Corporate Clients: A Study of Independent Auditor Concentration Several thousand certified See certification. public accounting (CPA) firms operate in the United States United States, officially United States of America, republic (2005 est. pop. 295,734,000), 3,539,227 sq mi (9,166,598 sq km), North America. The United States is the world's third largest country in population and the fourth largest country in area. . These firms range in size from sole practitioners to international organizations employing thousands of professionals and generating several billion dollars of revenue. The market for independent audits is highly stratified stratified /strat·i·fied/ (strat´i-fid) formed or arranged in layers. strat·i·fied adj. Arranged in the form of layers or strata. with large CPA firms auditing the largest clients and local firms servicing smaller clients. In general, smaller CPA firms are unable to compete with large firms' vast resources of personnel and technical capabilities. In recent years, the Years, The the seven decades of Eleanor Pargiter’s life. [Br. Lit.: Benét, 1109] See : Time accounting profession has experienced a wave of merger activity which has consolidated the so-called Big-8 public accounting firms into a group of mega-firms termed the Big-5. As competition intensifies, the Big-5 firms continue to dominate the market for major corporate clients. These firms have gained their market positions by offering a broad array of accounting and related services. To maintain their individual positions in today's competitive audit market, Big-5 firms are engaged in intense marketing efforts, price competition, and are seeking to expand their client bases (Sommer Sommer is a surname, from the German and Danish word for the season "summer". It may refer to:
adv. Frequently; repeatedly. Adv. 1. oftentimes - many times at short intervals; "we often met over a cup of coffee" frequently, oft, often, ofttimes opens the door for the CPA firm to market other more profitable services, such as management consulting Noun 1. management consulting - a service industry that provides advice to those in charge of running a business service industry - an industry that provides services rather than tangible objects , to newly acquired client. This competition for emerging corporate clients pits the Big-5 firms against smaller accounting firms as well as against one another (Minyard & Tabor, 1991). The purpose of this article is to generate an understanding of the extent of independent auditor competition for emerging corporate clients. Through the use of market concentration ratios, a comparative analysis is made of the trends in independent auditor competition in the markets for emerging corporate clients represented by the "Forbes 200 Best Small Companies in America" and for major corporations listed on the "Fortune 500." Analysis is made of independent-auditor concentration at five-year intervals, including 1981, 1986, 1991, and 1996. Additionally, concentration measures are presented for subsequent to the recent merger of Price Waterhouse There have been several famous people with the surname Waterhouse:
Measuring Market Concentration Market concentration is a measure of the extent of competition (or non-competition) in a particular market. When competition is high and individual firms have relatively low market shares, it is likely that firms will be price-takers rather than price-setters. In concentrated markets characterized char·ac·ter·ize tr.v. character·ized, character·iz·ing, character·iz·es 1. To describe the qualities or peculiarities of: characterized the warden as ruthless. 2. by few firms with large market shares competition is likely to be imperfect imperfect: see tense. and firms will engage in joint rather than independent actions (Wootton Wootton is an English place name meaning place by the wood. See also Wootten.
