Rochester Institute of Technology
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Articles
2011
Second-tier auditing firms: Developments and
prospects
Ashok Robin
Mithu Dey
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ACCOUNTING
&
AUDITING
auditing
Second-TierAuditing Firms:
Developments and Prospects
By R. Mithu Dey, and Ashok Robin
T
he Government Accountability Office (GAO) offers mixed
signals in its studies of the auditing market. On one hand,
it finds no evidence that concentration has affected audit
quality or audit fees; on the other, the GAO, citing "data
limitations," acknowledges it is unable to conclude that the
auditing market is competitive. (See a 2008 GAO report,
"Audits of Public Companies: Continued Concentration in Audit
Market for Large Public Companies Does Not Call for Immediate
Actio1;1," www.gao.gov/new.itemsld08163.pdf. For a succinct summary, see Robert Bloom and David Schirm, "An Analysis of the
32
GAO Study on Audit Market Concentration," The CPA
April 2008.)
Today, the concern remains: The Big Four audit n
80% of SEC-listed 'firms and capture more than 90% of i
paid by these finns. Evidence of increased competition
the emergence, in recent years, of a thriving cCihort 0:
tier auditing firms. It is widely acknowledged that the j
four firms are contained within this category: BDO :
Crowe Horwath, Grant Thornton, and McGladrey & Pull
finns have broken ahead of the pack of smaller audit
JUNE 2011 / THE CPA,
and continue to chip away at Big Four
dominance, and one day may emerge as
alternative sources of auditing services even
for large publicly traded companies. The
growth achieved by these second-tier fums
is evident in summary information contained in the annual Public Accounting
Report's 2008 Top 100 list, published by
CCH. These reports and other databases
such as Audit Analytics make it possible
to paint a detailed picture about changing
client growth, productivity, and strategy,
and also offer an opportunity to compare
the four firms contained within this important audit fum category.
The increasin'g attention placed on the second tier resulted from the demise of Arthur
An~ in 2002, which left only four large
auditing finns. There is potential for a wide
variety of problems because of this consolidation. First, audit quality may be jeopardized; although not supported by their
analyses, this appears to be an important concern in GAO reports (e.g., www.gao.gov
/new.items/d08163.pdf). Second, audit costs
may increase. 'This is a widely feared consequence of consolidation and has been confirmed by various academic studies and by
data presented in this article. Third, a failure of any of the Big Four fums could unsettle financial markets more than the Andersen
collapse. All three concerns would be sufficiently alleviated if a vibrant second-tier market emerges and if several second-tier fums
actively compete with the Big Four.
Accordingly, various constituents have
indicated a desire for increased market penetration by the second tier. The sentiments
expressed in GAO reports are echoed in a
report issued in 2008 by the U.S. Treasury's
Advisory Committee on the Auditing
Profession (www.treasury.gov/presscenter/press-releases/Pageslhp lI58.aspx).
Firms and stock exchanges too have made
public their concerns about concentration and
hopes for the viability of the second tier
(for example, see Glenn W. Tyranski,
"Concentration and Competition in the
Auditing Profession" The CPA Journal,
October 2(08).
Finns in the Second Tier
All four finns in the second tier have long
histories of at least 50 years, but have
evolved in different ways. Grant Thornton
started as Alexander Grant & Co. in Chicago
in 1924 and expanded internationally through
partnerships with firms in Europe starting
in the inid·1960s, eventually leading to its
merger with U.K. firm Thornton Baker to
form Grant Thornton in 1980. BOO
Seidman is one of the oldest accounting
furns. Founded in 19m in New York City,
it has mainly domestic operations and has
embarked on a growth strategy since the
1960s. Crowe Horwath was founded in 1942
in South Bend, Indiana, as Crowe Chizek
and changed to its current name only in 2008
EXHIBIT 1
Sf!("olld Tier Sliapshot 01 SliltliS
III
as it cemented its partnership with Horwath
International. Finally, McGladrey was founded in 1926 in Cedar Rapids, Iowa Its growth
was facilitated by two key mergers, one with
Broker Hendrickson & Co in 1978 and
another with AM. Pullen in 1984. Overall,
all four fums acquired their current stature
by growing throl1gh acquisitions (domestic
and international) and through partnerships.
