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The Big Four

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"Messrs. Gow and Kells have made an invaluable contribution, writing in an amused tone that nevertheless acknowledges the firms' immense power and the seriousness of their neglect of traditional responsibilities. 'The Big Four' will appeal to all those interested in the future of the profession--and of capitalism itself." —Jane Gleeson-White, Wall Street Journal

With staffs that are collectively larger than the Russian army and combined revenues of over $130 billion a year, the Big Four accounting firms—Deloitte, PricewaterhouseCoopers, Ernst & Young, and KPMG—are a keystone of global commerce. But leading scholar Ian Gow and award-winning author Stuart Kells warn that a house of cards may be about to fall.

Stretching back to the Medicis in Renaissance Florence, this book is a fascinating story of wealth, power, and luck. The founders of the Big Four lived surprisingly colorful lives. Samuel Price, for example, married his own niece. Between the world wars, Nicholas Waterhouse collected postage stamps while also hosting decadent parties in his fashionable London home.

All four firms have endured major calamities in recent decades. There have been hundreds of court cases and legal prosecutions for failed audits, tax scandals, and breaches of independence. The firms have come so close to “extinction level events” that regulators have required them to prepare “living wills.” And today, the Big Four face an uncertain future—thanks to their push into China, their vulnerability to digital disruption and competition, and the hazards of providing traditional services in a new era of transparency.

This account of the past, present, and likely future of the Big Four is essential reading for anyone perplexed or fascinated by professional services, working or considering working in the industry, or simply curious about the fate of the global economy.

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14 Chapters

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1 Introduction

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Stretching back centuries, the history of Deloitte, EY, KPMG and PwC is a fascinating story of wealth, power and luck. In many profound ways, the so-called Big Four accounting and audit firms have influenced how we work, how we manage, how we invest and how we are governed.

The firms have been called many things. High priests of capitalism. More powerful than sovereign states. Protectors of the public interest. The conscience of the free market. Heroes of corporate integrity. Benign watchdogs. Toothless lapdogs. A necessary evil. An institutionalised oligopoly. Corporate sweatshops. Accountants of fortune. Skilled enablers of white-collar fraud. Each of the Big Four is a case study of corporate triumph – and drama. Underneath their polished images are colourful tales of commercial success, but also of ethical compromises, professional angst, botched ventures, debauched parties, scandalous marriages, disreputable interests and arcane rites.

In a field that is seen as somewhat beige and lacking in prestige, the Big Four are the glamour boys, the glowing success stories of their field. In 2011 their total revenue broke emphatically through the US$100 billion mark. Since then it has kept on rising, surpassing US$130 billion in 2016. In that year, before a regrettable incident at the 2017 Oscars, PwC ranked alongside Disney, Nike and Lego as one of the ten most ‘powerful’ brands in the world.

 

2 Glory, Not Infamy The Medici Bank as a precursor to the Big Four

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Piero de Medici – known as ‘Piero the Gouty’ (‘Piero il Gottoso’) – was born in 1416. In 1464 his father died and Piero inherited, at the age of forty-eight, a famous institution that was exceptionally profitable and well-run. Piero’s father – the illustrious Cosimo de Medici – and his grandfather – Giovanni de Medici – had built the family business into Europe’s most important private enterprise: the greatest bank in the world.

The Medici Bank was based in Florence, the capital of Tuscany. In the late middle ages, Florence was a substantial and prosperous city and the centre of global finance. A large gold coin, the florin, was first issued and named there; its widespread use throughout Europe added to the city’s financial prestige.

Unlike most cities and countries in late medieval Europe, Florence was ruled by a mercantile family, the Medici. The activities of the Medici Bank were intertwined with those of the Florentine state, to such an extent that the boundary between bank and state was conspicuously fuzzy. Upon Cosimo’s death, Piero became the head not only of the Medici Bank but also of the Florentine government.

