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INTRODUCTION

Stretching back centuries, the history of Deloitte, EY, KPMG and PwC is a fascinating story of wealth, power and luck. In many profound ways, the so-called Big Four accounting and audit firms have influenced how we work, how we manage, how we invest and how we are governed.

The firms have been called many things. High priests of capitalism. More powerful than sovereign states. Protectors of the public interest. The conscience of the free market. Heroes of corporate integrity. Benign watchdogs. Toothless lapdogs. A necessary evil. An institutionalised oligopoly. Corporate sweatshops. Accountants of fortune. Skilled enablers of white-collar fraud. Each of the Big Four is a case study of corporate triumph – and drama. Underneath their polished images are colourful tales of commercial success, but also of ethical compromises, professional angst, botched ventures, debauched parties, scandalous marriages, disreputable interests and arcane rites.

In a field that is seen as somewhat beige and lacking in prestige, the Big Four are the glamour boys, the glowing success stories of their field. In 2011 their total revenue broke emphatically through the US$100 billion mark. Since then it has kept on rising, surpassing US$130 billion in 2016. In that year, before a regrettable incident at the 2017 Oscars, PwC ranked alongside Disney, Nike and Lego as one of the ten most ‘powerful’ brands in the world.

With almost 1 million staff operating worldwide (not counting subcontractors), the Big Four are collectively one of the world’s top employers. They directly employ more staff than there are active personnel in the Russian military. The number of people who have worked for a Big Four firm is much larger still. Many are now in other professional services firms, or senior roles in industry or government. In their work, they operate according to a ‘Big Four style’ – or in arch reaction against it.

Paul Gillis, a former PwC partner, described the Big Four as ‘supranational organisations, substantially unrestrained by national borders, transcending nationalistic claims and state based attempts to regulate them’. The firms are formally – and seemingly intractably – integrated into the functioning of the modern financial system and modern democracies. They enjoy growing connections, too, with less democratic governments in the developing and recently developed worlds. In China, for example, the firms have become agents of the economic boom, and hot targets for regulatory control.

The four firms dominate several key markets for accounting, tax and audit services. Nearly all the largest businesses in the United States and the United Kingdom, for example, are audited by one or more of the firms. Of the 500 companies in the S&P 500 index, 497 used a Big Four auditor in 2017. Nearly all those businesses also buy management consulting services from the Big Four. In 2017, PwC alone claimed to provide services to 422 of the Fortune Global 500. Modern economies simply cannot function, it seems, without accountants, auditors and management consultants.

The Big Four got to where they are today through a complex process of commercial marriages and tie-ups – a process so elaborate and repetitive it is suggestive of fractal biology. Corporate mergers on a colossal scale (and with questionable rationales) were a feature of the business world in the 1980s. Examples from America include Pan Am’s acquisition of National Airlines, Standard Oil’s purchase of Kennecott Copper, and the Campeau Corporation’s hostile takeover of Federated Department Stores – a transaction that Fortune magazine called ‘the biggest, looniest deal ever’. Accounting firm mergers also reached a crescendo in that decade. In 1986 Peat Marwick and the mostly European firm KMG came together to create KPMG. In 1989 Ernst & Whinney and Arthur Young combined to become Ernst & Young. In the same year Deloitte Haskins & Sells merged with Touche Ross to form Deloitte & Touche. With the latter two mega-mergers, the Big Eight became the Big Six.

Five years earlier, Deloitte Haskins & Sells had come close to a merger with Price Waterhouse. There was much to recommend the marriage. The firms shared a common history, stretching as far back as the sector’s early days in London. Both had advised England’s railway companies, for example, and helped build the professional prestige of accountancy. The merger promised to create a modern powerhouse. In America alone, Deloitte at the time had 103 offices and 8000 employees; Price Waterhouse’s American footprint encompassed ninety offices and 9000 employees. But internal opposition to the merger was strong. Naysayers claimed the two firms had starkly different cultures. In fact, the cultures were not really divergent, but considered in the context of the overall sameness of accounting practices, small differences loom large. When put to an international vote among partners, the merger option was rejected.