Allliough most second-tier tirms, especially
Grant Thornton, have international operations, the data used in this analysis pertain
only to U.S. operations.
According to information from Public
Accounting Report's 200~ Top 100 list, second-tier finns together pulled in U.S. revenues
of about $3.8 billion (see Exhibit 1). In
comparison, the average Big Four firm
showed U.S. revenues of $7.8 billion; this
underscores the Big Four's dominance over
the second tier. The disparity in revenue also
helps explain why people think of the auditing rnarlret as comprising tiers. Firms in the
two categories, Big Four and second-tier, are
clearly different in terms of scale and scope.
The Big Four and the second tier also diff~
in tenns of productivity. If one measures productivity using revenues per partner or: revenues per professional, the Big Four outperforms the second tier by at least 20%. The
disparity in productivity is probably related to
the marl<et power of the Big Four-their ability to obtain lucrative work from large
clients--and to the economies of scale 'aIis-
lIw LJ S (20031
~r
Grant Thornton
Pertne" Professionals Offices
3,916'
522
52
Revenue
Revenue. Revenue. per Professional.
SEC Clients ($ millions) per Partner Professional per Partner
$2,289,272
361
1,195
sad5,158
8
307,944
.
2,4n,444
8
345
659
BOO'Seidman
266
2,140
37
Crowe Horwath
McGladrey
&Pullen
143
728
1,606
5,400
23
100
107
159
493
1,468
3,444,755
2,015,934
306,725
271,778
11
7
Total Second Tier
. Second Tier
Average
1,659
13,062
212
972
3,814
10,227,405
1,191,605
8
415
3,266
53
243
954
2,556,851
297,901
8
Big Four Average
2,235
21,898
89
1,280
7,782
3,462,419
357,643
10'
:'
"
Source: "Public Accounting Report's 2008 Top 100" (August 31,2008), published by CCH Inc. Notes: All values reflect U.S. opera~(ms
only; Revenues ani from public as well as private clients and contain fees for providing audit, tax, and consulting/other services.
~'
JUNE 2011 / THE CPA JOURNAL
,~,,~
"">'~
33
ing from serving large clients. But there is a
contrarian viewpoint concerning revenue per
partner: Petbaps the second tier competes by
providing more resources per audit For example, the second tier appears to deploy more
partners per clien~ engagement. The average
professional-to-partner ratio of the second tier
is significantly lower (second tier 8-to-l, Big
Four 100to-l).
While the second tier, as a category, dif·
fers from the Big Four, fums in the second tier show within-group disparity in
scale and produc~vity. Among the secondtier firms, McGladrey ($1.5 billion) and
Grant Thornton ($1.2 billion) have the
largest revenues. These ranks are preserved
when one considers the number of
offices, partners, and professionals. But if
one focuses on SEC clients, the firms
with the largest number are Grant Thornton
(361) and BOO Seidman (345). If pro·
ductivity is measured in terms of revenue
per partner, Crowe dominates ($3.4 million per partner); if instead revenue per professional is the productivity metric, Grant
Thornton, BOO Seidman, and Crowe are
roughly equal (approximately $0.3 mil·
lion per professional). Thus, second-tier
rums differ in terms of their scale, SEC
market penetration, and productivity.
Overall, considering all aspects including
scale, SEC clients, and productivity,
Grant Thornton appears to be somewhat of
a dominant firm in this category.
investors. Therefore, it is not swprising
the auditing market for public firms (
clients) is often perceived as more impo
than the auditing market for private f
(non-8EC clients). How has this mark~
SEC clients changed over time, and
have second-tier fIrms performed in
important market? What changes OCCl
immediately following passage of
SaIbanes-Oxley Act of 2002 (SOX)? ,
The Second Tier and Revenue
changes occurred more recently as the
from SEC Clients
ket for auditing services has evo:
Investors of public finns require high-qual- toward a long-term post"SOX equilibri
ity financial information for valuing their The authors report some answers be
investments and for making trading deci- focusing on changes in fee income ani
sions. But because of various types of number of SEC clients.
