The failure of Enron and subsequent demise of Arthur Andersen led to significant changes for public reporting and auditing but not much change in the concentration of audit market power among the remaining Big Four global firms: Deloitte, Ernst & Young, KPMG, and PwC.

The last time the United States government officially scrutinized the level of concentration in the market for public company audits was January 2008. Despite more than five years of unprecedented change in the audit industry following the dissolution of one of the five largest audit firms in the world, Arthur Andersen, and the passage of the Sarbanes-Oxley Act in 2002, the General Accounting Office came to the same conclusion it had reached in a study concluded in 2003: The audit market for large public companies was still highly concentrated. However, the level of market concentration “did not appear to be having a significant negative impact overall.”

The 2008 concentration report, which followed up on one prepared a bit too soon right after the demise of Arthur Andersen in 2003, was prepared by the General Accounting Office under the Comptroller General’s authority to conduct evaluations on his own initiative, in order to assist Congress in reviewing concentration in the market for public company audits.

It hit shortly before the financial crisis was at its peak, bringing the largest waves of failures, forced acquisitions, and effective nationalizations of major banks and financial services all over the world. Almost all of the largest mortgage originators, global banks, and investment firms affected by the crisis were audited by one of the Big Four remaining firms and some, like Freddie Mac, had been audited by Arthur Andersen before its demise. 

The GAO said in 2008 that it was “unlikely” that concentration in the audit market for large public companies would be reduced in the near term, either by the development of new capabilities or by mergers of the next tier and smaller firms that would result in a firm with the level of expertise and critical mass needed to perform multinational audits. The GAO report authors admitted that “there was no general consensus for various proposals put forth for addressing concentration.”

Large companies told the GAO that they prefer the Big Four because of their capabilities in terms of size, geographic reach, technical expertise, and industry specialization, as well as reputation. During a Stigler Center conference on concentration in America in March, University of Chicago Booth School of Business Professor Luigi Zingales (Faculty Director of the Stigler Center and one of the editors of this blog) argued that “there is a direct connection between economic power, bigness, and political power.”

The failure of Enron and subsequent dissolution of Arthur Andersen—the firm never filed for bankruptcy but gave up its licenses as a result of its criminal conviction—led to significant changes for public reporting and auditing but not much change in the concentration of audit market power among the remaining Big Four global firms: Deloitte, Ernst & Young, KPMG, and PricewaterhouseCoopers.

Unlike the post-crisis Dodd-Frank reforms, which focus on financial institution systemic risk and do not mention the auditors at all, those post-Enron failure reforms were focused on the auditors’ role in detecting fraud and on improving corporate financial reporting.

In their 2015 paper, “Competition in the Audit Market: Policy Implications,” Joseph Gerakos of Dartmouth’s Tuck School of Business and Chad Syverson of the University of Chicago Booth School of Business noted that the audit market periodically gets attention from policymakers because of its “unique combination of features—its role in capital market transparency, mandated demand, and concentrated supply.” Gerakos and Syverson explored the possibility of further supply concentration due to the exit of a Big Four audit firm.

The possibility of losing another large firm like Andersen because of a criminal indictment has been minimized. The U.S. government learned its lesson with Andersen about the collateral economic damage from the demise of an audit firm. When faced with the choice again three years later, in 2005, the Department of Justice entered into a deferred prosecution agreement instead of indicting KPMG for tax fraud that helped clients evade $2.5 billion in taxes. The largest global audit firms now enjoy the benefit of a “too few to fail” regulatory hall pass.

Financial failure of another large firm due to catastrophic litigation is very real, however. Last summer PricewaterhouseCoopers, the U.S. member firm of the global professional-services giant, faced three bet-the-firm trials for allegedly negligent audits. An unfavorable verdict in any one of them, given the multibillion-dollar plaintiffs’ claims, could have inflicted significant financial damage. Unfavorable judgments in all three could have been fatal. Two have since settled for undisclosed amounts.

However, PwC will face its third trial in early 2018, brought by the Federal Deposit Insurance Corporation, for the crisis-era bank failure caused by the Colonial Bank fraud case. The FDIC is seeking damages of $1 billion.