In 1989 Price Waterhouse again found itself in merger talks, this time with Arthur Andersen, the raging upstart founded by a former Price Waterhouse employee. Those talks also failed; Price Waterhouse would have to wait another nine years before finally consummating a union – with Coopers & Lybrand, thereby forming PricewaterhouseCoopers and reducing the Big Six to five.

Soon after, Ernst & Young and KPMG flirted but did not reach third base. (Speaking about the difficulty of consummating a merger, the chairman of Ernst & Young in China lamented that such exercises were ‘like wooing a pretty young lady – one may lose for no reason at all’.) Even so, the Big Five did become the Big Four – and in a way that no one expected. Arthur Andersen’s rapid and spectacular exit in 2002, in the wake of scandals involving Enron, WorldCom and Waste Management, left behind four majors. Such was the market concentration of the accounting industry now that another top-tier merger was impossible.

Since that time, the firms have been remarkably stable, and remarkably successful. So successful, in fact, that regulators and commentators have raised concerns about the monopoly power of the Big Four. Accountancy is notably less competitive than other professions, such as law and engineering. Competition is especially weak in the market for audit services. In 2016 the editor of London’s Financial Times called for greater competition in that market: ‘Four big firms are too few, not least because their very scarcity makes the application of strict regulation more difficult.’

Monopoly concerns were raised even before Arthur Andersen’s exit. In 1997 Christopher Pearce, finance director of Rentokil and chairman of a group representing the finance directors of FTSE 100 companies, told the Economist that the merger of Price Waterhouse and Coopers & Lybrand would ‘reduce the choice for auditing services and increase the conflicts of interest’. As early as 1976, the US Senate’s Metcalf Report worried that ‘[t]he Big 8 are so large and influential in relation to other CPA firms that they are able to control virtually all aspects of accounting and auditing in the US’. The economic literature on monopoly and oligopoly is well established. Faced with a captive market, the monopolist raises prices, works inefficiently and shirks on quality. With the Big Four operating under a valuable monopoly concession in auditing, observers have noticed the commoditisation of audit services, and an erosion of their scope and reliability.

On the surface, the accounting and auditing industry has reached a state of cosy equilibrium. The firms collaborate in industry forums; staff move regularly between them; the firms match each other’s market presence and service lines, and copy each other’s pricing, outputs and marketing strategies. Cosy or not, though, things are about to change. Today, the firms have a very uncertain future. They are on the cusp of a new era. In this book, which looks both backwards and forwards in time, we describe explosive pressures in each of the major service lines of the Big Four firms. Examples are the technological innovations that are rapidly making traditional forms of audit obsolete, and new sources of competition. Taken together, these pressures for change have an inexorable power, such that the industry will not be the same in five years’ time.

The transformation may well arrive sooner than that – and it might be messy. Since the 1970s, the major accounting firms have endured recurring crises and have been sued thousands of times. Some of the suits, particularly those against the Big Four as auditors, have been perilously large. In 2011 the Association of Chartered Certified Accountants published its concern that audit firms would see ‘potentially catastrophic litigation’.

As recently as 2016, PwC narrowly escaped the financial equivalent of what astrobiologists term an ‘extinction-level event’ (ELE). Taylor, Bean & Whitaker (TBW) was a US mortgage company. Lee Farkas, the company’s chair and majority owner, masterminded a fraud that bankrupted the company and its major subsidiary (and main lender), Colonial Bank, one of the twenty-five largest banks in the United States. The fraud involved cash transfers and fake mortgages that massively inflated the assets of TBW and Colonial. Soon after the FBI raided TBW’s grand headquarters, the two businesses declared bankruptcy. The collapse of Colonial – the biggest bank failure of 2009, the third-biggest since the beginning of the financial crisis, and the sixth-biggest in US history – cost the Federal Deposit Insurance Corporation (FDIC) around US$3 billion. A thousand employees lost their jobs, and multiple lawsuits were launched.