,agency problems-between shareholders and
SOX, because it increased overall der
managers, ,and between large shareholders for auditing services, has been a fina
and minority shareholders-external boon to auditing firms. In fact, SOX c
investors (shareholders as well as bond- ed a rising tide that benefIted all aud
holders) may not have complete trust in firms. Undeniably, both the Big Four
financial information released by firms. In the second tier showed impressive gro\\
this setting, the attestation by auditors fulfills fees during 2003-2005 (see Exhib
an important role and helps make financial Panel A). During this period, Big Four
information transparent and useful to from SEC clients increased by $3.9 bi
or 40%. Because the Big Four serve
rrugority of SEC clients, the rise in fee
the Big Four is reflective of growth iJ
EXHIBIT 2
overall market; the second tier also grew
SecOIlil Ti(~r V(~ISIIS Biq FOIII SEC eli()lll (J, owth
ing the same period. Although the d
value for fee growth ($303 million) rna:
Second Tier
Big Fou~
be as impressive, the percentage grt
achieved by the second tier was a whOI
A. Fee Growth
163%. Thus. both the Big Four an<
$3,933,431,467
$302,547,635
2005 vs. 2003
second tier benefitted in the years imr.
ately following passage of SOX.
Percentage change
31%
163%
Fee growth tabulated for the period
$3,739,381,419
2008 vs. 2003
$339,904,776
2003 to 2008 provides evidence 0'
29%
Percent~ge change
183%
.longer time period. Because of some i
bility hlthe data for 2008 (as A
2008 vs. 2005
$31,357,141
1$194,050,048)
Analytics was updated), the authors I
-1%
Percentage change
8%
pared their numbers with other sou
such as Public Accounting Report, for
B. Growth In the Number of SEC Clients
fumation of overall trends. Neverthc
some caution is advised in using the '
2005 vs. 2003
-652
166
numbers. During 2003-2008, the se
Percentage change
-9%
23%
tier and the Big Four show total fee gr
of $340 .million (183%) and $3.7 bi
2008 vs. 2003
111
-2,041
(29%) respectively. These valuel
-27%
Percentage change
15%
quite comparable to the value!
';1,389
-55
2008 vs. 2005
2003-2005 and offer a similar concll
of
growth in both the Big Four and the
Percentage change
-6%
-20%
ond tier. Additionally, note that since :
the Big Four have essentially had
Source: Audit Analytics Audit Fee. database for 'appropriate fiscal years.
growth while the second tier (rrms
Notes: Data pertains to public clients only. Fees contain all fees paid to primary
continued
to grow. This indicates thf
auditor including audit, tax, cons~lting, and other services.
long-term trend is one of continuing gI
..-.
34
JUNE 2011 / THE CPA JOUI
rprising that
firms (SEC
re important
rivate fInns
; market for
e, and how
med ~n this
;es occurred
,age of the
OX)? What
as the marlS evolved
~uilibrium?
vers below,
lme and the
:raIl demand
. a fmancial
SOX creatall auditing
19 Four and
vegrowthin
Exhibit 2,
ig Four fees
$3.9 billion,
lr serve the
e in fees for
uwth in the
so grewdurb. the dollar
on)maynot
age growth
a whopping
Jur and the
ars immediC.
period from
mce over a
some insta(as Audit
Ilthors cornIer sources,
ort, for con'evertheless,
ng the 2008
the second
1fee growth
$3.7 billion
values are
values for
~ conclusion
and the sec:since 2005,
ly had zero
fmms have
ates that the
luing growth
'A JOURNAL
in the second tier and perhaps a closing
of the gap between the two tiers.
Why Is the Second Tier Gaining .
SEC Clients?
When considering revenues from SEC
clients in the post-SOX era, both the Big
Fout and the second tier have made revenue
gains and the second tier has shown greater
growth in revenueS since 2005. This result
calls for further exploration.
SEC client statistics (see Exhibit 2, Panel
B) provide a stronger case than revenue
statistics concerning the strength of the
second tier. During 2003-2005, while the
second tier shows an increase of 166 (23%)
ih the number of SEC clients, the Big Four
count actually decreases by 652 (-9%).
