Auditing

Big Four Stems Exodus to Smaller Auditors

The stream of companies switching from Big Four auditors to smaller firms slowed by 40 percent in 2007.
Alix StuartJanuary 31, 2008

In a recent 8-K, Catapult Communications demonstrated that ditching a Big Four accounting firm for a smaller auditor can mean big cost savings. With a $102 million market cap, the telecom test equipment maker expects to save almost 50 percent on audit fees this year by moving from Deloitte & Touche to Stonefield Josephson. Nevertheless, fewer companies are following that path these days.

Indeed, the stream of companies switching from Big Four auditors to smaller firms continued to slow in 2007, a CFO.com analysis of recent data from Audit Analytics shows. In 2007, 101 public companies moved from a Big Four firm to a mid-tier or regional firm, down about 40 percent from 163 in 2006 and 275 in 2005. (See charts below.)

Chart 1: Big Four to Smaller Audit Firm
Market cap 2007 2006 2005 2004
$501m 14 15 31 34
$100m – $500m 38 61 115 85
$100m & under 49 87 129 198
Total: 101 163 275 217

What’s behind the slowdown? Donald Whalen, director of research at Audit Analytics, says it’s part of a general decrease in auditor switches. Considering that the number of companies moving from one Big Four firm to another dropped by 40 percent as well, Whalen says he sees the trend as “a drop in changes, rather than a drop in preferences” for one s of auditor over another. “It looks like things have settled down, with more people seeming to be happy where they are,” he adds. The total number of companies switching auditors was down by 10 percent last year, according to an analysis of the data by Glass Lewis.

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Jack Ciesielski, accounting expert and editor of the Analyst’s Accounting Observer, says the decline in switches from Big Four firms to smaller auditors is likely due to being “farther away from 404 and all the bad feelings that went with it.” Complying with Section 404 of the Sarbanes-Oxley Act, which covers internal controls over financial reporting, considerably stiffened relations between auditors and corporate finance executives. The lack of new regulations of the magnitude of 404 in the past few years has also helped. “Now everyone’s comfortable with each other again…until the next dislocation,” he says.

Within all the moves that occurred, Tier 2 firms were still the big winners. Glass Lewis counts a combined gain of 66 clients for BDO Seidman, Grant Thornton, McGladrey and Pullen, and Crowe Chizek, compared to a net loss of 85 for the Big 4 and net loss of 24 public companies for all other regional audit firms.

Those Tier 2 firms seem to be garnering more clients out of choice, rather than desperation, too. Just under 15 percent of downstream switches stemmed from a big-name auditor resigning in 2007, compared to 22 percent in 226 and 35 percent in 2005. Most of those resignations occurred at small and mid-sized companies, with market caps of $500 million and under.

There are early signs, however, that the big international audit firms may regain some of their former predominance in coming years. Ernst & Young became the first Big Four firm in at least five years to have a net gain in clients, according to Glass Lewis. The gain was small – one client – but it reverses the downward momentum. PricewaterhouseCoopers, Deloitte, and KPMG lost 10, 35, and 41 clients, respectively.

CFO.com’s analysis shows that the number of public companies moving from a smaller auditor to a Big Four firm inched up, from 36 in 2006, to 50 in 2007. Over 40 percent of companies switching up in 2007 were fairly small, with $75 million in market capitalization or less.

Some even think that the movement from small audit firms to big ones will continue as Section 404 work tapers off and audit firms must re-deploy their supersized staffs. “It will be interesting to see if, through 2008, the Big Four go back to pick up some of those companies they lost to Tier 2 firms,” says Mark Grothe, research analyst at Glass Lewis. “Now that they have more resources available, they will definitely want to maximize revenue.”

Chart 2: Smaller Audit Firm to Big Four
Market cap 2007 2006 2005 2004
$501m 13 7 6 6
$100m – $500m 16 16 11 11
$100m & under 21 13 27 13
Total: 50 36 44 30
Chart 3: Big Four to Big Four
Market cap 2007 2006 2005 2004
$501m 45 64 56 61
$100m – $500m 13 30 30 30
$100m & under 5 11 9 19
Total: 63 105 95 110

Source: Audit Analytics, CFO.com