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What could the splitting of EY mean for the audit market?

Just as splitting an atom can cause a chain reaction, splitting a Big Four firm might unleash a huge amount of energy into the market.

We’ve known since May that EY is seriously considering separating its audit and consulting businesses. We don’t yet know when the final decision will be made, or exactly what the two new firms will look like, but just as splitting an atom can cause a chain reaction, splitting a Big Four firm might unleash a huge amount of energy into the market.

How other firms react will depend largely on how EY’s split goes, and whether it’s perceived as successful from the point of view of the people that matter most. No, not clients, the partners!

In the short run, both the audit partners and consulting partners will want to know if they’ll make money out of splitting the firm. It’s assumed that the consulting business of EY will move towards an IPO, but how difficult (and costly) the process of disentangling the firms and listing the resulting consulting business might be—and how much will ultimately raised by any IPO—will be monitored closely by other firms. The costs of ringfencing the two separate practices may turn out to be significant, as integrated systems, processes, and support need to be separated and duplicated.

While the audit business of EY is more likely to stay a partnership, in order to vote through the split, both audit and consulting partners will need to be assured they’ll at least be as well off as before. How partners of both parts of the business are compensated from the split will also be a key factor in determining how the split is perceived by partners at other firms. Ultimately, if partners at other firms think they can get a big payday, and EY demonstrates it’s not only possible, but practical to achieve this, it will be very tempting for other firms to follow suit.

Of course, partners have an eye on the longer-term too, and what a split could mean for their remuneration, and becoming a publicly listed company may act as a restraint on pay, as more of the profit has to be shared with outside investors. While share options can provide an incentive, they’re not as certain as money in the bank. Talent at EY below partner level may also have their heads turned if they no longer see a route to the level of pay they may have previously expected as a partner, prompting moves to other consulting firms that retain a partnership model.

If partners at other firms see EY struggling and losing business, that may weigh against the desire for an instant pay-day. It’s possible that EY could lose business if clients prefer to work with an integrated firm (despite the operational separation that would remain between audit and consulting) or if clients are confused and put-off by the branding changes that would result from a split.

“Becoming a publicly listed company may act as a restraint on pay, as more of the profit has to be shared with outside investors.”

However, both parts of EY (and, by extension, the partners) may do better after a split: Audit clients may prefer the independence of a separate, big, international auditor, and the audit firm could now win new work from consulting clients they were previously conflicted out of selling to. Equally, consulting clients may also prefer to work with the new EY consulting firm knowing that doing so would no longer limit their choice of auditor.

The new consulting brand may also be able to shift perceptions away from negative associations with audit and associated scandals, while an IPO may raise significant funds for investment in technology and new assets. If other firms see the new separate elements of EY strengthened as competitors after the split, that may also push the rest of the Big Four into change to remain competitive.

A chain reaction

If one further firm joins EY in splitting in two, there may be a rush for the rest to join as the chain reaction takes hold: It’s harder to make the argument for remaining an integrated firm if you’re the last one standing. And that argument won’t just play out among partners, but also with regulators. Despite the increasing internal separation between audit and advisory work, there continues to be criticism about potential conflicts of interest, and regulators (particularly in the UK) have considered enforcing further separation or an outright ownership split. If EY splits successfully—in terms of maintaining (or even improving) the quality of audits—and if clients support the firm’s move, it will become harder for the rest of the Big Four to argue against any regulator that wants to force them to split up.

Of course, if the Big Four split of their own accord, the regulators’ work will be done for them. This could make things challenging for regulators wishing to push other reforms to the audit market, as the general public may consider the headline issue (conflict of interest) has been solved. That will reduce the political pressure for change. But if a split of the Big Four does indeed improve audits and make clients satisfied, that’s a good problem for regulators to have.

Interested in finding out more about the auditing market at this volatile time? Download our Perceptions of Audit Firms in 2022 report, available from September.