Both categories showed declines during
20051...2008 as the well-known post-SOX
phenomenon or' finns going private/dark
, unfolded, but the overall period 2003-2008
'
strongly indicates strength for the second
tier: While the Big Four lost 2,041 clients clients veered toward the second tier. There
during the 2003-2008 period, the second are also indications that the increased fees in
tier added III clients.
the aftermath of SOX encouraged firms that
What are the reasons behind the increas- traditionally looked to engage Big Four audiing market share for the second tier and the tors to also consider second-tier auditors.
decreasing market share for the Big Four?
Second-tier firms appear to have increased
Although mentioned above, it is worth reit- . their value proposition to SEC clients and
erating the impact of Andersen and SOx. are particularly attractive to smaller listed
The former created a supply shock (decrease firms. While large multinational corporations
in supply of auditing services) and the latter continue to seek Big Four auditors, smaller
created a demand 'shock (increase in demand firms increasingly fInd the quality-price ratio
for auditing services). Both effects created of the second tier attractive. There is abunand reinforced market opportunities for the dant anecdotal evidence supporting this
second tier. Some additional forces were also perspective. For example, an article in the
at work. Recent research (Chris Hogan and Long Island Business News provides examRoger Martin, "Risk Shifts in the Market ples of Long Island-based public firms
for Audits: An Examination of Changes in (Aceto Corp., Langer, and Steve and Barry's)
Risk for 'Second Tier' Audit Firms," switching from the Big Four to the second
Auditing: A Journal of Practice & Theory, tier. It identifIes the increased workload of
November 2009) suggests that the Big Four the Big Four following SOX as the reason
jettisoned risky clients--often with restate- for the switches. (Claude Solnik, "First-rate
ments, internal control weakness,'or disclo- Growth Across Accounting's 'Second Tier,'"
sure control weakness-and some of these January 19, 2007).
Grant Thornton
$85,783,966
$146,470,197
Crowe Horwath
198%
$23,740,802
$74,934,114
$124,298,234
166%
$111,762,633
149%
. ($12,535,601)
$11,724,314
$12,198,873
104%
$22,242,780
190%
$10,043,907
10%
-6%
42%
171%
$170,210,999
334
51
15%
18
5%
-33
-9%
JUNEt20no/'<'tHE CPA JOURNAL
BDO Seidman
222
86
39%
15
7%
-71
-23%
91
2
2%
20
22%
,18
McGIBdrey & Pullen
$13,076,039
$19/580,331
150%
$35,688/364
273%
$16,f08,033
. 49%
72
27
38%
58
81%
27
35
,
Second-tier finns also appear to be differentiating their product Based on evidence presented earlier, they appear to be deploying
more partners compared to the Big FoW". The
turbulence in the reporting world in the
aftennath of SOX (when issues concerning
reporting weaknesses rose to the fore), as well
as the capacity constraints faced by the Big
FoW". allowed the second tier to carve themselves a niche among SEC clients. The perception of a differentiated product \nvolving
the greater deployment of partners is captured
by the tagline "the partners are already on it"
in a recent BOO commercial.
The phenomenon of clients switching
from the Big Four to the second tier is
not without controversy. If the new
clients of the second tier are predominantly firms undergoing accounting trouble, it
would subject these auditors to increased
litigation risk. But research indicates that
while risky clients flow from the Big
Four to the second tier, there is a somewhat offsetting flow of risky clients from
the second tier to smaller auditing fums.
Nevertheless, it is clear that the second-tier
fums need to address client portfolio risk
as they increase their market share.
Differential Growth and Productivity
While the second-tier category overall has
shown impressive growth relative to SEC
clients, are there particular fums within the
category participating more in this groWth?
Comparing fee data for the foW" second-tier
firms can help answer this question. At the
start of 2003, Grant Thornton and BOO
Seidman were roughly similar in terms of
fees from SEC clients, at $86 million and
$75 million respectively (see Exhibit 3, Panel
A). The other two firms, Crowe and
McGladrey, were much smaller players, with
fees of $12 million and $13 million respectively. This disparity between the two pairs
of firms appears to have been preserved at
the'end of oW" time perioo, 2008. By 2008,
Grant Thornton and BOO Seidman had dramatically increased their fees, by $170 million and $112 million respectively. The
dollar increment is not so dramatic for the
two other finns, Crowe and McGladrey, at
$20 million and $37 million respectively.
These figures. indicate that the second tier is
not homogeneous, at least in the scope of
its firms.
