Consultants and the beast with seven heads - 360
Stuart Kells
Published on August 14, 2023
The ‘Big Four’ consultants are coming under increased pressure over their relationships with governments, which present a series of risks.
The world’s biggest consulting firms have grown large and profitable by walking all sides of the street in their relationships with governments.
The Big Four, Pricewaterhouse Coopers (PwC), Deloitte, Ernst & Young and KPMG, have branched out from accountancy and auditing into new areas, and as they have done so, their own dangers and exposures have multiplied.
Each new service line has brought with it a bundle of new risks. At the same time, the diversification of the major accounting firms has presented new risks for governments, which have been influenced by the misplaced idea that the firms are systemically important and therefore too big to fail.
There were warnings five years ago that the cultural and commercial tensions facing the Big Four would necessitate radical changes in how they are structured and how they operate. Today, the tensions have predictably intensified, and the firms’ diversification strategy is no longer viable.
In Australia, the PwC scandal has enabled a rare level of scrutiny and criticism. It is not an exaggeration to say that the firms are fighting to preserve their social licence to operate.
The reason why is simple: Their failure to manage the conflicting interests of diversified firms.
A PwC tax partner, who was privy to secret information about Commonwealth Government plans to address tax avoidance, shared this information with some other PwC partners, and they reportedly used it to market tax minimisation services to major commercial clients.
The allegations are now at the centre of a Senate inquiry into the four firms and how they operate.
Through an organic process of mergers and expansion over more than 100 years, the Big Four now dominate public company auditing around the world. And through the firms’ parallel ‘supermarket’ strategy of diversification, they now offer services that span a diverse range of fields including management consulting, corporate finance, tax, infrastructure, insolvency, marketing, IT, human resources and the law.
Until recently, the strategy of diversification and growth served the firms well. They built strong positions in several other markets beyond traditional accounting and auditing, including the provision of advice and other services to governments.
Now employing nearly 1.5 million staff and collecting USD$190 billion in annual revenue, the firms have travelled a long way from their modest origins in the provision of a narrow set of accounting and audit services.
In 2018, KPMG’s Australian chair Alison Kitchen remarked that her firm had enjoyed almost double digit growth for the five years up to that point: “With the economy growing at about 3 percent during that time, clearly that cannot continue indefinitely or else we’d end up taking over the world.”
From the point of view of governments, the Big Four collectively are a seven-headed beast.
Head one: Ally and fellow traveller in the pursuit of corporate integrity
Governments care about corporate conduct and the integrity of financial information. Accordingly, governments care about – and are eager consumers of – the public good outcomes that arise from corporate audits. Those outcomes are aligned with and supportive of the goals that governments seek through corporate regulation.
The activities of the Big Four also align with the goals of government in other ways. They have long served as sources of and training grounds for junior staff looking to work in public sector roles that entail accounting and audit skills and nearby capabilities.
Head two: Supplier of services and, occasionally, provider of ‘flak jacket’ protection
Around the world, governments are prominent direct purchasers of Big Four products and services, such as evaluations, business cases, forensic investigations, policy reviews, stakeholder engagement support, market soundings, internal audits, asset valuations and project management services. The Big Four serve also as a ‘body shop’ or resource bank for governments, by enabling temporary or permanent outsourcing of public sector functions.
Government purchases of Big Four services extend across a wide range of major portfolios including defence, healthcare, infrastructure and utilities, education, research bodies and environmental management. They also extend across all levels of government, including the local level.
Within western governments, Big Four advisory reports serve a complex anthropological purpose. When ministers and senior officials are making decisions about the use of public money and state power, the presence of a Big Four-branded report is often a source of safety and reassurance. Until recently in Australia, few people were ever fired for engaging a Big Four consultant to provide advice.
Sometimes, the perceived value of a Big Four advisory report is warranted, but more than once, such reports have functioned merely to wrap a non-government veneer or security blanket around something that officials already knew, and could have produced themselves (see ‘competitor’ points, below).
