Joint audit series, part 2: How joint audit increases diversity in the audit market

Today, the audit market in Germany is characterised by the dominance of four audit firms, the so-called Big Four: PwC, KPMG, EY and Deloitte. This high market concentration can impair audit quality due to lack of competition. This has become even more clear since the Wirecard case.

At first glance, it may seem that four large market players would be sufficient to ensure market diversity. However, this is not the case due to the particular nature of the audit market: regulations regarding mandatory rotation restrict companies’ choice of auditor, as do laws that prevent a company from being advised and audited by the same firm at the same time. In light of these restrictions, the market can quickly become very narrow, leaving companies with a lack of choice when selecting their auditor.

Consequently, there is a need for a more diversified audit market, in order to increase audit quality. Experience in France has shown that joint audit, which brings the “four-eyes” principle, is an effective instrument to establish new players in the market and achieve an audit market with a high level of competition. Within the context of new planned legislation, joint audits are back on the agenda both in Germany and at EU-level.

Read what a joint audit is in Part 1 of our joint audit series.

In this second article, we look at the issue of market concentration, the consequences for the audit market and companies, and the effect of the introduction of joint audit. 

A brief history of market concentration: Eight becomes four

Since the 1980s, the worldwide audit market has become increasingly concentrated. In only 16 years (between 1986 and 2002) the number of large audit firms decreased from eight to four. After the first major merger in the audit market between PMI (Peat Marwick International) and KMG (Klynveld Main Goerdeler) to form today's KPMG in the mid-1980s, the term Big-Eight emerged. Two more mega-mergers followed, resulting in Ernst & Young and Deloitte. The Big-Eight became the Big-Six, which dominated the audit market for about a decade.

Following the merger of Price Waterhouse with Coopers & Lybrand to form today's PwC in the late 1990s, the Big Five emerged. The collapse of Arthur Andersen in 2002, following the Enron accounting scandal, led to the firm's audit practice being split primarily between Big Five counterparts, Ernst & Young and Deloitte. For 20 years now, the current Big Four has dominated the audit market. Following the Wirecard case, in certain circles, the Big Four are already becoming the Big Three.

Despite political efforts, lack of choice is still a problem today

More than ten years ago, the EU Commission made it clear: an overly-concentrated market harms competition and thus quality of statutory audit. The financial crisis in 2008 and preceding accounting scandals made audit market reform within the EU necessary, because, in the opinion of the EU Commission, auditors were partly responsible for the crisis. In its Green Paper from 2010, the EU Commission explicitly criticised the high concentration of audit firms within the EU. At the conference "Financial Reporting and Auditing: A time for change?" in 2011, the then EU Internal Markets Commissioner, Michel Barnier, called for more choice for audited companies.

In addition to mandatory auditor rotation after a certain number of years, the EU Commission also proposed in its Green Paper the implementation of mandatory joint audit in order to mobilise competition in the audit market. In June 2014, the EU Commission adopted a final - albeit much less ambitious compared to the Green Paper and proposed regulation - EU regulation on statutory auditors, with voluntary joint audit as an incentive, but not as a duty.

Although this reform pointed in the right direction, it did not achieve a diversification of the audit market. This is the conclusion of both the EU Parliament in its report "EU Statutory Audit Reform - Impact on costs, concentration and competition" from 2019 and the current study "Monitoring the Audit Market in Europe" by independent audit information service, Audit Analytics, from the end of 2020.

Joint audit improves competition and resilience in the audit market

Most audit firms (not only the Big Four) also provide advisory services, which now account for most of the Big Four's growth. To ensure that no conflicts of interest arise, there are regulations that prevent a company from being audited and advised by the same firm at the same time.

However, these regulations, which make sense in themselves, have a negative impact on competition. Since the Big Four are often also used as consultants for advisory services by large companies, they are not considered when audit mandates are re-tendered. When a company is coming up to rotation, this can mean only one Big Four firm, and in rare cases none at all, can actually be considered. This is a critical issue, particularly in view of mandatory rotation.

It is extremely important for companies to have a wide choice of auditors to prevent conflicts of interest, which is very challenging in such a narrow market. This will only become possible if challenger audit firms gain access to the market. Through joint audit, challenger firms can organically grow and make the necessary investments in order to be able to audit larger companies.

A reduction in market concentration is also essential to lower the risk of accounting scandals. Thus, the Wirecard case must be taken as an opportunity to fundamentally change the structure of the statutory audit market. Greater transparency and quality can be achieved through increased competition, and then confidence in the audit market can be rebuilt.

Given the high market concentration, the collapse of one of the Big Four would also severely disrupt the market. The lack of choice in the market makes the Big Four "systemically important" players, which makes it difficult for policymakers to appropriately sanction misconduct. This means the introduction of joint audit urgently needs to be considered, as this would enable the entry of further competitors to the audit market.

Joint audit leads to increased innovation and investment

Joint audit is a proven measure to overcome existing barriers to entry to the market for mid-tier audit firms such as Next Six. Joint audits make it easier for new entrants to break into the market for audits of large multinationals, and stimulate competition between a larger number of audit firms.

In addition, improved audit quality can be achieved through the dual control principle. The mutual assessment of the auditors work (cross-reviews) also leads to increased independence of the auditors.

A more diverse market triggers audit innovation among new competitors, and therefore a better response to market needs. In the long term, this would contribute to the provision of sufficient qualified audit firms, and that companies have more choice.

Overall, the introduction of joint audit should provide the momentum to solve a ”chicken-and-egg” problem: the prospect of a more open market allows small and medium-sized audit firms to make investments in their capacities and capabilities, which in turn strengthens competition.

In Germany, France and the EU, joint audit is once again at the top of the reform agenda

With regards to the reduction of market concentration, the EU audit reform in 2014 has not achieved its goals. Although the introduction of mandatory joint audit has not yet been implemented with the FISG, the German legislator will examine again within the framework of FISG II, to what extent joint audit can improve market diversity. This was explicitly anchored in the framework text of the FISG.

Things are also moving at EU level: the EU now wants to make a proposal for the reform of corporate reporting by the end of 2022, in which the topic of joint audit is also on the agenda (EU sees Wirecard as a wake-up call for possible audit reform).

The French supervisory authority for statutory auditors and audit firms, the Haut Conseil du Commissariat aux Comptes (H3C for short), has also spoken out on the EU's plans. In a letter to EU Commissioner Mairead McGuinness, the H3C calls, among other things, for the mandatory introduction of joint audit for certain companies at EU level. H3C argues that mandatory joint audit would help to improve diversity in the market, as demonstrated by the French market.


Three key takeaways to bear in mind:

  1. Joint audit stimulates competition between audit firms. This promotes innovation and leads to a better response to market needs.
  2. Joint audit allows new competitors to access and develop in the audit market for large multinationals.
  3. Joint audit can minimise the risk of market concentration increasing further and the Big Four becoming the Big Three.

Click here for Part 1 of our joint audit series in German.