Research sees shift in strategy among Big Four accounting consulting firms

Big Four auditors examine a firm's finance in an accounting consulting audit.

Regulatory requirements spur changes in services from Big Four accounting firms

Unintended consequences of regulation are typically associated with negative outcomes, but research from CSU’s College of Business has identified an unforeseen effect of financial regulation that introduced more competition and helps to break up the Big Four’s accounting firms’ hold on the market.

The Sarbanes-Oxley Act was passed in 2002 in the wake of landmark financial frauds by companies such as Enron, Tyco and WorldCom. It mandates that companies receive auditing services from a firm separate from the one they receive regular consulting services. In “Client Consulting Opportunities and the Reemergence of Big 4 Consulting Practices: Implications for the Audit Market,” the Department of Accounting’s Elizabeth Cowle and her coauthors find that as consulting opportunities become more lucrative, the largest auditing firms have shifted, often transferring clients from audit to accounting consulting services. This changeover pushes those clients to seek audit services from other sources.

“We find they’re more likely to go to smaller firms, which could broadly benefit the market,” Cowle explained. “There’s a lot of concern that the Big Four have too much market share so this could be beneficial for the overall diversity of the audit market, where smaller firms can come in and have a chance to take on clients that they previously may not have had access to.”

Elizabeth Cowle, Assistant Professor of Accounting
Elizabeth Cowle, Assistant Professor of Accounting

“Client Consulting Opportunities and the Reemergence of Big 4 Consulting Practices: Implications for the Audit Market”
Elizabeth N. Cowle, Tyler J. Kleppe1,  James Moon2, Jonathan E. Shipman3
The Accounting Review

1 University of Kentucky – Von Allmen School of Accountancy
2 Georgia Institute of Technology – Scheller College of Business
3 University of Arkansas

The Big Four – Deloitte, Ernst & Young, KPMG and PwC – command nearly three quarters of global audit market according to the International Accounting Bulletin, but Cowle’s research, which has been published in The Accounting Review, suggests that nearly two decades after the act was codified, the Big Four’s increasing focus on consulting may be prompting a shakeup in the audit market. Cowle’s research fails to find any negative impact on audit quality for clients that switch away from the Big Four likely for consulting-related reasons.

“The regulatory decision to restrict the provision of both audit and non-audit services may have actually inadvertently created a mechanism to open up potential market share for these smaller firms and allow them to come in and grow their audit client market share while maintaining an acceptable standard of audit quality,” Cowle said.

Shifting to consulting from audit accounting

Taking a pulse of industry trends was a large job for the researchers. Drawing from transcripts from 3,360 companies’ quarterly conference calls between 2007 and 2016 across 153 auditors, Cowle and her coauthors used a technique called Latent Dirichlet Allocation, a form of topic modeling to identify topics related to consulting covered in the calls.

Once topics were identified, the team compared those to consulting services publicly advertised on the Big Four’s websites. From there, the authors compared the topics for which companies indicated a need during calls against accounting firms’ service offerings to measure the similarity between “what the client needs” and “what the accounting firms offer.” When applied to a client, the measure provides an estimation of each company’s consulting opportunities.

Their measure of client-specific consulting opportunities was then used to analyze how consulting opportunities and the reemergence of Big Four consulting practices have impacted the audit market, including whether auditor switches occur more frequently in the presence of more consulting opportunities, and how these consulting-driven switches affect subsequent auditor choice and audit quality. With an existing relationship between a client and an accounting firm, it often makes business sense for both parties to transition from lower-margin, higher-risk audit services to a more highly engaged – and more lucrative for audit firms – consulting relationship.

“The client could see room for future consulting and say, ‘I know I like this firm, I know this firm does great work in this area. I’d rather have them as my consulting firm than my audit firm,” Cowle said. “Alternatively, the firm could view their firm as better positioned to perform consulting work for the client. We think that the firms likely leverage existing client relationships and ask, ‘Does this make sense for us to continue on as your auditor or consultant?’”

Informing policy and practice

In addition to illuminating an unidentified consequence of Sarbanes-Oxley that can help fight concentration in the audit marketplace, Cowle’s research has practical consequences for policymakers and industry. Firms can use the new perspective to inform client selection and retention policies, weighing whether audit or consulting services would be a better fit for a specific client, ultimately saving clients the considerable trouble and expense of swapping firms in the future.

Regulators have expressed concerns that as the Big Four grow their focus on consulting, audit quality will suffer. The research shows those concerns may be unfounded.

“Our findings suggest the decision to limit the provision of both consulting and audit work to the same client has actually inadvertently provided this mechanism that reduces Big Four market share,” Cowle said. “It has opened up opportunities for smaller firms to grow their market share while still maintaining a similar standard of quality.”

The College of Business at Colorado State University is focused on using business to create a better world.

As an AACSB-accredited business school, the College is among the top five percent of business colleges worldwide, providing programs and career support services to more than 2,500 undergraduate and 1,300 graduate students. Faculty help students across our top-ranked on-campus and online programs develop the knowledge, skills and values to navigate a rapidly evolving business world and address global challenges with sustainable business solutions. Our students are known for their creativity, work ethic and resilience—resulting in an undergraduate job offer and placement rate of over 90% within 90 days of graduation.

The College’s highly ranked programs include its Online MBA, which has been recognized as the No. 1 program in Colorado for five years running by U.S. News and World Report and achieved No. 16 for employability worldwide from QS Quacquarelli Symonds. The College’s Impact MBA is also ranked by Corporate Knights as a Top 20 “Better World MBA” worldwide.