Big Four firms rethink governance after year of mis-steps and scandals
London, January 2, 2024
Auditors and regulators consider ways to strengthen oversight and hold management to account
A series of scandals and strategic mis-steps exposed shortcomings in the governance of Big Four accounting and consulting firms in 2023, prompting a rethink about how best to hold management to account.
EY’s US partners voted before Christmas to introduce a new governance system that includes a board to oversee management and approve strategy, according to people familiar with the matter. The revamp, which will come into force in July, was proposed after EY’s current US management team vetoed a plan to spin off the firm’s global consulting business, prompting anger from many partners.
PwC’s global boss Bob Moritz told the Financial Times that governance reforms in Australia, where it was hiring a chair from outside the firm for the first time, could become a blueprint for other countries in its global network.
Meanwhile, the US audit regulator has launched a “culture review” of the firms, to root out the cause of a rise in the number of public company audits that fail to meet regulatory standards. The review would examine whether something had gone wrong with “tone at the top”, the Public Company Accounting Oversight Board announced in December. It would also put the organisational structure of firms under scrutiny.
The debate over governance at the Big Four, which collectively employ 1.5mn people and audit most of the world’s largest public companies, was overdue following years of heady growth, according to Laura Empson, a professor specialising in the management of professional service firms at the University of London’s Bayes Business School.
“The current governance of the Big Four encompasses the worst aspects of partnership governance and the worst aspects of corporate governance,” she said. “The partnership model eliminates the principal-agent problem, in that owners, managers and major producers are one and the same. At a small scale that can work very effectively. The problem is, when it becomes scaled-up, the leadership becomes more and more divorced from the partners.”
The Big Four firms operate as global networks of locally owned partnerships, making them quite different from multinational public companies, where boards of directors have significant sway.
A common structure is for management to be overseen by a board made up of longtime partners from different parts of the firm, which has the responsibility of appointing the chief executive or senior partner and some role in approving strategy. Critics point out the circularity: even longtime partners owe their jobs in whole or in part to the chief executive.
This was laid bare in the scathing report on PwC’s culture in Australia, where a tax partner used secrets gleaned from his advisory work for the government to help craft tax planning services for multinational technology companies. The report said the governance structure created a clubby atmosphere that gave too much power to the chief executive. In response, PwC Australia said it would beef up its governance board overseeing management and bring in at least three independent board members, including one as chair.
Moritz, PwC’s global chair, said that he had been encouraging local partnerships to improve governance by involving independent outsiders for the past six years.
“Because of these unfortunate, unique circumstances, Australia’s got to leapfrog ahead quite a bit and jump right to that end game,” he said in an interview with the FT.
EY has been an outlier in not having a board overseeing its global management nor requiring that arrangement in its local partnerships. That led to the unusual spectacle of chief executive Carmine Di Sibio playing a kingmaker role in the appointment of his successor, who was picked by EY’s 18-member global executive committee in November. EY’s governance council ratified the appointment, but the group is made up of 38 people — too unwieldy for active decision making, according to governance experts.
Senior executives at EY have been working on proposals for governance reform, which will be in the packed in-tray of global chief executive-elect Janet Truncale.
The US is already ploughing its own furrow having approved the creation of a new board that will be chosen by elected partners and will have hiring and firing power over EY’s US leader. The local board could ultimately include members from outside the firm, according to a person familiar with the plan.
National regulators take divergent views on how the Big Four should be governed. In Europe, some countries have mandated the creation of oversight boards and the appointment of at least some independent board members.
In the UK, the Financial Reporting Council first recommended the introduction of independent non-executives from outside the firm in 2010 for those auditing 20 or more listed companies.
The regulator’s latest audit firm governance code, which operates on a “comply or explain” basis, recommends that larger firms have at least three independent non-executives who are in the majority on a supervisory body that oversees “public interest matters”.
Under separate plans for the Big Four in the UK to ringfence their audit businesses from their tax and advisory arms, they will be required to have a separate audit board with a majority of non-executives to oversee audit quality and the activities of their audit arms.
Meanwhile, since 2018, the Netherlands has required firms auditing public interest entities to have an independent supervisory board to oversee their internal activities.
In the US, the PCAOB has proposed requiring an audit firm to have at least one person who is not a partner sit on its board or some other kind of advisory body — but it concedes that all of the Big Four would already meet these limited criteria.
Francesca Lagerberg, chief executive of Baker Tilly International, a top-10 accounting firm by revenue, said independent non-executives were a “real positive” for the sector as they allowed firms to “break through their own echo chamber” and encourage management to question whether they were “doing the same old things in the same old way”.
But Bayes Business School’s Empson, who was a non-executive at KPMG UK from 2013 to 2016, cautions not to expect too much.
“The firms haven’t yet come to terms with how much involvement the non-execs need to have in order to perform the role that the regulators are expecting of them,” she said.
“In underestimating the time and commitment of their non-execs, the big audit firms also underestimate how much they need to pay them. As a result, it is not always easy to attract enough of the right people for the job.”
[The Financial Times]
