Why you should care about something as boring as an accounting firm merger

What it looks like when one snoozy business joins forces with another.
What it looks like when one snoozy business joins forces with another.
Image: AP Photo/Focke Strangmann
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PriceBoozHouse. PricewaterhouseBooz. BoozPrice. Pooz?

Those are just a few of the scintillating names that could come from combining two of the world’s biggest professional services firms, accounting behemoth PricewaterhouseCoopers, and management consulting house Booz & Company. The firms announced plans to tie up today, which should help give sluggish PricewaterhouseCooper a boost. But what’s good for the bottom line isn’t always good for the integrity of the business; the move raises concern about the accounting industry’s longstanding troubles with conflicts of interest.

One need only look back at the tangled tale of deceased energy giant Enron and its auditor Arthur Andersen, which created something of a Watergate moment for the auditing industry. The now defunct auditing firm is thought to have turned a blind eye to Enron’s crooked dealings to hold onto its lucrative consulting gig with the firm.

This unfortunate episode in American corporate history inspired the Sarbanes-Oxley Act, US legislation that, among other things, restricts auditors from providing some consulting services to their clients. Around this time, accounting firms rushed to distance themselves from consulting to protect their reputations, and their core auditing businesses; Arthur Andersen spun off its consulting arm into Accenture; PwC sold its consulting business to IBM; Ernst & Young, another major accounting firm, divested its consulting arm to France’s Capgemini, and KPMG listed its consulting arm on the stock market (today it’s known as BearingPoint).

Yet these reforms had little effect on competition in the industry. As we reported earlier this month, the average tenure for auditors of Fortune 100 companies remains a worrying 27 years, and efforts to enforce mandatory rotation in of auditors in the US and elsewhere have been met with stiff resistance. All but two of America’s S&P 500 companies use one of the “big four” accounting firms (PwC, Ernst & Young, KPMG and Deloitte) for auditing, which together collected two-thirds of the global accounting industry’s $165 billion in fees last year.

Meanwhile, as the audit business has become more streamlined (read rote and legalistic), CFOs at client companies have played accounting firms off one another to drive down audit fees, which in turn has encouraged those firms to re-embrace consulting to stay profitable. Accounting firms can offer all manner of consulting services to companies they don’t audit in the US, and with special approval from a company’s board they can offer some advisory services to audit clients, too. Restrictions on mixing audit and advisory abroad tend to be less strict outside the US.

PwC’s advisory business grew by 8% last year, easily outstripping the 1% growth in assurance, or audit revenue, and a 5% rise in revenue from tax advice. Consulting work—which can be anything from advising on mergers, acquisitions and divestitures to helping companies cost cut—now accounts for about 28% of the company’s total revenue.

One solution to the potential for conflicts of interest between auditing and consulting is for shareholders of companies using audit firms to pressure management into using separate firms for consulting. This is gaining traction globally. But shareholder activism is typically slow moving. And as history has shown, when regulators fail to step in and jolt the needle, everyone loses.