The shift of public accounting firms, traditionally focused on providing auditing and tax services, into expansive multidisciplinary firms has long raised concerns among investors and regulators.
These apprehensions reached their peak in the early 2000s following multiple accounting scandals and the demise of Arthur Andersen. At the time, public accounting firms often provided both auditing and consulting services to the same client, leading to concerns about compromised auditors' independence. In addition, the rising consulting revenues caused concerns over a change in firm culture, from a central focus on audit quality to an emphasis on growing revenue and profitability. "Keeping the client happy and doing what was necessary to retain the client achieved a prominence that did not exist prior to the advent of the consulting arms,"
The Sarbanes-Oxley Act of 2002 addressed the independence concerns by imposing substantial restrictions on the types of consulting services that public accounting firms could offer to their audit clients. Subsequently, most accounting firms divested their consulting services in the early 2000s. However, these firms' renewed focus on auditing and tax was short-lived. They started rebuilding their consulting practices in the second part of the decade, through a combination of internal growth and acquisitions. By 2023, Big Four firms reported an average of 49% of their revenues from their consulting practices, ranging from 43% at KPMG to 54% at Deloitte. On average, only 27% of Big Four firms' revenues are now credited to their auditing practice and 24% to their tax practice.
Does the revival of consulting services at Big Four firms pose a threat to audit quality today? The notion that, compared to the pre-SOX period, "this time is different," is tempting given the current restrictions on offering consulting services to audit clients. However, the rise of consulting services can still pose potential threats to audit quality. In 2014, then PCAOB board member Steven Harris
I believe recent changes to governance structures utilized by the Big Four accounting firms could potentially jeopardize audit quality. As partnerships, the firms' top management and board structure reflect the partners' collective will. As the percentage of consulting partners within the firm increases, so does their influence on the firm's vision and tone. The subsequent points highlight these recent changes and the anticipated consequences of a predominant presence of consulting partners:
• Consulting partner assumes the CEO position: Given the significant proportion of consulting partners in accounting firms, it is unsurprising that, for the first time in the history of U.S. public accounting firms, three of the Big Four firms recently elected consulting partners to assume the role of CEO. KPMG elected their first CEO with a consulting background in 2015, EY in 2018, and Deloitte in 2023. PwC US stands as the only Big Four firm that has yet to elect a consultant as the CEO; however, in 2023, it elected a consulting partner as chair of its global network. Given the recent unsuccessful collaboration between EY's global and U.S. leaderships to split the assurance and consulting services, the influence of a consultant as the head of a global network should not be minimized.
• Greater representation of consulting partners on firms' boards: A cursory view of Deloitte's website suggests consulting partners already make up more than half of its board. The share of consulting partners on PwC's and KPMG's boards is still below 50%, but the upward trend in consulting revenues suggests this too may change in the near future as the influence of consulting partners continues to increase. EY, having currently no board in place, has just announced plans to set up a governing board nominated by an elected partners' committee. This follows the failed attempt to split the auditing and consulting into two firms. It seems U.S. audit partners opposed the move, and the new proposed governance structure aims to give majority partners more voice in firm strategy. Needless to say, a consulting arm comprising the majority of partners in the firm will have vast sway over the firm's future oversight and strategy.
• Greater use of alternative practice structures: States require accounting firms to hold majority CPA ownerships in order to retain professional licensures. These rules were established to ensure individuals licensed by the state are responsible for managing and upholding the professional and ethical standards mandated by the state. With the change in firms' partnership composition and the loss of majority to the CPA partners, some public accounting firms have circumvented this requirement at the firm level by making use of alternative practice structures. These structures limit the ownership requirement to only part of the firm, typically including the particular unit or subsidiary that performs the traditional CPA services. While satisfying the state ownership requirements, this practice essentially allows firms to bypass the spirit of the law. Top management (CEO and board) is still voted into place by all partners in the organization. Thus far, regulatory attention on APS has been primarily focused on the compliance with auditor independence requirements. However, given the increase in the share of consulting partners in accounting firms, more scrutiny of the managerial implications of these alternative structures is warranted, especially in terms of its implications for audit quality.
The increasing dominance of consulting practices in Big Four firms over the past two decades and the concurrent profound shifts in the Big Four firms' governance structures, business structures, cultures and leadership dynamics magnify the threats to audit quality. A public accounting firm's CEO and leadership team have a duty to operate the firm for the financial benefits of all partners. However, audit and consulting businesses have different goals. The consulting business does not directly focus on investors' interests, while the audit business has a direct public role in delivering high-quality audits that serve investors' and other stakeholders' interests.
When most of the firm's owners are consulting partners, and the CEO is a consulting partner with little prior exposure to audit work, how can investors trust the firm's strategic and operational decisions would be made in a way that prioritizes public interest over the partners' financial interests? Recent accounting scandals and ethical lapses at the Big Four firms seem to lend weight to this concern. The most notable example is the cheating scandal in EY — not only were employees found to be cheating on CPE courses and ethics exams, but top management also attempted to conceal the wrongdoing.
The impact of decisions made by CEOs and leadership teams extends beyond the current quality of audits. Future generations of accounting professionals are impacted as well. Over the last decade, there has been a notable decline in the number of students studying accounting, with some universities experiencing a reduction in accounting enrollment of up to 50%. This decline can be attributed, in part, to substantial gaps in starting salaries between accounting firms and competitors for top talent.
What's more significant is the substantial wage gap within accounting firms, with consulting associates commanding higher starting salaries than audit associates. Instead of attracting the brightest students to the assurance and audit function, which constitutes a vital public interest function, the firms incentivize the best and brightest students to choose the more lucrative fields for the firm's financial interests. This trend reflects the shift in tone and priorities of accounting firms' management. As accounting educators, we value the importance of auditors serving the public interest, and constantly highlight the ethical foundation of the profession. However, students inevitably circle back to the issue of salary. Talented students with options prefer to focus on higher-paying jobs in finance, general management and consulting.
How do we ensure that leadership of accounting firms remains dedicated to the primary and crucial duty of auditors — safeguarding the interests of investors and other stakeholders by providing accurate and reliable information? Should we consider mandating the separation of consulting business from the accounting firms? Should we insist on top management having a background in assurance and audit? The next crisis might already be in the making. It is imperative that we initiate the conversation.