Economists have developed various measures for determining the degree of market concentration. Common measures include the two-firm and four-firm concentration ratios and the Herfindahl Index
The Herfindahl index, also known as Herfindahl-Hirschman Index or HHI . The two-firm and four-firm concentration ratios represent the total audit market share held by the dominant two or four independent auditors. The Herfindahl Index provides a useful way to include all firms in an assessment of the degree of market concentration (Theil, 1972). It is calculated by summing the squares of the relative market shares of the individual independent auditors. This means that higher relative market shares receive a greater weighting than lower relative market shares. Therefore, the Herfindahl Index increases with greater market shares held by one or a limited number of independent auditors. In this effort market share represents the proportion of the Forbes 200 or Fortune 500 firms that are clients of a particular independent auditor. To illustrate the use of the Herfindahl Index, let us assume that an audit market consists of one hundred client corporations and two independent auditors--A and B. In year one, 50 of the corporations use independent auditor A and the other 50 use B. In the second year, A is the choice of 90 corporations while the remaining 10 use B. Finally, in year three, A is used by all 100 of the corporations and none selects B. The relative frequencies and the calculated Herfindahl Indices for each year are presented as follows: Year A B Herfindahl Index 1 0.5 0.5 [0.5.sup.2] + [0.5.sup.2] = 0.50 2 0.9 0.1 [0.9.sup.2] + [0.1.sup.2] = 0.82 3 1.0 0.0 [1.0.sup.2] + [0.0.sup.2] = 1.00 This example demonstrates that the Herfindahl Index increases with greater market dominance Market dominance is a measure of the strength of a brand, product, service, or firm, relative to competitive offerings. There is often a geographic element to the competitive landscape. by one or a limited number of firms. The Index varies between zero (no market concentration and an infinite number infinite number a number so large as to be uncountable. Represented by 8, frequently obtained by 'dividing' by zero. of independent auditors with the same market shares) and one (one independent auditor for the entire market). Although simple, the Herfindahl Index provides a universal means that can be used to measure and compare the degree of concentration in various markets. Results and Data Analysis While the annual Fortune listing contains the 500 largest industrial corporations in terms of sales Terms of sale Conditions under which a firm proposes to sell its goods or services for cash or credit. , the "Forbes 200 Best Small Companies in America" consists of publicly traded United States-based corporations with annual sales between $5 million and $350 million. Equity must be in the form of common shares which excludes limited partnership units, real estate investment trusts, and closed-end closed-end adj. Issuing a fixed number of shares that can be traded publicly but are not redeemable by the issuer: a closed-end investment company. mutual funds. According to according to prep. 1. As stated or indicated by; on the authority of: according to historians. 2. In keeping with: according to instructions. 3. Forbes, these firms must show consistent increases in sales, earnings, and return on equity during the previous five years. Firms with declining sales and/or and/or conj. Used to indicate that either or both of the items connected by it are involved. Usage Note: And/or is widely used in legal and business writing. earnings were automatically screened out, as were stocks priced under $5. To ensure reasonable liquidity, corporations with fewer than 1 million shares outstanding or an average daily trading volume Trading volume The number of shares transacted every day. As there is a seller for every buyer, one can think of the trading volume as half of the number of shares transacted. That is, if A sells 100 shares to B, the volume is 100 shares. of under 1,000 shares were eliminated from the list. Similar criteria were used to compile To translate a program written in a high-level programming language into machine language. See compiler. the 1981, 1986, 1991, 1996, and 1998 Forbes 200 listings. Companies are ranked by their five-year average return on equity. Furthermore, no company can have a net loss in the previous five years and must have a net income of at least $1 million in the most recent year. Information on the independent auditors for each of the corporations listed on the Forbes 200 and the Fortune 500 was gained primarily from Who Audits America and Moody's Industrials. The results which are presented in Tables 1 and 2 indicate that the Big 8/6/5 firms continue to have an overwhelming presence in the Fortune 500 audit market. In recent years the Big 5 share of the Fortune 500 audit market has risen to slightly over 99 percent. In fact, only two non-Big 5 public accounting firms--BDO Seidman and Grant Thornton-- together have three Fortune 500 clients. Table 1 Profile of the Fortune 500 Audit Market
