How Indian Audit Firms Lost Out To The Big 4
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How Indian Audit Firms Lost Out To The Big 4

In 2002, a local chartered accountancy firm thought it was time to protect itself from the shift in the nation’s audit market. The economy had opened a decade earlier, and the four largest global auditors were gaining ground. To avoid losing business, Shridhar and Santhanam joined an international accounting network.

PKF International allowed use of brand name, referred clients, shared work knowledge and oversaw quality without controlling or managing affairs of the firm. That gave members a global scale while retaining their identity.

The fears of the Chennai-based firm weren’t misplaced. A little over decade-and-a-half later, the Big 4—Deloitte, KPMG, EY, and PwC—dominate India’s audit business, like the rest of the world. According to Prime Database, 60 percent of Nifty 500 companies are now audited by Big 4 or its affiliates. That’s when the nation, according to April 2018 data by the Institute of Chartered Accountants of India, has 71,223 chartered accountancy firms.

The dominance of the Big 4 has triggered concerns globally, calling for efforts to look beyond them. The U.K.’s Competition and Market Authority suggested a joint audit to improve “resilience” of the audit market and stronger competition by “breaking down the barriers that prevent challenger firms from auditing large companies”.

Indian firms are also calling for joint audits as a way to break their hold. Another measure, according to Tirthraj Khot, partner at Sharp & Tannan, could be not allowing auditor of the parent company to audit subsidiaries—a common practice as of now. And the Competition Commission of India is probing the dominance of the quartet, BloombergQuint reported earlier.

S Santhanakrishnan, managing partner at PKF Shridhar and Santhanam LLP, has another suggestion—separate audits from other lines of Big 4’s businesses—something even the U.K. has recommended.

A chartered consultancy firm cannot offer any other service to a client if appointed a statutory auditor. But the Big 4 have many affiliates registered as private limited companies. Such an entity can offer service like consulting even if any of the other affiliates of the same brand has been hired for auditing services. That gives rise to conflict of interest.

“If you’re both in audit and consulting, consulting will give you 10 times more than the audit fee. Will you not compromise?” he asked. “With the audit-only firms, investors will be happy that their rights are protected without any conflict of interest.”

A partner can charge at least Rs 18,000 a day for audit work, according to the ICAI’s minimum recommended fees. For consulting work such as investigation, management and special services, they can seek Rs 35,000 and more a day.

The big 4 would choose consulting because the fees are high to meet with their cost structures.
S Santhanakrishnan, Managing Partner, PKF Shridhar and Santhanam LLP

These may well be the first steps to reverse the concentration of audit business in the hands of Big 4.

How The Big 4 Became Big In India

Prior to the 1991 reforms, the audit market wasn’t controlled by just a few, and many large companies were audited by local firms, Santhanakrishnan told BloombergQuint in an interview. “But these firms were unable to compete with the Big 4 and ended up being acquired by them.”

Most of the Indian chartered accountancy firms were Hindu Undivided Family businesses, he said. “When you have family control, you can only grow to an extent. Unlike manufacturing or any other industry where you can put money and employ people, this is knowledge work,” Santhanakrishnan said. “But unless you expand, you can’t increase your knowledge base. Family size restricted growth opportunities.”

For Big 4, that wasn’t a problem. Financial heft helped the quartet either expand or assimilate Indian firms as associates and draw talent with better payouts. That gave them reach and a larger share of the business.

International funding allowed accounting biggies to acquire firms, hire more manpower, and set up new verticals, according to Rajiv Singhi, managing partner at Singhi and Co. The Indian firms, he said, lacked resources.

‘Psychological’ Insurance

Gobbling smaller firms was not the only reason behind their dominance. Foreign investments and multinationals setting up shop in India after the liberalisation and their familiarity with the global auditing giants aided Big 4’s growth in India.

The Big 4 have globally established brands which the Indian firms are unable to match owing to professional restrictions around branding, Singhi said. The multinationals also have a Big 4 mandate globally which gives them a significant advantage here, he said. “This also led to them becoming a fancy of directors and chief financial officers of Indian companies.”

Mukund Chitale, partner at Mukund M Chitale & Co., calls preference for Big 4 a kind of insurance. “It’s psychological—when directors decide on selection of auditors without proper evaluation, then if anything goes wrong, the directors can claim that they did their job by appointing a firm which is already known in the world and pin the blame on it. When they appoint Indian firms, they would be held accountable and questioned on why they preferred a local firm.”

Moreover, Indian corporates who intended to expand overseas insisted on a foreign auditor, according to Santhanakrishnan. There was a reason for this preference—they could benefit from the international network, experience and presence.

Word Of Mouth Vs Brand Promotion

The global scale and repute allowed the Big 4 to promote multiple lines of businesses such as management services, design and implementation of any financial information system, actuarial services and investment advisory without violating Indian norms.

The regulations of the Institute of Chartered Accountants of India restrict advertisements; don’t allow auditors to share the list of clients; and bar them from using generic names, forcing them to christen the firms after the partners or their initials. These restrict local firms’ ability to reach out to potential clients and makes them dependent on word of mouth to get business.

The Big 4, however, have large marketing budgets that they use to promote the parent brand—though not the audit firm. Yet, it has a positive rub-off on all their verticals, including consulting, audit and tax.

Another restriction to the growth of local auditing firms was the provision in the Companies Act, 1956 that allowed only proprietorship and partnership firms to be appointed as statutory auditors. The Partnership Act capped the number of partners at 20. By comparison, the four biggest global firms could have a much larger pool of partners through their affiliates.

While limited liability partnerships were allowed after the LLP Act was passed in 2008, such firms were not allowed as statutory auditors. It was only after a clarification by the Ministry of Corporate Affairs in 2011 that such firms were allowed to take up statutory audit assignments.

Yet, two years later, a provision in the Companies Act, 2013 aimed at improving transparency is helping the Big 4 again. The new law mandates rotation of auditors every five years in case the auditor is a sole proprietorship, and in 10 years if it’s a firm with multiple partners.

A report by Prime Database, which studied auditor rotation at 984 listed companies in 2017-18, found that the share of Big 4 increased by 3 percentage points to 29 percent during the period.

The Outliers

Joining a global network was one of the ways to take on the dominance of the large auditing firms. Other audit firms chose different paths.

In 2002, six firms, including one incorporated in 1936, merged to create CNK & Associates LLP with nine partners. It has since grown bigger, according to its website, and now has around 450 employees and 23 partners.

The merger allowed partners to specialise, Gautam Nayak, partner at Mumbai-based CNK & Associates, said. Earlier, they had to keep up with changes in laws and regulations in different areas, he said, adding that the merger helped solve that problem by promoting division of work and specialisation. “It also helped attract and retain talent.”

Another section of firms decided to directly take on the Big 4. Mukund M Chitale & Co., incorporated in 1973, neither merged with other firms nor opted for any international association. It now employs more than 100 people, including 10 partners.

Mukund Chitale and Sushrut Chitale, the father-son duo and partners at the firm, object to pigeonholing auditors as Big 4 and others. The categorisation should actually be on quality, they said, suggesting a system of grading based on internal procedures, technology adoption, peer review and documentation. An independent framework should be created to review and grade firms, they said, adding that should be the benchmark of quality.

But for Santhanakrishnan of Shridhar and Santhanam, association with PKF has paid off. “Most of the international funds insisted on Big 4 being their auditor. There was a second layer of people who were not interested in Big 4 but wanted an international name,” he said. “We came handy only because we were recognised as an international brand.”

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