One can also assess the second tier in
terms ofgrowth in fees. Over the entire
time period 2003-2008. all firms recorded an exceptional rate of growth i,n fees (at
least 100%). The highest growth rate was
recorded by McGladrey (273%) and the
second-highest was recorded by Grant
Thornton (198%). The performance of
Grant Thornton was particulai'ly impressive, given that it started from a larger base.
But the figures also indicate that
McGladtey is picking up some momentum
and could potentially rival the performance
of Grant Thornton and BDO Seidman in
terms of SEC clients.
The recent focus on the second tier (e.g.,
the 2008 GAO report) was motivated by
the issue of whether firms in this category are emerging as competitors to Big Four
firms. The data on SEC client fee increases indicate that two firms in the second
tier-Grant Thornton and BDO-are possibly emerging as Big Four competitors.
This result is corroborated by SEC client
acquisition data for 2003-2005 (see Exhibit
3, Panel B). During this period, these two
fl!l11S acquired the most clients of the second tier. However, a different picture
emerges when one considers the longer
period 2003-2008. During this period,
McGladrey dominated the other three
fl!l11S, with a net growth of 58 clients (an
increase of 81 %). If McGladrey maintains
this momentum, it is likely to join Grant
Thornton and BDO Seidman in challenging the Big Four.
.
In addition to fees and the number of
clients, it is also interesting to consider how
the productivity of the second tier (fees per
partner and fees per professional) has
evolved over time (see Exhibit 4).
Overall, the Big Four continues to dominate the· second tier, although the differences have diminished somewhat over
time. Considering fees per partner, all
second-tier ftrms, except Crowe, offer a
similar proftle, exceeding $1 million in
2003, then nearly doubling in 2008. Crowe
earned almost $3.5 million per partner in
2008, a value similar to the Big Four. Fees
per profe
able mea
four firn.
the SecOl
ly $300,(
Dlfferel11
·The a~
in tenns
publiclpri
industry e
ied fer B
to start. 1
client siz
studied,
standing
Audit
means to
To build
ing firm
resource!
(people)
infrastrt
resources
or be orl
finnmus
beforem
cost can
types of
SIC £ci
13
28
Grant Thornton
8D,0 Seldmin
Crowe Horwath
McGladrey & Pullen
$1,256,228
$1,848,739
tJ.,477,444
tJ.,377,885
$3,036,667
$3,444,755
$1,164,659
$1,459,161
tJ.,015,934
Big Four Averige
A. Revenues per Partner
2003
2005
2008
$1,282,051
$1,764,128
tJ.,289,272
$2,193,814
$2,611,949
$3,462,419
B. Revenues per Profeuional
2003
2005
2008
$193,611
tJ.52,550
$305,158
60
tJ.87,225
tJ.94,314
$307;944
tJ.53,901
tJ.75,019
$306,725
tJ.14,259
$235,987
$271,778
tJ.91,759
$321,519
$357,643
Source: "Public Accounting Reports Top 100" for 2003, 2005, and 2008 published by CCH Inc.
Notes: Revenues are from public as well as private clients and contain fees for providing audit, tax, and consultinQlother services.
36
35
36
37
38
JUNE 2011/ THE CPA JOURNAL
63
67
73
Source
seeon
JUNE 201
d tier (e.g.,
Itivated by
lis categoJ Big Four
~ increashe second
-are posImpetitors.
mc client
lee Exhibit
these two
of the secnt picture
the longer
.is period,
ther three
clients (an
maintains
join Grant
I challengrlUmber of
nsiderhow
:r (fees per
lonal) has
:hibit 4).
s to domithe differwhat over
artner, all
fe, offer a
million in
108. Crowe
partner in
Four. Fees
per professional, arguably a more reasonable measure of productivity, show that all
four fInns are roughly the same. In 2008,
the second-tier fInns eamed approximately $300,000 each per professional.
Differential Client Strategy
'The authors also examined client strategy
in tenus of industry expertise, location, and
publiclprivate clients. Of these topics, the first,
industry expertise, has been t".xtensively studied for Big Four firms, so it is a good place
to start. The other two aspects, location and
client size/status strategies, are not as well
studied, but they are important in understanding the evolution of the second tier.