The Hirschman-Herfindahl Index (HHI) is one of the concentration measures government agencies, including the Department of Justice and Federal Trade Commission, use when assessing concentration levels to enforce U.S. antitrust laws. The GAO calculated the Hirschman-Herfindahl Indexes in its 2008 report for several groupings of audit firms from 2002 to 2006. According to Department of Justice guidelines, HHI scores of less than 1,000 are thought to indicate an unconcentrated market with no competitor able to exert market power.

Based on data provided by research firm Audit Analytics, the GAO calculated an HHI of over 2,500, more than 2.5 times the level where key competitors can exert market power, for auditors of companies with more than $1 billion in revenue. The index remained at that high level in 2006. The category of companies with revenues greater than $1 billion roughly corresponded to the Fortune 1000 list at the time. The GAO found that the audit market for all public companies with revenues greater than $500 million remained highly concentrated during the five-year period. 

Between 2002 and 2006, the HHI for the audit market for the smallest public companies—those with annual revenues of less than $100 million—declined from a level of 1,400 to about 800.

Gerakos’ and Syverson’s paper follows up on the GAO’s work with an analysis of annual market shares of SEC registrant audits for the Big Four and non-Big Four audit firms, as well as the mean HHI of those shares within three-digit SIC industries. Although their data shows the non-Big Four firms are gaining a greater share of the market between 2002 and 2010, they calculate an HHI using market shares based on number of clients that is greater every year than the one last calculated by the GAO, and it’s increasing every year.

Source: Joseph Gerakos and Chad Syverson, “Competition in the Audit Market: Policy Implications” (2015). Gerakos and Syverson used “SEC registrants with available data” to calculate annual market shares for the Big Four and non-Big Four firms, as well as the mean HHI, according to their paper. A review of comparable data from Audit Analytics for the same period suggests that the research firm’s current calculations of market share are based on the much larger population of all 1934 Act filers. Therefore, the Gerakos/Syverson data will show many fewer observations, a significant reduction in the number of firms, and therefore a higher concentration level.

Research firm Audit Analytics has also produced annual reports on auditors’ market shares since 2009 and its data shows that the trend toward large company auditor concentration continues. Its most recent analysis, dated March 2017, shows that the number of large accelerated filers—companies with a public float of more than $700 million—decreased in number from the prior year by 2.9 percent. The number of accelerated filers—companies with public float between $75 million and $700 million—decreased by 4.1 percent.

The Big Four global firms dominated the audit market for both categories of public companies, auditing 90.9 percent and 54.8 percent, respectively. In both markets, Ernst & Young audited the most companies by a large margin.

Using raw data provided by Audit Analytics, I calculated HHIs for 2015, and 2016 early 2017 (until March):((Graphics assistance courtesy of Terrance Horan at

For large accelerated filers, the overall HHI of 2,128 as of March 2017 means the level of concentration by the Big Four remains very high. The HHI for accelerated filers is close to the GAO threshold at 949. The audit market for smaller reporting companies is significantly more dispersed with 323 firms auditing 2,599 companies. The Big Four together have less than 4 percent market share in smaller reporting company audits, making the HHI a very low 119.

The good news from a concentration perspective is that the smallest audit firms are taking a bigger bite of the diminishing number of public company audits. Despite the one hundred plus IPOs that took place in 2016, the smaller reporting company category dropped in number the most, almost 12 percent. 

The bad news is that the Public Company Accounting Oversight Board (PCAOB), which checks auditor quality via an inspection process, looks at smaller audit firms—those that audit fewer than 100 issuers—only every three years, and there are so many more of them to review than larger audit firms.

That means there’s some reason to be glad that there is concentration among auditors for the largest public companies. Audit work at those firms—Deloitte, KPMG, EY, and PwC—is inspected by the PCAOB every year and the inspections are rigorous. The bad news, however, is that if one of those global audit firms falters financially or fails, the remaining three will unlikely be able to absorb the clients, the work, and the employees the way four of them did back in 2002 following the failure of Arthur Andersen.