Sometimes the reports are long and deliver a satisfying ‘thud’, even though the analysis and findings could have been expressed more succinctly. (This ‘thud factor’ is sometimes a basis for pricing of consulting reports.) And sometimes, the reports are merely examples of what Andre Spicer has aptly termed ‘business bullshit’.
In these and other ways, Big Four products serve complex functions in how politicians, officials and government agencies fulfil their own roles and manage their own risks. The anthropological value of Big Four reports is highly vulnerable to episodes such as tax scandals and botched audits that damage the Big Four brands.
Head three: Regulatee and (possibly) auditee
As organisations, the Big Four operate conspicuously outside the frameworks for taxation and corporate governance that apply to corporations. This is because the four are not corporations at all. They are owned by their partners, rather than shareholders; and they are not subject to typical corporate reporting and auditing requirements.
But aspects of the Big Four’s activities do attract attention from the regulatory and oversight functions of governments. In the US, for example, the Public Company Accounting Oversight Board (PCAOB, referred to as ‘Peekaboo’) oversees the quality of Big Four assurance services.
In Australia, some Big Four tax services are scrutinised (with mixed success) by bodies such as the Tax Practitioners Board and the Australian Taxation Office. The PwC leaks scandal has led to a multi-pronged regulatory response. Australia’s Federal Treasurer Jim Chalmers has promised to strengthen the Tax Practitioners Board, for example, and other responses are emerging in the domains of competition policy, integrity agencies, law enforcement and the courts.
Though the Big Four are not subject to external audits in the way public corporations are, aspects of their activities could be subject to more audit-style scrutiny. One example is the pending demerger of PwC’s government advisory business into the new entity, ‘Scyne Advisory’ in Australia.
The new entity is a corporation, with outside shareholders. The carve-out of this business gives rise to numerous practical problems, and potentially more serious legal and contractual ones, such as with regard to existing government engagements, membership of government ‘panels’, and the handling of government client files.
For instance, if a government client has contracted with PwC, and PwC is now withdrawing from that service area, and Scyne intends to take over that service area, can Scyne have access to historical files and other information?
Carving out Scyne will inevitably involve decisions like this, and there is a case for a suitable public sector oversight body, such as the Australian National Audit Office, to observe in real time the unwinding of contracts and the treatment of confidential information.
Head four: Substitute and competitor
In providing services (such as policy advice, policy development and project management services) that have traditionally been delivered by the public sector, the Big Four have become in some respects competitors to and substitutes for some functions of government.
In Australia, the scale of outsourcing of services to the Big Four is very large, and there have been calls during the PwC scandal to return those services to the public sector. The suggestion has even been made that the federal government should ‘nationalise’ the public-sector-related functions of one or more Big Four firms. (There have been similar calls in the UK.)
The Big Four compete with government departments and other government agencies in other ways as well. They are engaged in a competition for influence. Ministers and senior officials have looked to major consulting firms in the past as an alternative source of informal counsel.
The substitutability of Big Four activities for certain public sector functions is a further complication. It is also a potential source of conflicting interests, such as when the firms might recommend in an advisory report that public functions should be outsourced.
Head five: Opponent and counterparty
As well as standing alongside public sector clients as trusted advisors, the Big Four sometimes sit on the opposite side of the table, advising corporates and other entities in conflict with government and, sometimes, in conflict with the public interest.
Take for example tax avoidance or advice to cigarette manufacturers and other heavily regulated industries.
The Big Four dominate the global tax-avoidance industry with their services estimated to cost taxpayers more than US$1 trillion per year in lost revenue.
The firms have had their share of tax scandals. In 2005, the US Department of Justice accused KPMG of marketing tax shelters that were ‘abusive’ and ‘fraudulent’. In 2013, a British parliamentary committee report described the tax authorities as fighting an unwinnable battle against the Big Four’s provision of sophisticated avoidance advice.
Head six: Integrity quicksand and landmine
In numerous ways the Big Four are sources of integrity risk for governments and public sector agencies. Risks arise from political donations and from the recruitment of former ministers and senior officials into senior Big Four roles.