Audit fInns use industry expertise as a
means to grow and maintain market share.
To build expertise in an industry, an auditing firm must invest resources. These
resources are principally human 'resources
(people) but they may also be physical
infrastructure (offices). Both types of
resourCes may either be acquired in markets
6rbe organically developed. The auditing
fum must calculate the cost-benefit tradeoff
before making these investments. While the
cost can be substantial, there are various
types of benefits. First, industry expertise
allows the fum to deliver a higher quality
product. Second, as expertise increases, costs
decrease due to efficiency as well as
acquisition of new clients. Third, industry
expertise ups the ante and provides a barrier against competition. '
Infonnation from Audit Analytics can
help differentiate the industry expertise
strategies of the fInns in the second tier
(see Exhibit 5). The first step was to identify all (two-digit) industries in which f1nns
have more than five clients. This helps produce a list of "significant industries" or
"industries of interest" for each finn and
helps c;ompare the scope and diversifIcation of the four firms. Grant Thornton
and BOO, because of their greater market
share among SEC clients, produce a list of
II and seven significant industries, respectively. In contrast, Crowe and McGladrey
have a presence in only one and two industries, respectively. These data once again
reinforce the result that the second tier is
not monolithic and that Grant Thornton and
BOO are different from Crowe and
McGladrey.
The next step is to understand the nature
of industries targeted by the second-tier fIrms.
All sec~:md-tier auditors are heavily involved
EXHIBIT 5
r
28
14
~9
19
a particular focus on banks. For Crowe,
banking is the only industry in which it has
more than five SEC clients. It is therefore
noteworthy that Crowe has 52 banks as
clients. McGladrey has 10 banks as clients,
but it also has six investment fIrms as clients.
Grant Thomton and BOO are much more
diversified and have expertise in a host of
industries. But why do all second-tier firms
focus on banks? One possible explanation
for the importance of banking for the second tier is ease of entry; the fragmented
nature and large size of the banking industry might make it easier for smaller auditing fIrms to enter this particular auditing market niche.
The two large second-tier firms, Grant
Thornton and BOO Seidman, also have
expertise in a host of other industries. There
is some overlap, however. Both Grant
Thornton and BOO Seidman have a signifIcant presence in oil and gas, chemicals,
photographic, and business services.
Additionally, Grant Thomton has a presence
in machinery and equipment, electronic, and
utilities. BOO Seidman appears to have
strength in fmancial services because of its
Clielll Indllstry SII aleqy
35
36
37
38
49
58
60
63
87
73
t.l
BOO
Grant
Thornton
Seidman
16
7
Chemicals and Allied Products
9
11
Industrial and Commercial Machinery and Computer Equipment
Electronic
10
22
Transportation Equipment
7
SIC Code Industry
13
Oil and Gas Extraction
j
Ylrage
in the banking industry. Two second-tier
fIrms, Crowe and McGladrey, appear to have
P~otographic,
Clocks
t
14
Electric and Gas
7
Eating and Drinking
Banks
7
21
Crowe
Horwath
McGladrey
& Pullen
.
.....
9
,
8
Insurance Carriers
52
10
6
Holdlngl and Other Investment Firms
Business Services
11
86
29
17
Sauroe: Audit 1m clients as well as their industry affiliation are obtained from Audit Analytics. Notes: Industries in which each
vices.
IIcond·tler: firma has ~ore than five clients are identified. The exhibit lists these industries along with the number of clients.
~,
, JOURNAL
JUNE 2011 / THE CPA JOURNAL
37
focus on insurance in addition to banks
and investment firms. The authors also
obtained information from the websites of
the second-tier finns. Grant 'Thornton lists
the largest number of industries on its
website, consistent with its position as perhaps the leading second-tier finn in terms
of SEC clients. But in general, no pattern
in the industry lists was found. Neither
was there a link: between stated expertise
(found' on a firm's website) and actual expertise (gathered from SEC client lists in Audit
Analytics). It is possible that this lack of a
connection is explained by the fact that the
stated list reflects clients in public as well
as private fInns, while the list compiled
using Audit Analytics only contains public
fInns. An alternate explanation is that the
lists of industries displayed on websites are
aspirational and hence do not correspond
to the actual industries currently serviced by
the finns.