Federal prosecutors described Farkas as a ‘consummate fraudster’. Others called him a ‘burly college dropout’ and a ‘pathological liar’ who was ‘as generous as he was vicious’; employees on the receiving end of his office tirades referred to having been ‘Farkased’. He and his co-conspirators were accused of submitting materially false financial data to the Securities and Exchange Commission and the Government National Mortgage Association (Ginnie Mae). In 2011 Farkas was found guilty of misappropriating US$3 billion and trying deceptively to obtain US$570 million in taxpayers’ funds from the Troubled Asset Relief Program to prop up Colonial. Farkas used the money to buy caviar, holiday homes, classic cars, a private jet, a seaplane, strip clubs and a portfolio of Brazilian and Asian-fusion restaurants. Sentenced to thirty years, Farkas began his imprisonment at a medium-security jail in North Carolina – where Bernie Madoff was a fellow inmate. Paul Allen (TBW’s former CEO), Delton De Armas (its former CFO), and Desiree Brown (its former treasurer) also received prison sentences.

PwC had audited Colonial’s holding company, Colonial BancGroup, every year from 2002 to 2008. TBW’s bankruptcy trustee accused PwC of failing to detect an unmissable fraud, and of certifying the existence of more than a billion dollars of Colonial assets that were in fact worthless, or were not owned by the company, or never actually existed at all. The ensuing legal action – the biggest claim ever made against an audit firm – sought US$5.5 billion from PwC.

In August 2016 PwC settled the lawsuit. The value of the confidential settlement is closely guarded but is believed to be one of the largest ever in the history of the Big Four. The TBW–Colonial fraud and its consequences featured in an episode of the television series American Greed – agonising watching for the auditors. And the agony is not over yet. At the time of writing, PwC is still involved in TBW-related litigation launched by the FDIC. That agency has also gone after Colonial’s former internal auditor, Crowe Horwath.

In 2005 KPMG faced its own ELE when the US government accused the firm of knowingly selling tax shelters that gave the finger to the Internal Revenue Service (IRS). The shelters, it was claimed, generated more than US$100 million in fees for KPMG, and deprived the public of billions in tax revenue. In an enormous stroke of luck for KPMG, the government decided not to indict. A conviction, the government feared, would destroy the firm – and the current system of corporate auditing. Without KPMG, the lawmakers worried, the Big Four would become the Big Three, and there would not be enough large accounting firms to audit America’s corporations. Terrifyingly for KPMG, though, the decision could easily have gone the other way. KPMG barely escaped a fate similar to that of its former Big Five rival Arthur Andersen.

The other firms have also had their share of trouble. In the early 1990s, for example, EY had to pay out more than US$400 million for failures relating to the savings and loan crisis. The firm was forced to publish full-page newspaper advertisements to rebut rumours that the payouts would send it into bankruptcy. In 2010 EY was again in strife, accused of ‘a broad pattern of negligence and complicity’ after a series of further lawsuits and calamities. And all four firms were deeply and controversially implicated in the 2008 financial crisis, the largest financial upheaval since the Great Depression. Deloitte, for example, had audited TBW in the years leading up to Colonial Bank’s collapse; Deloitte paid to settle three related lawsuits in 2013.

Just as dangerously, the Big Four have been drawn into a toxic series of tax scandals, including LuxLeaks and the Paradise Papers. Ours is a new era of transparency and digital disruption, and in no area of Big Four services are those forces more intense than in taxation advisory.

The firms have come so close to the abyss that regulators and legislators have recommended that they prepare ‘living wills’. A dismal concept borrowed from banking, such wills set out contingency arrangements for the orderly transition of clients and contracts; for ring-fencing of viable business units; and for the rapid winding-up of unviable ones. They also include agreements with regulators on how assets, staff and funding would be dealt with in the event of a calamitous failure.

The demise of Arthur Andersen provides a vivid case study of what such a failure looks like. Convicted in 2002 of obstruction of justice, the firm shrank from 85,000 employees to a rump of 200. (Late in 2001, Andersen’s global CEO Joe Berardino had toured overseas offices and reassured staff that ‘everything would be OK’.) In the months before the firm collapsed, it had become a laughing stock. In January 2002, for example, at the Alfalfa Club dinner in Washington DC, President George W. Bush joked that he’d just received a message from Saddam Hussein. ‘The good news is he is willing to let us inspect his biological and chemical warfare installations,’ Bush said. ‘The bad news is that he insists Arthur Andersen do the inspections.’