 

3 Transported How the Big Four began in the dangerous world of nineteenth-century accountancy

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Lombard Street in the City of London was named after the colloquial term for an Italian banker. By the nineteenth century, London had long supplanted Florence as the centre of global finance and the prime mover in financial innovation. All the Big Four trace their history directly to predecessor firms that began in nineteenth-century London, such as Deloitte & Greenwood, Cooper Brothers, W.B. Peat & Co. and Marwick, Mitchell & Co. The nineteenth century was a boom time for accounting. It was also the profession’s ‘wild west’ era, even more so than the 1980s. In 1811 the London trade directories listed twenty-four accounting firms. Seventy years later they would list 840.

Many of the men who were attracted to accountancy would quickly leave the field. Richard Le Gallienne, for instance, left the Liverpool-based accounting firm of Chalmers Wade & Co. to become a poet. (Other former accountants throughout history include the actor Randolph Scott, the author John Grisham, and the pistol designer Georg Luger.) But among those who remained were some now famous names. William Deloitte started practising in 1845; Samuel Price, in 1848; William Cooper, in 1854.

 

4 A Curious Match The remarkable founders of the Big Four

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Dining together, playing golf together, going to church together – the routines of partnership created a sense of brotherhood and common purpose among accountants. The profession’s self-confidence grew, just as its boundaries became more distinct.

To the extent that there was any competition between the major accounting firms, it was decidedly mild and gentlemanly. The partners collaborated at the ICAEW and in other professional bodies. They moved in the same clubbish circles. Freemasons were prominent in the profession’s early years; George Sneath of Price Waterhouse and Sir Arthur Whinney of Whinney, Smith & Whinney, for example, were both leading members of the Chartered Accountants Lodge. Firms refrained from poaching one another’s staff and clients. They even traded jointly when delivering services abroad.

In 1911, for example, the rival firms Price Waterhouse and W.B. Peat & Co. merged their Egyptian businesses. They traded in Cairo and Alexandria as Messrs Peat, Waterhouse & Co. Other collaborations would soon follow. In St Petersburg (from 1916) and Rotterdam (from 1919) Waterhouse and Peat traded together as Price, Waterhouse, Peat & Co. The Russian office was inevitably short-lived. When the revolution came, the partners were lucky to escape with their lives; they left behind the firm’s books and petty cash. From 1920 the two firms adopted the same form of joint representation in Calcutta, Johannesburg and Buenos Aires. That same year the firms also extended their European collaboration to cover the whole of the Continent.

 

5 Mere Automata Staking out the Big Four’s turf

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In one of his notorious purges, Henry Ford famously sacked his accountants en bloc. ‘They’re not productive,’ he said. ‘They don’t do any real work. I want them out of here today.’ That story cannot be the whole truth; Ford’s enterprise would’ve collapsed without in-house bookkeepers and financial controllers. But the anecdote helps illustrate a wider twentieth-century trend, that of large industrial companies electing to outsource their accounting services. Corporates that had maintained significant in-house accounting units – such as IBM and Unilever – would decide it was preferable to buy those services from the marketplace.

This trend, unsurprisingly, helped spur and transform the accounting firms, as did other twentieth-century shifts: diversification of the firms’ activities, particularly into ‘management consulting’ or ‘advisory’ services; cosying up with governments; benefiting from the ‘audit explosion’ and the rise of the ‘audit society’; and, like modern Medici, spreading out internationally, with networks of branded franchises in which each national practice was a separate legal entity.

 

6 An Injudicious Change Adventures and misadventures in Big Four branding

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Branding was key to how the Medici Bank flourished. From Scotland in the west to China in the east, the bank’s brand was immediately recognisable as a signifier of safety and integrity. And it served a more local purpose, too, helping keep ambitious junior staff in line. A manager in a hurry could strike out on his own and establish a rival enterprise using Medici methods, but he could not claim to be part of the trademarked Medici Bank: the right to use that name was an exclusive privilege of the partnership.

Despite the family’s criminal origins, and all the twists and turns in the Medici story, the name is still one to conjure with – an all-time great brand. Even today, it is used in European banking. The current Big Four names, too, are among the most recognisable worldwide brands, and so are among the firms’ most valuable assets.

Early in the twentieth century, fans of Britain’s magnificent Great Western Railway called it ‘God’s Wonderful Railway’; detractors called it the ‘Great Way Round’. The first large-scale mergers among railway companies were remarkable for their anguished deliberations about corporate titles. Whose brand would have the greatest prominence in the new name? Whose heritage would come first? The same anguish has since featured in mergers of large accounting firms.

