Survival of the Large Accounting Firms — You Wanna Bet?

How confident are you in what you think you know? How certain that the facts underlying your belief are fixed and unchanging?

A renowned food writer was dining on the bouillabaisse in a storied Marseilles restaurant. In a dazzling flash of cutlery at tableside, the server expertly beheaded, skinned and de-boned the platter of cooked fish for addition to the classic soup.

In response to the writer’s extravagant praise for her display of elegance and precision, the server was understated. “Madam, I’ve been doing this for thirty years,” she said. “Every night, the bones are in the same place.”

Not so, elsewhere. I was recently challenged to a non-trivial wager, by a highly placed member of senior management of a Big Four accounting firm. He is prepared to take the other side of this proposition, that the Big Four’s days are numbered:

“Within five years — by March of 2014 — one (or more) of the Big Four will have incurred an event because of which its network will be unable to provide a single report on the consolidated financial statements of a significant number of its large global clients.

“This event could be a civil litigation impact, prosecution or other law enforcement action, professional regulatory sanction, voluntary or strategic withdrawal in one or more key countries, or some other event the identity of which cannot be known today.”

A lot is certain to happen in the next five years. Not least, we should both hope to be around for the reckoning. And my side of the bet should be seen as a modest hedge against my firm belief that – whatever its problems and shortcomings (see here and here) – a worthy profession and those relying on it deserve a better fate than its disintegration into ignominy or irrelevance.

Still, we are at a legitimate standoff. He views me as academic and na?ve, detached from the “reality” of the capacity for change in the market for professional services. I in turn view him as operating under several types of bias, of the type I explore in my MBA students’ Risk Management course.

With access to both a classroom and this platform, I have the advocate’s advantage:

First, with his optimism about the stability of the Big Four’s audit franchise that I only wish I could share, my friend shows the “proximity” bias of a handsome compensation package and regular paychecks that are, for the moment, accepted at financial institutions worldwide.

Second, he has the common “induction” bias that over-values what he knows, minimizing the credible likelihood of a disruptive unknown. He reasons that because it hasn’t happened before – that large-company assurance has become unavailable – therefore it won’t happen in the foreseeable future.

Third and closely related, he rationalizes as proof of the Big Four’s stability that it has survived the last decade’s close calls and danger signals. His conclusions of strength — despite the 5-to-4 shrinkage after Andersen’s collapse, KPMG’s avoiding a tax-shelter indictment, and PwC’s near-death experience in Japan — resemble the tragically optimistic rationalizations of NASA management, that the Challenger and Columbia shuttles were safe to fly, despite the prior evidence of O-ring burn-through or insulation impact damage.

Fourth, a typical “hindsight” bias in any projection is to minimize conditions changed for the worse. In evaluating the Big Four’s ability to survive, past experience should in fairness be adjusted for the steady escalation in claim and settlement amounts, the collapse all around of major institutions once thought invincible (all involving Big Four clients, incidentally), and an atmosphere of public hostility to both corporate malefactors and their proximate watch-dogs.

I am in this dialog wrongly charged as being the pessimist whose dour predictions, over enough time, will be proved right.

Like the server in the restaurant, I demur – not saying that Big Four collapse must necessarily happen, but that the prospects that it may are likely enough that deliberate, explicit attention and consideration are required.

To my MBA students, this will be a stimulating if academic exercise. Out in the profession itself, under managements’ real obligations of stewardship to safeguard four enterprises that together employ 600,000 people and have worldwide revenue exceeding $100 billion, wishful thinking is not an option.

Nor is “hope for the best” a strategy.

It is, instead, a bet I will be sad to collect.

www.jamesrpeterson.com