This paper examines from a historical perspective the effects of the Big Eight and Big Six accounting firm mergers on concentration measures and market share percentages of major accounting firms in the US large company audit market. Concentration ratios and Herfindahl indices reflect an increasingly concentrated audit market, though individual firms differ in their success at capturing market shares in the three exchanges examined, as well as in their ability to capture newly listed companies or companies switching auditors over the 1988 to 1999 period.
The 1990s were characterized by unprecedented merger activity throughout
the global economy. As mergers increase, so too does governmental concern
regarding anti-trust issues. In the December 1999 issue of the
Journal of
Accountancy
, Jim Romeo discussed corporate mergers in the US, and some
of the issues focused on by regulators. Romeo noted that an important
consideration is that ‘the market is not concentrated after the merger’
(p. 60). He further explained that ‘to determine if a merged company will
have excessive market power, the increase of market concentration must be
measured’ (Romeo, 1999, p. 62). Similarly, Nobel Prize economist George
Stigler wrote: ‘The purpose of a measure of concentration is to predict theextent of the departure of price (or alternatively, of rate of return) from the
competitive level’ (seeStigler, 1968, p. 30). To provide some insight into
this assessment, this paper examines current auditor concentration within
the US, putting it in a historical context.
When four Big Eight accounting firms merged in 1989, concerns
were raised about the increased level of accounting/auditor concentration.
Apprehension arose again in 1997, when two of the resulting Big Six
accounting firms announced their merger (effective in 1998), creating the
Big Five. The
Financial Times
in an editorial (Consolidating Accounts,
1997, p. 13) wrote: ‘Not only is this undesirable on competitive grounds; it
will also allow the merged firm to exercise an unhealthy degree of influence
over the standards and practices of the profession as a whole’.
This paper updates and expands upon prior research by investigating the
effects of the 1989 and 1998 accounting firm mergers on the concentration
within the market for audit services in the US. To investigate such effects,
concentration ratios and Herfindahl indices are developed. Additionally,
the impact on the market shares of the merged firms is considered. In this
respect, we are motivated by the 1985 Mueller study of 1000 companies
in which he concluded that merged companies did not necessarily increase
their market shares when compared to companies that did not merge.
Although mergers can have an immediate effect on measures of auditor
concentration and market shares, over time there are confounding factors
that can alter the consequences of such mergers (Beattie & Fearnley, 1994,
pp. 303–304). To help isolate such factors, the success of major firms in
securing clients as auditor switches and companies entering the market is
examined. The paper concludes with a discussion of other factors that may
influence the competitive outcomes of the mergers.
Comparisons of pre and post-merger concentration measures indicate that
the Big Eight and Big Six mergers have impacted concentration and marketstructure in the large client audit market in the US. Four, six, and eight
firm concentration ratios have substantially increased over the 1988–1999
period. While the four firm Herfindahl index reflects a balanced market due
to the relatively equal competitive market shares of the four leading firms,
the six and eight firm Herfindahl indices illustrate an increasing imbalance
among the firms. This imbalance is due to the disparity in firm size and the
relatively small audit market shares held by the second tier firms included
in the index calculation subsequent to the mergers (and evidencing an
increase in concentration among the top firms combined with an inability
on the part of second tier firms to approach an equilibrium with the top
firms).
In regard to the effects of the Big Eight mergers on individual market
shares, results differ. The merged firm of Ernst & Young was able to
maintain its market share, consistent with the combined pro forma numbers
for the two separate firms. In contrast, Deloitte & Touche lost market
share (based on clients) subsequent to the merger of Deloitte Haskins &
Sells and Touche Ross. Beattie & Fearnley (1994) point out that in order
for a firm to maintain its market share, it must capture a corresponding
percentage of newly listed companies and secure a corresponding percentage
of companies that switch auditors. Apparently, Deloitte & Touche was not
entirely successful at doing this. It is probably too early to completely assess
the market effects of the Price Waterhouse and Coopers & Lybrand merger.
Although concentration levels and market structure are important
indicators of the competition that exists within an industry, past competitive
practices and pricing patterns provide insights for the implications of
mergers on competition as well. For more than twenty years, the large
client audit market has been considered as concentrated and at the same
time competitive. This conclusion has been drawn in both the financial
press (e.g. Bernstein, 1978; Palmer, 1989; Crane, 1990; Okell, 1991; Kelly,
1995) as well as by academic researchers (e.g. Dopuch & Simunic, 1980;
Danos & Eichenseher, 1986; Hermanson
et al
., 1987; Maher
et al
., 1992;
Copley, 1993; Wootton
et al
., 1994; Brown
et al
., 1995; Balsam, 1996).
While corporations have been willing to pay more for a Big Eight/Six
audit (Simunic, 1980; Francis & Simon, 1987; Chung & Lindsay, 1988),
it appears that the demand for the audit service of an individual firm
is relatively price elastic. Several writers (Bedingfield & Loeb, 1974;
Eichenseher & Shields, 1983; Lynn, 1988; Beattie & Fearnley, 1998)
have concluded that audit fees are an important factor in a company’s
decision to change auditors and then in a company’s consideration of its
new auditor. It appears that accounting firms are aware of the importance
of audit prices, and studies (DeAngelo, 1981a; Simon & Francis, 1988;
Ettredge & Greenberg, 1990) show that firms sometimes ‘lowball’ their fees
in order to obtain an audit. Securing an audit is often looked upon as a way
to gain access to a corporation’s demand for other services, which can be
more profitable.Moreover, as corporations merge and downsize, cost reductions have
become very important. In the movement for greater cost containment,
audit fees can become a commodity to minimize. As such, corporations may
be less likely to accept increases in audit costs without significant perceived
value added. Thus, although in the rapidly changing accounting profession
nothing is certain, these realities may provide incentives for accounting firms
to continue to competitively price their audit services.