1981 1986 1991 1996 1998
Concentration ratios:
2-Firm Ratio 0.340 0.377 0.409 0.402 0.512
4-Firm Ratio 0.589 0.661 0.733 0.720 0.870
Herfindahl Index 0.129 0.137 0.169 0.163 0.212
Equally Distributed Shares 0.111 0.111 0.143 0.143 0.167
Aggregate Market Shares:
Big 8/6/5 96.8% 95.8% 98.2% 97.0% 99.4%
Non-Big 8/6/5 3.2 4.2 1.8 3.0 0.6
Individual Big 8/6/5
Firm Market Shares:
Arthur Andersen 15.0% 17.6% 18.6% 18.2% 19.0%
Deloitte, Haskins
& Sells(*) 11.7 7.8
Touche Ross(*) 5.1 5.3
Deloitte & Touche(*) 12.6 16.2 16.7
Ersnt & Whinney(**) 13.2 14.2
Arthur Young(**) 10.9 7.4
Ernst & Young(**) 21.7 22.0 22.7
KPMG Peat Marwick 11.5 12.1 13.8 12.8 12.4
Price Waterhouse(***) 19.0 20.1 19.2 15.6
Coopers & Lybrand(***) 10.3 11.2 12.3 12.2
PricewaterhouseCoopers(***) 28.5
(*) Deloitte, Haskins, & Sells and Touche Ross Ross , Sir Ronald 1857-1932. British physician. He won a 1902 Nobel Prize for proving that malaria is transmitted to humans by the bite of the mosquito. merged to form Deloitte & Touche in 1990. (**) Ernst & Whinney and Arthur Young Arthur Young is the name of several notable people
(***) Price Waterhouse and Coopers & Lybrand merged to form PricewaterhouseCoopers in 1998. Table 2 Profile of the Forbes 200 Audit Market
1981 1986 1991
Consentration Ratios:
2-Firm Ratio 0.253 0.253 0.425
4-Firm Ratio 0.465 0.474 0.749
Herfindahl Index 0.081 0.094 0.166
Equally Distributed Shares 0.111 0.111 0.143
Aggregate Market Shares:
Big 8/6/5 75.1% 83.0% 93.3%
Non-Big 8/6/5 24.9 17.0 6.7
Individual Big 8/6/5 Firm
Market Shares:
Arthur Andersen 13.2% 12.9% 21.5%
Deloitte, Haskins, & Sells(*) 8.4 7.7
Touche Ross(*) 6.2 10.2
Deloitte & Touche(*) 13.3
Ernst & Whinney 12.1 12.4
Arthur Young(**) 6.2 9.8
Ernst & Young(**) 21.0
KPMG Peat Marwick 11.4 7.7 19.0
Price Waterhouse(**) 7.70 10.8 7.7
Coopers & Lybrand(***) 9.9 11.3 10.8
PricewaterhouseCoopers(***)
1996 1998
Consentration Ratios:
2-Firm Ratio 0.400 0.470
4-Firm Ratio 0.710 0.800
Herfindahl Index 0.153 0.192
Equally Distributed Shares 0.143 0.167
Aggregate Market Shares:
Big 8/6/5 92.5% 95.5%
Non-Big 8/6/5 7.5 4.5
Individual Big 8/6/5 Firm
Market Shares:
Arthur Andersen 20.0% 25.5%
Deloitte, Haskins, & Sells(*)
Touche Ross(*)
Deloitte & Touche(*) 18.0 16.0
Ernst & Whinney
Arthur Young(**)
Ernst & Young(**) 20.0 17.0
KPMG Peat Marwick 13.0 15.5
Price Waterhouse(**) 11.5
Coopers & Lybrand(***) 10.0
PricewaterhouseCoopers(***) 21.5
(*) Deloitte, Haskins, & Sells and Touche Ross merged to form Deloitte & Touche in 1990. (**) Ernst & Whinney and Arthur Young merged to form Ernst & Young in 1990. (***) Price Waterhouse and Coopers & Lybrand merged to form PricewaterhouseCoopers in 1998. The results also indicate the Big-5 has gained a similar degree of dominance in the Forbes 200 audit market. The Big 5 share of the Forbes 200 audit market has increased from 75 percent in 1981 to 95 percent in 1998. The two-firm and four-firm ratios indicate that both the Fortune 500 and Forbes 200 audit markets have become increasingly concentrated in recent years. However, both the two-firm and four-firm ratios indicate slightly greater concentration in the Fortune 500 audit market. During the 1981-1998 period, the two-firm ratio increased from 0.340 to 0.512 in the Fortune 500 market, while the change in the Forbes 200 market was from 0.253 to 0.470. The four-firm ratio reflects a change from 0.589 to 0.870 in the Fortune 500 market and an increase in the Forbes 200 market from 0.465 to 0.800. These results are supported by the Herfindahl Index which takes into account the market shares of all auditors AUDITORS, practice. Persons lawfully appointed to examine and digest accounts referred to them, take down the evidence in writing, which may be lawfully offered in relation to such accounts, and prepare materials on which a decree or judgment may be made; and to report the whole, together in the market. Over the 1981-1998 period, the Index increased to 0.212 from 0.129 in the Fortune 500 market, while the Index changed from 0.081 to 0.192 in the Forbes 200 market. From the results it is obvious that there is increased concentration in both markets. However, this does not mean that both markets are necessarily concentrated with little or no competition