An analysis of client location complements an industry analysis. To understand
whether the second-tier firms were focusing efforts on certain cities, the authors
searChed for client clustering by city. A list
of all cities (along with associated states
and regions) in which flnns had more than
five clients is shown in Exhibit 6). Overall,
the second tier appears to have a presence
in niche regions and states. Regarding
regions, there is a greater presence in the
Southwest, Midwest, and Mid-Atlantic
regions relative to others. Regarding states,
the second tier only has a presence in 13
states. Regarding cities, although the second tier has a presence in key cities such
as Atlanta, Chicago, New York, and San
Francisco, there is also a presence in cer-
tain niche cities such as Tulsa (Grant
Thornton), Grand Rapids (BOO), and
Cleveland (Crowe). The selective geographical presence underscores the fact that
the second tier has only a small market
share in the overall market for auditing.
As a final analysis, the authors considered the public/private strategy of the four
second-tier fIrms. No fIrm obtains more
than 30% of its total revenues from SEC
clients (see Exhibit 7). Thus, the second
tier services primarily private finns. Among
the second tier, the public/private strategy
differs. Grant Thornton and BOO obtain
approximately one-quarter of their revenues
from SEC clients, confirming the results of
our earlier analyses. Crowe and McGladrey
obtain less than 10% of their revenues from
SEC clients. The most telling fact is that
McGladrey has the highest revenue of all
firms (abo
lowest pel
(3%). 'Thu
independel
Given tl:
market sh;
concentratJ
logical to f
mostly sm
tion, cons
exceedinl
Interesting
of McGlae
of billion-d
lier result!
tivity. GraI
ber of bi:
McGladre
Surprising:
nu~ber(4
S~clienl
range fro
(Crowe). J.
Big Four I
er • firms'I
bet:ause of
Region
State
AUditor OffICI
Grant Thornton
BOO Seidman
Southeast
GA
Atlanta
9
9
Southwest
OK
7
Th, Futon
Southwest
OK
Tulsa
Oklahoma City
8
appear to I
Southwest
Dallas
18
10
Houston
13
8
Irvine
6
Midwest
TX
TX
CA
CA
CA
IL
Chicago
Midwest
OH
Cleveland
Midwest
MI
Midwest
MN
Grand Rapids
Minneapolis
Midwest
IL
Oak Brook
Midwest
MI
Southfield
Mid-Atlantic
NJ
Livingston
10
Mid-Atlantic
KY
Louisville
6
Mid-Atlantic
NY
New York
13
Mid-Atlantic
PA
Philadelphia
18
New England
MA
Boston
8
Southwest
West
West
West
CtoWe Horwath
McGladrey & Pullen
, Grant
r
fuatketin~
selves as
Four. The
recent se
I
San Francisco
,7
Los Angeles
-.:
6
10
10
9
8
9
10
10
8
22
9
8
Sour,ee:
Source: Data from Audit Analytics are used to identify locations in which each sec.ond-tier firms has more than five clients. The
exhibit lists these locations along with the number of clients.
38
sons, tbesc
JUNE 2011/ THE CPA JOURNAL
Aee~un
Notes:'
JUNE 2011
lisa (Grant
300), and
:ctive geothe fact that
la11 market
, auditing.
10rs considof the four
'tains more
,from SEC
the second
ms.Among
ate strategy
IDa obtain
eir revenues
le results of
McGladrey
lenues from
fact is that
lenue of all
firms (about $1.5 billion), yet it has the
lowest percentage of SEC client income
(3%). Thus, SEC client strategy appears
independent of audit firm size.
Given that second-tier finns have a small
market share of SEC clients and mostly
concentrate on auditing private firms, it is
logical to assume that their SEC clients are
mostly small 'f1rt11S. To test this assumption, consider SEC clients with assets
exceeding $1 billion (see Exhibit 7).
Interestingly. all firms with the exception
of McGladrey have a signillcant number
of billion-dollar clients. Consistent with earlier results on fees, growth, and productivity, Grant Thornton has the highest number of bilfion-dollar clients (53) and
l\:1cGladrey has the lowest number (13).
