In today’s Finshots we talk about EY’s plan to initiate one of the biggest breakups in the history of big accounting firms.

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The Story

A few days ago, employees of global audit and advisory giant EY received an email from their CEO Carmine Di Sibio. The mail addressed a rumour. A rumour about a potential breakup of its audit and advisory businesses.

In the email, the CEO remained non-committal, stating that they hadn’t made a decision, yet. But if they did go ahead i.e. if they split their business, it would be an unprecedented event. It would shake up the Big 4 —  Deloitte, PricewaterhouseCoopers, KPMG, and EY — companies that have dominated the accounting, and strategic advisory landscape for decades now. The EY split could change that — the Big 4 could become the Big 3!

So, the big question here is — Why is EY flirting with the idea of a split? Especially when none of its peers seems to be considering it.

Well, let’s go back a couple of decades and see how we got here. In 2001, the world witnessed one of the biggest accounting scandals of all time. The Energy giant Enron inflated revenues and buried bad debts, to project a very rosy picture of the company. But when it became evident that they’d cooked the books, the ship began to sink rather quickly. Alongside Enron, we had another casualty. Their auditor — Arthur Anderson LLP or A-A in short. At the time A-A was one of the biggest accounting firms. It was even part of the big 5. But in the 1990s, they started pushing their advisory business, so much so that they began compromising on the auditing aspect. If they believed a client could bill them for advisory services, they’d go easy on the audits — to build a sweet business relationship.

But when the Enron scandal came to light, people began looking at A-A’s auditing practices. They soon found multiple instances of fraud precipitating at companies including Sunbeam, Waste Management Inc and WorldCom. This shattered A-A’s reputation and they never regained their former glory. In fact, the company gave up its auditing license and filed for bankruptcy soon after.

But here’s the thing — they did hive off their consulting business much before the scandal came to light. They spun it off as a separate entity and it’s called Accenture today. Even Ernst and Young decided to sell their consulting business to Capgemini for $11 Bn.

But once the scandal came to light, everybody began recognising the fact that this separation was perhaps for the best. The US government got in on the act too. They introduced legislation to prevent companies from auditing their client and taking on consulting projects from them while at it.

However once the chatter died down, the likes of EY  decided to build up the consulting business from the ground up once again and this brings us to the second point — “Consulting outperforms the Audit division today and it’s creating friction.”

Take EY for instance.

While the company’s audit arm clocked in revenues worth $13.6 billion last year, its faster-growing advisory sibling generated double the earnings at $26.4 billion. And that’s been a trend since 2012 at least. In the past decade, while the revenues of EY’s audit wing have grown by 27%, the non-audit businesses have registered growth of 93%. So if the split were to happen, EY’s advisory business could start working with biggies like Google, Facebook and Amazon — who right now happen to be clients with the auditing arm.

Just look at Accenture. Their growth, after separating from Arthur Andersen has been phenomenal. They reported almost double the revenue of EY’s advisory wing last year — $51 billion!

But with a mega plan of this sort, there are bound to be some hiccups as well.

You see, this split can’t just be decided on the whims and fancies of the head office. EY actually has to get the nod of approval from  its many subsidiaries and partners across 150 countries in the world. And that could prove to be a little tricky.

Why’s that? Well, for starters, one of the big draws of the Big 4 business is being made “partner”. And EY has 13,000 partners across the globe. Now the tag of being a “partner” comes with a lot of fat perks including a much higher salary, stock options, and even a say in how the business is run. Now imagine for a moment that you’re a partner in the audit wing. You know that a lot of the perks you enjoy may be attributable to the phenomenal growth of the non-audit division. What happens to all of it when the company splits? Maybe your growth slows. And for the younger employees looking to get their hands on the partner tag, it may not even be forthcoming in the future. Talented folks may not stay on.

It’s not just retention that could be a problem but even new recruitment. You see, having an audit, tax, and consulting arm under one big company has so far meant that it’s relatively easy for someone to switch their line of work. But, if this spinoff takes off, it isn’t clear if it’s still possible. So newbies looking to make a career in the Big 4 might just prefer joining EY’s peers instead for the flexibility.

So, all in all, how’s this uncertain design going to pan out? And will the pressure of replicating this clean-up, build on EY’s peers? We’ll have to wait and watch.

Until then…

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