The aftershocks of the firm’s troubles reverberated far and wide. Fewer top students thought of joining the major accounting firms. Opinion poll respondents rated accountants low on professional integrity. The firms were subjected to increased government scrutiny, mainly via the Sarbanes–Oxley Act. The greatest impact fell on the former Andersen staff, the vast majority of whom ‘had nothing to do with Enron but lost their jobs nonetheless’. They’d all been Enroned.

According to author Robert B. Reich:

Some senior partners moved to other accounting or consulting firms. Joseph Berardino . . . got a lucrative job at a private equity firm. Some other senior partners formed a new accounting firm. But many lower-level employees were hit hard. Three years after the conviction, a large number were still out of work.

Partners and staff lost much of their retirement benefits. When the Supreme Court later reversed the conviction that had led to Andersen’s collapse, a former ‘Android’ wrote on the website for Andersen alumni: ‘Does this mean we can bring a class action against the DOJ for ruining our lives?’

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Much of the literature on business and economics has a particular type of firm in mind: an industrial company that produces physical goods. That type of firm, though, is becoming less and less representative of the modern economy. Firms that deliver services, and that trade in intellectual property, have prospered spectacularly. The Big Four are an example of this, indeed an exemplar. How they deviate from the standard picture of enterprises is of much practical interest for the study of economics and business.

The Big Four provide a rare opportunity to study service firms in detail. That opportunity, though, has not been taken up in a wholly satisfactory manner. Despite the importance and success of the Big Four, and despite the precarious position in which they find themselves, they are surprisingly under-documented. Remarkably little has been written about them or their conduct. Most of the studies that do exist have a particular flavour. In large part, the academic literature on audit and accountancy consists of narrow and ahistorical studies whose attitude towards the Big Four is typically reverential, or at least non-confrontational. Moreover, as Cooper & Robson (2009) observed, most accounting firm histories are ‘whiggish in their perspectives and orientations. They tend to focus on those who led the firm and construct events as the accomplishment of professional ideals through the response to client and market demands’. Burrage (1990) similarly criticised much of the historical work on the professions:

[Historians] tended to concentrate on the elite of the profession and the issues that came to the attention of their governing bodies. They rarely sought to study the working practice of the rank and file members of the profession, rarely referred to other professions, rarely sought to relate changes in the profession to changes in the wider society and rarely therefore found any reason to criticize the profession. Their main task was to recount the success story of responsible leaders coping with the problems that faced the profession.

There is another difficulty, too, for people wishing to look upon a true picture of the accounting profession: much of the extant history of the Big Four was commissioned by the firms themselves. In their marketing and corporate communications, the firms promulgate a safely homogenised version of their past. As the histories of many major companies show, however, there is often a big difference between the public narrative and the true story. In our Big Four research, we’ve found just such a difference. The true history is much more colourful, and more fascinating, than the manicured versions.

This book is our attempt to understand the past, the present and the likely future of the Big Four. Reflecting our personal interests and backgrounds, we’ve adopted what we believe is a novel approach. Robert Skidelsky wrote in 2016:

Today’s professional economists . . . have studied almost nothing but economics. They don’t even read the classics of their own discipline. Economic history comes, if at all, from data sets. Philosophy, which could teach them about the limits of the economic method, is a closed book. Mathematics, demanding and seductive, has monopolized their mental horizons. The economists are the idiot savants of our time.

Skidelsky’s critique, which applies equally well to many of today’s accounting academics, is something we’ve tried strenuously to heed – by keeping a clear eye on accountancy’s place in history and society.

Partners and staff in accounting firms use tools that depend on a series of innovations: Hindu–Arabic numerals, the invention of zero, the mathematics of fractions, the concepts of assets and liabilities, the genius of double-entry accounting, and the fraught practice of auditing, which has always meant different things to different people. Each of these innovations came from somewhere and someone. The histories of science, commerce and culture shed invaluable light on the current predicament of accountancy. For insight into the Big Four, we’ve looked far and wide. We’ve read the standard business texts, but also Dickens and Thackeray, Pacioli and Fibonacci, Darwin and Snowden. Our book is not a history of concepts or of organisations but of people, full-blooded and fallible.