 

7 Porn Star The culture of the Big Four

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The day-to-day correspondence of the Medici Bank reveals men concerned with external matters such as the alum mines, the wool and silk markets and the creditworthiness of monarchs. But they were also concerned with internal matters. Were the bank’s systems strong enough to detect fraud and prevent financial disaster? Who was ready for a pay rise and a promotion? Were the young men graduating from the abacus schools up to Medici standards?

Angelo Tani, Rinieri da Ricasoli and Cosimo de Medici all understood ‘leverage’, which in partnerships means growing the business by hiring junior staff to complement and extend the capacity and capability of partners. The Medici Bank was one of the first large partnerships to grapple with the underlying equation of leverage: the incontrovertible calculus that profit per partner is equivalent to margin times hourly rate times utilisation (the extent to which staff are busy) times the number of staff per partner. Bringing on more staff was one of the few ways in which the bank could pursue higher profits.

 

8 The Most Average Guys in the Room Big Four professional values

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In his 1915 book Of Human Bondage, Somerset Maugham described the interior of a nineteenth-century accounting office: ‘It was dark and very dingy. It was lit by a sky-light. There were three rows of desks in it and against them high stools. Over the chimney-piece was a dirty engraving of a prize fight.’ The quality of furnishings conveyed status. At Price Waterhouse’s offices, for example, partners had ornate fireplaces, mahogany desks and Turkish carpets. Clerks warranted none of these luxuries.

Viewed through modern eyes, the daily routines of nineteenth-century accounting firms look like quaint antiques. At the start of each day, commissionaires sharpened pencils, changed nibs and restocked pins and paperclips. Porters served bread and biscuits for afternoon tea. Auditors working in the field were expected to wear a top hat and either a tailcoat or a frockcoat. Bowler hats and short coats were acceptable for clerks in the office. In Cooper Brothers’ early years, there was a clear division between partners and staff. After work, the latter would enjoy ‘smoke concerts’ at the local pub. The highlights of the concerts were irreverent songs about the foibles of the partners.

 

9 Unqualified Auditing as the foundation of the Big Four brands

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All the Big Four provide audit and advisory services, and in all the firms there are significant differences across these two service lines with respect to: staff qualifications and experience, job sizes, charge rates, delivery timelines and contract types. Compared to advisory, auditing is a higher-cost, lower-margin business with different economics and a different culture. Audit and advisory practices occupy separate divisions within the Big Four firms, and are often physically separate too. A Big Four advisor can go a long time without even seeing a Big Four auditor, and vice versa. When young staff speak of Big Four work as ‘indentured labour’, they are more than likely speaking of audit work. The daily routine of a junior auditor is dull and repetitive – so much so that the Big Four seldom highlight audit in their corporate communications and marketing to graduates. Inside the firms, auditing is deprecated and its practitioners have low status. Most graduates view a stint in auditing as a stepping-stone towards something else. Anything else.

 

10 Clean The impairment of Big Four auditing

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The complexity of modern corporations is often put forward as a principal cause of the rich tableau of audit failures. The Royal Mail case was an early example of auditors trying to come to grips with complexity. The enterprise in question consisted of a large and diverse group of international shipping and trading businesses. Multiple subsidiaries transacted with the parent company in multiple ways. The parent and its subsidiaries maintained a complex set of reserves. Complicated transfers between those reserves were ultimately what concealed Royal Mail’s significant trading losses. Thanks to the company’s structure of divisions and accounts, it was – in the words of Edgar Jones – ‘virtually impossible’ for an external assessor to judge the company’s viability. In the legal aftermath of the scandal, the auditors’ lawyers took Herculean steps to marshal the complexity; the seven volumes of colour-coded defence documents became famous in legal circles as the ‘rainbow brief’.

In the twenty-first century, developments in derivatives, intellectual property, corporate structuring and corporate accounting have made businesses even more complex, and even more difficult to audit.