among auditors. The Herfindahl Index results must be compared with a measure of equally distributed market shares. For example, an equally distributed audit market consisting of the Big-8 plus the non-Big-8 treated as a single firm would have a 0.111 (1/n) Herfindahl Index. An equally distributed Index for the Big-6 would be 0.143 and for the Big-5 market 0.167 (Stigler, 1950; Grossack, 1965). The results indicate that prior to the merger of Price Waterhouse and Coopers and Lybrand the Big-8 and Big-6 had Herfindahl Indices approximating the measures for equally distributed market shares. However, subsequent to the merger of Price Waterhouse and Coopers and Lybrand there is a pronounced difference between the Herfindahl Index and the equally distributed market share. The recent auditor auditor n. an accountant who conducts an audit to verify the accuracy of the financial records and accounting practices of a business or government. A proper audit will point out deficiencies in accounting and other financial operations. merger activity has affected individual firm market shares in both the Fortune 500 and Forbes 200 audit market. In 1981 Price Waterhouse lead the Fortune 500 market while Arthur Andersen For the U.S. Supreme Court case commonly known as Arthur Andersen, see . Arthur Andersen LLP, based in Chicago, was once one of the "Big Five" accounting firms (the other four are PricewaterhouseCoopers, Deloitte Touche Tohmatsu, Ernst & Young and KPMG), performing had the greatest share of the Forbes 200 market. In 1998 the merged firm of PriceWaterhouseCoopers lead in the Fortune 500 market while Arthur Andersen is dominant in the Forbes 200 market. Conclusion The results indicate that the Big-5 firms continue to be powerful competitors for both Fortune 500 and emerging corporate clients. The recent merger activity is intensifying in·ten·si·fy v. in·ten·si·fied, in·ten·si·fy·ing, in·ten·si·fies v.tr. 1. To make intense or more intense: the Big-5's strength in offering a broad range of accounting, tax, and management consulting services. As a consequence, the differences between the Big-5 and smaller accounting firms are being accentuated (Lamarre, 1989). Smaller accounting firms are unable to directly compete in all areas with the Big-5 firms. To survive and prosper smaller firms will have to develop specialties and carve out Carve out Usually occurs when a company decides to IPO one of their subsidiaries or divisions. The company usually only offers a minority share to the equity market. Also known as equity carve out. niches in the market (Nelson, 1990). For example, smaller firms may develop and emphasize industry specialties, such as real estate or technical expertise in areas of information systems. However, over the long run, smaller firms may possess certain economies of scale advantages over the Big-5 in servicing medium and small sized clients. References Grossack, I.M. (1965). Towards an integration of static and dynamic measures of industry concentration. Review of Economics and Statistics. August, 301-308. Lamarre, L. (1989). The very big one. Outlook. Fall, 16, 17, 19, 20. Minyard, D.H. and R.H. Tabor (1991). The effect of big eight mergers on auditor concentration. Accounting Horizons. December, 79-90. Nelson, M. (1990). Rising opportunities for the small firm, Outlook. Winter, 8-12, 14, 17, 18. Sommer, Jr., A. A. (1989). Commentary on the challenge of mergers. Accounting Horizons, December, 103-106. Stigler, G. J. (1950). Capitalism and monopolistic competition monopolistic competition Market situation in which many independent buyers and sellers may exist but competition is limited by specific market conditions. The theory was developed almost simultaneously by Edward Hastings Chamberlin in his Theory of Monopolistic Competition : 1 the theory of oligopoly oligopoly: see monopoly. oligopoly Market situation in which producers are so few that the actions of each of them have an impact on price and on competitors. Each producer must consider the effect of a price change on the others. . The American Economic Review. May, 23-34. Theil, H. (1972) . Statistical decomposition decomposition /de·com·po·si·tion/ (de-kom?pah-zish´un) the separation of compound bodies into their constituent principles. de·com·po·si·tion n. 1. analyses. North Holland Publishing Company. Wootton, C. W. and S. D. Tonge, and C. M. Wolk (1994). Pre and post big 8 mergers: comparison of auditor concentration. Accounting Horizons. September, 58-74. Steven A. Fisher Professor, Department of Accountancy California State University Enrollment  Long Beach, CA 90840-8504
|
|
||||||||||||||||||
Printer friendly
Cite/link
Email
Feedback
Reader Opinion