The Big Four firms are culturally rich environments. Rainmakers. Beauty parades. Sales targets. Three-sixty reviews. Casual Fridays. Consistency meetings. Qualification meetings. Stand-up meetings. Hot-desking. Body shopping. Eating what you kill. Burning the code. Feeding the baby. Ranking and yanking. Upping or outing. Finders, minders, grinders. Golden handshakes, golden parachutes, golden cushions. Big Four partners and staff share a corpus of lore and trade-craft that is as rich as the fabled in-house traditions of stage playing, ice skating or the armed forces. Using our inside-outside perspective, we’ve tried to capture Big Four culture accurately, and to convey what life in the firms is actually like.

Authors deciding where to start a book on the Big Four are spoiled for choice. The firms’ activities and services can be traced back through early-modern times to medieval, classical and even older precedents. Accountants are news today, and they’ve been news for millennia. In ancient Mesopotamia, for example, proto-accountants and auditors measured harvests, recorded royal purchases and checked the payment of tributes and taxes. Their activities are documented in clay tablets, books thousands of years older than Summa de Arithmetica. Bookkeepers can fairly claim to have invented writing and created the very first books.

We’ve elected to start with the Medici Bank of the late middle ages and the Renaissance. That illustrious bank’s history contains lessons that are sharply relevant today. The bank’s leaders established partnership structures and a professional legacy from which the Big Four were, in large part, born. Its history also parallels in intriguing ways the lives and passions of several pioneering accountants. So the Medici – along with Britain’s railways – serve as a powerful lens through which we can examine the origins and destinations of the Big Four.

Those destinations include corporatisation, digital disruption and regulatory separation – such as into eight full-service accounting firms, or some other number of pure audit and pure consulting businesses. Whichever form it takes, the imminent transformation of the Big Four will have enormous implications for the firms’ staff, partners and clients, and for our overall democratic and economic systems. One intention of this book is to help prepare us all for those implications.

We hope our book is timely. The Big Four tend only to come under significant scrutiny when something goes really badly wrong: a failed mega-audit, for example, or a botched mega-merger. Yet the pressures currently confronting the Big Four are just as dangerous and, potentially, as dramatic as those that precipitated the firms’ worst disasters.

In a 1958 article for Accounting Review, Nicholas Stacey sought to explain why there were so few accountants in modern literature. Accountants, Stacey wrote, were ‘innocent of romance’. We disagree. In this book we’ve endeavoured to capture some of the romance, grandeur and nobility of accountancy, and of the past, present and future of the Big Four.

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The book is organised as follows. Part I, ‘Infancy’, investigates the economic and cultural history of the Big Four. We explore medieval and early-modern precedents of the Big Four’s global partnership structures, examine the creation story of the modern accounting firm, and relate important episodes from the early days of the four firms’ antecedent partnerships. The focus of this part is the pioneers, the founders and their milieu, and the dynamics of partnerships and professions.

Part II, ‘Maturity’, describes the Big Four in their modern incarnations: how they have defined themselves, their professional values and their boundaries, how they brand themselves, whom they hire. We attempt to understand how the modern Big Four culture emerged, and the predominant features of that culture.

Part III, ‘The Difficulties of Adulthood’, explores the hard challenges that the Big Four currently face across all their major service lines. A series of spectacular Big Four calamities can be traced to recurring causes, including fundamental conflicts between the service lines, and an apparent underinvestment in auditing – a service that is uniquely important to the value of the Big Four brands. In this context, the ‘audit expectation gap’ has emerged as a key battleground for the Big Four. We examine that battleground, along with the fraught concept of ‘audit quality’. In the field of taxation services, too, there is a surfeit of problems. We explore Big Four tax disasters, and how a new ethic of disclosure is undermining old models of tax avoidance. The part concludes with an examination of the rich suite of challenges facing the Big Four in their most important new market: China.

Finally, Part IV is concerned with obsolescence and endgames. We look ahead to the immediate future and what may well be the ‘Twilight Years’ of the Big Four. Much can be learned from the firms’ challenges and calamities. We examine how a combination of old and new pressures is likely to force the firms into a radical transformation. These pressures include technological change, regulatory action and the arrival of disruptive competition. The likely impacts span all aspects of the firms – their people, ownership, structure, networks, services and methods. We also return to the late middle ages and the Renaissance to explore how everything can go wrong for an international, diversified, networked organisation. We conclude with an examination of the Big Four’s legacy.