 

11 Get Ready to Dance Conflicting interests in Big Four taxation services

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Secrecy underpinned the Medici Bank’s success, especially in its ecclesiastical dealings. Through patronage and opportunism, most senior churchmen accumulated savings and investments, such as grand estates within and beyond Italy’s borders. Cardinal Hermann Dwerg, a friend of Pope Martin V, lived in ‘a spirit of evangelical poverty’ – while simultaneously holding 4000 florins, at a time when, according to author and banker Chris Skinner, ‘thirty-five florins would have paid a year’s rent on a small townhouse’. With each change of pope, the clerics faced the danger that their investments would be arbitrarily taxed or even confiscated by a new and unsympathetic man. The solution was a system of secret accounts, held by the Medici and accessible wherever the papal court resided. Cardinal Dwerg kept his 4000 florins in a Medici deposit account. In the twentieth century, secrecy was equally important to the success of the major accounting firms.

For the most part, Big Four taxation services originated in the Edwardian era, when income tax became more complex and burdensome, and advice on tax compliance – and tax minimisation – became indispensable. The simple days of the Domesday Book were long gone.

 

12 One Four Ten The Big Four in China

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In China, the Big Four have attained a dominant position in the accounting services market. Each of the firms is generating billions in revenue there. In a sign of just how much the world has changed, some of China’s largest state-owned enterprises have become Big Four clients. This surprising victory, though, is likely to be short-lived. At every step of their China foray, the firms have faced opposition from powerful forces. That opposition has now reached a crescendo. And it has reached the courts.

Disputes about something as seemingly incidental as audit working papers have become the centre of a transnational legal and regulatory battleground. In Shanghai, Deloitte recently found itself in a wicked dilemma. Deloitte had been the auditor of Longtop Financial Technologies. Longtop, a Chinese financial software company, had failed after accounting fraud was revealed. Longtop’s chairman admitted to Deloitte that ‘fake cash recorded on the books’ was the result of ‘fake revenue in the past’, a reminder that the strictures of double-entry accounting extend even to fraud. The American SEC demanded that Deloitte hand over working papers related to the audit. But Deloitte argued that handing over the papers would place it and its personnel at ‘substantial risk of prosecution’ under Chinese law. Facing enforcement action from the SEC, Deloitte worked frantically to resolve the dispute.

 

13 Disrupted The obsolescence of Big Four technology

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Since the reopening of China’s economy, the country’s government agencies and state-owned enterprises have gobbled up patents and other intellectual property in areas as diverse as microwave ovens, rare earth elements, telecommunications and solar power. The fields of accounting and auditing, too, were identified as potential areas of focus for the gathering of IP. According to Paul Gillis, Chinese officials initially saw joint ventures with the Big Four as a means of transferring technologies from the firms to China. That was the plan until the officials spent some time with the foreign firms and came to a surprising realisation: public accountancy depended on very few proprietary technologies, and most were available over the counter. The core innovations upon which accountancy depended had long been available in the public domain; there was very little technology for the Big Four to transfer.

This is not to say that accounting and audit are technology-free, or that there is no innovation taking place. In fact, accountancy today is a hotspot of innovation, and the impact on the Big Four of that innovation is profound. And complex – the industrial landscape of accounting is rapidly changing in multiple ways.

 

14 Conclusion

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Painful arthritic gout afflicted many of the Medici men. But Piero il Gottoso, ‘frail, bedridden and bad-tempered’, suffered at least as much as any of his brethren. A collector like his father, Piero accumulated gems, coins, tapestries, cameos, silverware, jewellery, tournament weapons, musical instruments and books. He was so crippled by his condition that he had to be carried into his barrel-vaulted study-cum-library, which Luca della Robbia had sumptuously decorated.19

Cosimo de Medici died in 1464. For the funeral, Piero bought mourning clothes for four female slaves: Catrina, Chateruccia, Cristina and Zita. Piero’s library was a sanctuary, but his father’s death plunged him into a crisis. Despite his illness, and his limited experience in banking and business, Piero embraced his new role with a determination to live up to the legacies and the reputations of his father and grandfather. Florence was a dangerous, conspiratorial place. To navigate through its many pitfalls, Piero took advice from men such as the politician Diotisalvi Neroni, who’d also advised Cosimo. In the first months of Piero’s new tenure, he chose a course of action that was the wrong one.

 

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