Who Needs the Big Four?

Companies both big and small that are going global, need access to regulators, and want to avoid the cost of switching—that's who.
Alix StuartJanuary 24, 2008

The promise of lower audit costs and better service is luring an increasing number of small and medium-sized companies away from the Big Four and into the arms of second-tier or regional accounting firms.

From 2002 to 2006, in fact, the proportion of smallest public companies that used a Big Four auditor
fell by half
, according to a recent GAO report. What’s more, auditors and investors acknowledge that regional firms can do the same work for less, with few repercussions. “Particularly for emerging, pre-revenue companies, you’d have a hard time persuading me that an audit done by a Big Four firm will add more value than one done by a regional firm,” says Don Mackenzie, CFO of Polaris Venture Partners and an alum of both Ernst & Young and PriceWaterhouse Coopers.

Yet some small corporations are steadfastly sticking with high-cost big-name auditors. Marcus Corp, a $328 million operator of movies, hotels, and resorts, even went through the trouble of switching from one to another—
Ernst & Young to Deloitte & Touche—
earlier this month.

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What keeps the Big 4 so popular?

The strong international presence of the bigger firms is a key driver, say many finance executives. “As companies increase in size, complexity, and geographic reach, there’s every reason to engage the Big Four,” says Mackenzie.

Further, with globalization advancing apace, companies both big and small need help in far-flung areas of the world. IPG Photonics, for example, is a $143 million laser manufacturer based outside Boston. With operations in Russia, Germany, and Italy, and sales offices scattered elsewhere across the globe, IPG uses Deloitte for its audit.

In large part, that’s because the auditor has reliable staff outside the United States. “Some of the smaller audit firms, particularly in Russia, probably have limited resources,” says IPG finance chief Tim Mammen. “With Deloitte, you get access to high-quality people in those locations.” IPG spent just over $1 million on audit fees last year, including the work leading up to a December 2006 initial public offering.

To be sure, some mid-tier firms are building their international presences. Further, many local firms are affiliated with overseas firms through networks like The International Accounting Group or Accountants Global Network. Nevertheless, some say the quality and consistency of the overseas partners generally isn’t the same as those within a single firm. “There are other internationally recognized firms, but clearly the Big Four [are] the gold standard,” says Jeanne Henry, CFO of Atlas Venture, a venture-capital firm with offices in Boston, London, Munich, and Paris.

Bigger can be better even when it comes to U.S. operations, says Art Technology Group CFO Julie Bradley. The $103 million (likely to be $136 million when it announces earnings on Feb. 5) E-commerce-platform provider spent $1.1 million last year to have Ernst & Young audit its books. The auditor’s “vast client base” can be a critical source of information on how to handle tricky accounting questions, says Bradley. Although E&Y doesn’t disclose the identities of the other clients, “most of the time we can find some others with similar issues, so we can have some consistency,” she says. The internal database allows her company to leverage Securities and Exchange Commission responses to other firms as well.

It’s also hard to ignore the clout that the big firms carry with standards-setters. “To be able to call upon the national expert at E&Y who maybe even helped craft the statement that just came out is worth a lot,” says Bradley. Three of the Big Four firms are currently represented on the Financial Accounting Standards Board’s advisory council, for example, while only one second-tier firm, Crowe Chizek, has a seat.

Then there’s the cost of switching auditors. That cost – or at least the perception of that cost – is formidable enough to keep many companies at status quo. “To do a change in auditor, the last I looked at it, meant an automatic SEC review,” says Bradley, noting that that would mean extra time and risk exposure.

Add to that the price of educating a new audit team, and the fact that auditor salaries are going up across the board, and “I don’t think there’s probably a huge savings” in going to a second-tier firm, says Bradley.

Big name auditors may also underprice their services to growing or pre-IPO companies, particularly in high-tech meccas like Boston or Silicon Valley. The reason? “They want to be part of the next EMC or Microsoft,” says Jeanne Henry of Atlas Venture. She’s seen big audit firms offer sweet deals to some of Atlas’s portfolio companies in order to boost their images in certain industries. Depending on how close the firm is to an IPO or an acquisition, it can be hard to turn them down.

Beyond all the practical reasons for having a Big 4 audit firm, though, at least one CFO is brave enough to admit that at some level, it’s still a status thing. “It’s not that other audit firms can’t do the work very well, it’s that Deloitte doesn’t take on companies unless they have a very strong regard for the company’s management team,” says IPG’s Mammen. “The credibility comes from them agreeing to do the work” – and in this market, that may be priceless.