The Biggest Split?
Ernst and Young, one of the Big Four Accounting Firms, employing nearly 3 lakh people from more than 150 countries, has announced a split of its 2 major business arms: Auditing and Consulting, with a view to maximise its reach in both arenas. This will provide a lot of opportunity to EY’s partners, the people, customers and ironically, its competitors. The expansive proposal would divide EY's accountants, who audit businesses like Amazon Inc, Alphabet Inc., etc., from its consulting division, which is expanding more quickly and provides guidance on mergers, tax concerns, and other matters.
This will lead to the establishment of an audit company with $18 billion annual revenue, and a $24 billion consulting arm, where the audit division will still run under the EY brand even though the advisory firm will have new branding. Millions of dollars in cash payouts to audit partners and share awards for consultant partners who depart are anticipated from the newly established consulting unit.
The audit-focused partnership that results from the split will need to demonstrate to regulators that it can withstand upcoming high-stakes litigations. Moreover, EY is currently dealing with multibillion dollar legal claims in Germany and the UK as a result of its allegedly flawed audits of the fintech startup Wirecard AG, and the hospital operator NMC Health PLC. The split may make it possible for EY's consultants to avoid such audit-related lawsuits. The main benefit of the split is that it will be easier for regulators to prevent conflicts of interest, allowing EY to provide non-audit services to its audit clients as well. The federal agencies are pleased with the deal's potential to reduce conflicts of interest between the firm's auditors and consultants.
According to reports, the consultancy firm will file for an IPO with a goal of raising $10 billion by selling a 15% stake. It will further take $17 billion in debt, most of which would go towards paying off the partners at EY's core auditing business.
However, the consulting arm's separation entails practical concerns that include the separation of common resources, whether they be technological or human. Things will become more complicated due to the separation of the company's large and lucrative tax operation, some of which will go to both the divisions.
Besides all the other benefits, the advisory company might also earn an additional $10 billion in consulting fees each year owing to the removal of conflicts that prevent it from working with EY's major audit clients.
It's unclear right now how things stand in India. Non-audit (or consulting) services, according to SRBC & Co. LLP, EY's India audit division, are offered by EY LLP. If so, India has already experienced the division. The separation would provide SRBC & Co. LLP the freedom to audit businesses that the consulting entities' clients own, giving it a chance to grow its clientele. Given that they are all members of Ernst & Young Global Limited, the National Financial Reporting Authority, an independent regulator, has questioned whether these entities in the IL&FS case are indeed distinct from one another. Apprehensively, both the divisions do not reveal any of their transactions with one another. The separation, however, ought to clear up this complication, making life simpler for audit committees, investors, and regulators.
However, this would result in SRBC & Co. LLP suffering from severe losses in terms of reputation, and clout among businesses and decision-makers. It may turn into a bigger version of the same unexciting auditor. Moreover, in the future, it won’t be possible to have the same access to the government, regulators, and company directors. This may make it more challenging for the business to recruit, hire, and retain top talent while giving them a fair remuneration.
The audit and advisory sectors might undergo significant changes as a result of EY's decision. There may be major poaching of top talent from EY by the other firms in the Big 4. This will also help other small financial firms that provide specialised services, and independent auditors to increase their clientele. For some, it might be a value-unlocking activity, but it might also mean more competition for others. The rivalry between firms like BCG and McKinsey will be fiercer. Tax compliance and advisory may face significant challenges. PwC, Deloitte and KPMG have not yet decided on the division of their business, as has been done by Ernst & Young. It seems that PwC is more likely to wait it out, while KPMG and Deloitte may shortly follow EY’s footsteps. It appears that the question is when, not if.
Since Arthur Anderson's collapse in 2002, due to the Enron accounting fraud, which reduced the “Big Five” to “Big Four”, this move has caused the industry's greatest upheaval. However, Accenture, which had been separated from Arthur Andersen and listed in 2001, went through something similar and has grown in value from $6 billion to $183 billion since its initial public offering. Will this structural split alleviate EY's problem by appeasing the federal agencies? Or, will things worsen once it exits the Big Four, losing its long-held title?
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