Problems with ‘revolving door’ personnel movements between government and the Big Four have previously been identified in the UK and Europe, and the issue was also prominent in the PwC scandal in Australia. There also have been calls for an end to Big Four political donations. PwC Australia pledged that it would no longer make donations to any political parties.
Head seven: Weaver of the neoliberal ether
This role for the Big Four is somewhat more abstract than the others and more pervasive. During the peak decades of neoliberalism, the Big Four have been champions and extenders of that pattern. Their consulting toolkit, along with their general advice and advocacy, has helped perpetuate neo-liberal ideas and expand the scope of their application, such as into social services and environmental policy.
Standard neoliberal tools in the Big Four kit include asset valuation methods, ‘cost of capital’ concepts, risk management tools, project management tools and market-based instruments, all of which have helped maintain the dominant position of neoliberal ideas in public policy – even though several of the tools rest on fragile or contentious theoretical and empirical foundations.
To borrow a term from finance, the Big Four have been able to ‘arbitrage’ across and between their respective service lines. The phenomenon of arbitrage involves exploiting differences across separate markets, such as by buying an asset in one market and selling it for a premium in another.
The Big Four have engaged in reputational and branding arbitrage between auditing, advisory and tax services. Auditing gives their brands an aura of integrity and the firms have exploited that aura in other, non-audit fields.
They have also engaged in informational arbitrage across their different relationships with government, such as between their relationships as advisors and their relationships as competitors and counterparties.
In the UK and elsewhere, the firms have seconded consultants to tax authorities, to provide advice on tax law changes. The consultants have advised corporate clients on the same changes. Such relationships have been described as ‘poacher, turned gamekeeper, turned poacher again’.
Through this arbitrage strategy, the Big Four have successfully monetised gaps in public sector regulation and oversight of their conduct. The benefits from reputational and informational arbitrage seem to be significant drivers of the firms’ overall diversification strategy.
The Big Four have grown large and profitable by walking all sides of the street in their relationships with governments. As a result, conflicts of interest loom large.
The 2018 book ‘The Big Four’ (Ian Gow and Stuart Kells) warned that, by 2023 or thereabouts, the regulatory, technological, cultural and commercial tensions facing the Big Four would necessitate radical changes in how they are structured and how they operate. Today, the tensions have predictably intensified, and the firms are more or less on schedule.
The firms’ diversified, multi-dimensional ‘arbitrage’ strategy is no longer viable. One reason is there exists a new culture of institutional openness, and there are new technologies enabling that culture.
A wave of transparency has swept through hitherto dark places such as navy ships, locker rooms, casting couches and the offices of tax advisors. Arms-length commercial functions that depend on secrecy are increasingly untenable.
For other reasons, too, the diversified model has an impending use-by date. Governments and regulators around the world have increased their scrutiny of the Big Four. A natural next step will be to require the Big Four to unwind their highly diversified mega-partnerships.
The identified conflicts of interest in Australia have escalated to become an existential moment for the Australian PwC partnership.
In recent years, regulators have baulked at the idea of the Big Four turning into the Big Three or fewer. Those scenarios, regulators have feared, would have systemic consequences for corporate governance and potentially for the financial system and the wider economy.
Those fears were misplaced.
All of the Big Four service lines have substitutes, and indeed most of them are subject to significant competitive pressure, including from innovations such as AI and ‘audit bots’.
The Big Four have successfully positioned themselves as seemingly indispensable, but in reality they are certainly not ‘too big to fail’.
Stuart Kells is Adjunct Professor at La Trobe University’s College of Arts, Social Sciences and Commerce, and Honorary Senior Fellow in Federation University’s Collaborative Research Centre in Australian History. He was formerly a research fellow at the University of Melbourne’s Melbourne Institute, and a member of Monash University’s Centre for Regulatory Studies. His numerous books and shorter works have been published around the world.
Originally published under Creative Commons by 360info™.