Surprisingly, Crowe has the second-largest
n\1Il1ber (47). As a percentage of fees from
SEC clients, fees from billion-dollar clients
tange from 18% (McGtadrey) to 55%
(Crowe). As larger clients migrate from the
lUg fOur to the second tier and as smaller firms get discouraged from listing
Oecause of sox section 404 and other reasons, these percentages should increase.
lb,Future
G'r41nt Thornton and BDO Seidman
appear to have embarked on a high-profile
lnarketing campaign positioning themse es as credible alternatives to the Big
Four. These flnns are also exploiting the
recent sequence of crises (Enron and
WorldCom, backdated stock options, and tional firm that switches from national
subprime lending and the housing bubble) accounting standards to IFRS might attract
by stating that they are different from the the interest of second-tier auditors.
Big Four. The data indicate that at least
Regardless of the effect of IFRS, evithese two second-tier firms and possibly dence gleaned from the post-SOX era indialso McGladrey have starting taking mar- cates the secular rise of the second tier.
ket share from the Big Four. Will this This has many implications. An obvious
change in market share accelerate or stag- one is a more competitive auditing market.
nate once the economy is past the effects Competition has the potential to lower costs
of the recent crises? While the authors have and increase quality. Perhaps the secondno crystal ball, we think that the advent tier firms are too small today to have had
of International Financial Reportin'g a discernible impact on overall cost and
Standards (!FRS) will playa significant quality, but they have the potential to do
role in the not-too-distant future.
so in the future. An important tipping point
Prior to implementation of IFRS, the seems to have been reached and it is no
second tier fllCCS high fixed costs in servi~ longer taboo for public firms to consider
ing global U.S; firms and foreign firms. In second-tier auditors. This psychological
addition to the requisite physical infrastruc- acceptance may tum the tide and lead to
ture (offices in foreign locations), firms must more clients switching to the second tier.
also acquire a knowledge of diverse account- Are the second-tier firms ready to face
ing systems and standards. These fixed costs the challenges that their larger clients bring
serve as a bamer to entry and explain why with them? Can they set up the requisite
the second tier focuses on U.S.-based small infrastructure efficiently? Can they sucpublic firms and large private firms as cessfully deal with the attendant risk of
niche markets. The advent of IFRS has the lawsuits and prosper? Time will tell. 0
potential to change the auditing market.
Although the second tier (and the Big Four
as well) will have to make an investment in R. Mithu Dey, PhD, CPA, is an assistant
generating IFRS capability over a long professor ofaccounting and Ashok Robin,
period of time, because this investment is a PhD, is a professor of finance, both at
sunk cost (auditing firms will have no choice the Saunders College of Business at
in the matter and will have to build IFRS Rochester Institute of Technology,
capability), the second tier might look to Rochester. N. Y. Ashok Robin acknowledges
recoup it using a global rather than a financial support from the Madelon and
national strategy. Hypothetically, a multina- Richard Rosett Chair for Research.
EXHiBIT 7
La!"!,!! 1'11111 SII clll:qy
Pllhl;l:/PIIVdtl~ dllli
c
.P
Fen from SEC
Clients 18
Percentage of
Revenue
Total FilS
frOm SEC
Clie. with
Assets over
$1 Billion
(S millions)
256
21%
66
26%
I
"evenue from
Private Ind
SEC Clilnts
(S millions)
..
G~8At lIbl!lmton
1,195
BUm S,idman
C~owe HOMBth
McGIBdl'8l/ &.,.Pullan
Spuroe: ~. u
ants. The
FilS from
SEC Clients
(S milllonl)
JOURNAL
Number
of SEC
Clients with
Aslets over
$1 Billion
53
~59
187
28%
61
32%
33
493
34
7%
19
55%
47
1,468,
49
3%
9
18%
13
"
.
I'
iic Accounting Report's 2008 Top 100" (August 31, 2008) published by CCH Inc. Total revenue from Public
'Acc~unting Report 2008 and SEC ~lient revenues from Audit Analytics Audit Fee database for 2008.
.
N0t88: BlII1enUa8 81'8 from public as well as private clients and contain fees for providing audit, tax, and consulting/other services.
,
. c.
~
Percentage of
Total Fees
from SEC
Clients with
Assets over
$1 Billion
JUNE 2011/ THE CPA JOURNAL
·o~·
39