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Report to Congressional Addressees: 

United States Government Accountability Office: 

GAO: 

January 2008: 

Audits Of Public Companies: 

Continued Concentration in Audit Market for Large Public Companies Does 
Not Call for Immediate Action: 

Public Companies: 

GAO-08-163: 

GAO Highlights: 

Highlights of GAO-08-163, a report to congressional addressees. 

Why GAO Did This Study: 

GAO has prepared this report under the Comptroller General’s authority 
as part of a continued effort to assist Congress in reviewing 
concentration in the market for public company audits. The small number 
of large international accounting firms performing audits of almost all 
large public companies raises interest in potential effects on 
competition and the choices available to large companies needing an 
auditor. This report examines (1) concentration in the market for 
public company audits, (2) the potential for smaller accounting firms’ 
growth to ease market concentration, and (3) proposals that have been 
offered by others for easing concentration and the barriers facing 
smaller firms in expanding their market shares. 

GAO surveyed a random sample of almost 600 large, medium, and small 
public companies on their experiences with their auditors. GAO also 
interviewed the four largest accounting firms and surveyed all other 
U.S. accounting firms that audit at least one public company. GAO also 
developed an econometric model that analyzed the extent to which 
various factors, including concentration and new auditing requirements, 
affected fee levels. To supplement this work, GAO interviewed market 
participants, including public companies, investors, accounting firms, 
academics, and regulators. 

This report makes no recommendations. 

What GAO Found: 

While the small public company audit market is much less concentrated, 
the four largest accounting firms continue to audit almost all large 
public companies. According to GAO’s survey, 82 percent of large public 
companies—the Fortune 1000—saw their choice of auditor as limited to 
three or fewer firms, and about 60 percent viewed competition in their 
audit market as insufficient. Most small public companies reported 
being satisfied with the auditor choices available to them. 

Figure: Percentage of Companies Audited by Four Largest Accounting 
Firms, by Company Size Percentage: (Number of companies): 

This figure is a bar chart showing percentage of companies audited by 
four largest accounting firms, by company size. The X represents 
company revenue. The Y axis represents percentage (number of 
companies). 

2002: <$100 million: 1,606: 44%; 
2006: <$100 million: 794: 22%. 

2002: $100 million-$500 million: 1,190: 90%; 
2006: $100 million-$500 million: 907: 71%. 

2002: >$500 million-$1 billion: 498: 95%; 
2006: >$500 million-$1 billion: 516: 92%. 

2002: >$1 billion: 1,211: 98%; 
2006: >$1 billion: 1,513: 98%. 

[See PDF for image] 

Source: GAO analysis of Audit Analysis data. 

[End of figure] 

Although audit fees rose significantly in recent years, market 
participants attributed these increases to expanding accounting and 
auditing requirements and higher costs for accounting firm personnel. 
GAO’s model also found that factors other than concentration appeared 
to explain audit fee levels. Public company officials generally 
acknowledged that audit quality had increased. Although current 
concentration does not appear to be having a significant adverse 
effect, the loss of another large firm would further reduce large 
companies’ auditor choice and could affect audit fee competitiveness. 

Smaller accounting firms face various challenges in expanding to audit 
more public companies, although most are not interested in these 
clients. As a result, concentration in the audit market for large 
public companies is likely to continue. Large public companies that GAO 
surveyed said that smaller firms lacked the capacity and technical 
expertise they wanted in an auditor. Audit firms that GAO surveyed said 
that adding qualified staff and increasing their name recognition were 
the most significant challenges they faced in expanding their public 
company audit practices. Some have taken steps to increase their 
capacity by joining networks with other firms. 

Academics and business groups have put forth proposals to reduce audit 
market concentration and address challenges facing smaller accounting 
firms, including capping auditors’ liability and creating an office to 
share technical expertise. Market participants raised questions about 
the overall effectiveness, feasibility, and benefit of these proposals, 
and none were widely supported. Given the lack of significant adverse 
effect of concentration in the current environment and that no clear 
consensus exists on how to reduce concentration, no compelling need for 
immediate action appears to exist. 

To view the full product, including the scope and methodology, click on 
[hyperlink, http://www.GAO-08-163]. To view the results of GAO's 
surveys to public companies and accounting firms, click on GAO-08-
164SP. For more information, contact Orice Williams at (202) 512-8678 
or williamso@gao.gov 

[End of section] 

Contents: 

Letter: 

Results in Brief: 

Background: 

With Continued Audit Market Concentration, Large Public Companies See 
Limited Choices, but No Apparent Significant Effect on Fees: 

Midsize and Smaller Firms Face Challenges Auditing Public Companies, 
and Growth in These Firms Is Unlikely to Ease Concentration in the 
Large Public Company Audit Market: 

Proposals for Addressing Concentration and Increasing Market Share for 
Smaller Auditors Have Significant Disadvantages: 

Agency Comments and Our Evaluation: 

Appendix I: Objectives, Scope, and Methodology: 

Appendix II: Other Issues Related to Concentration in the Audit Market: 

Appendix III: Analysis of Auditor Changes: 

Appendix IV: Trends in Audit Costs and Quality: 

Appendix V: Econometric Analysis of the Effect of Industry 
Concentration on Audit Fees: 

Appendix VI: GAO Contacts and Staff Acknowledgments: 

Tables: 

Table 1: Summary of Selected Sarbanes-Oxley Act Provisions Affecting 
Public Companies and Accounting Firms: 

Table 2: Largest, Midsize, and Smaller Accounting Firm Capacity, 2006: 

Table 3: Disposition of Public Company Sample: 

Table 4: Disposition of Accounting Firms Selected for Survey: 

Table 5: Market Shares of Audit Fees by Accounting Firm Size: 

Table 6: Public Companies Changing Accounting Firms, January 2003 to 
June 2007: 

Table 7: Percentage and Number of Changes Public Companies Made in 
Auditors, by Region: 

Table 8: Descriptive Statistics of the Panel Data Set, 2000-2006: 

Table 9: Hirchman-Herfindahl Indexes by Sector, 2000-2006: 

Table 10: Primary Variables in the Econometric Analysis: 

Table 11: Correlation Matrix, GAO Panel Data Set, Select Variables: 

Table 12: Random-Effects and Fixed-Effects Models Explaining Log of 
Fees: 

Table 13: Fixed Models Explaining Log of Fees, by Market Segments, 2001-
2006: 

Figures: 

Figure 1: Significant Mergers of the 1980s and 1990s: 

Figure 2: Public Companies and Their Auditors, 2002 and 2006: 

Figure 3: Hirschman-Herfindahl Indexes for Public Company Market 
Segments Grouped by Company Revenues: 

Figure 4: Percentage of Midsize and Small Companies That Reported 
Having Three or Fewer Choices for Auditor: 

Figure 5: Percentage of Small and Midsize Companies Reporting They Did 
Not Have Enough Choices for Auditor: 

Figure 6: Changes in Auditors among Small and Midsize Public Companies: 

Figure 7: Percentage of Public Companies Indicating That the Level of 
Audit Market Competition Was Sufficient: 

Figure 8: Firms' Challenges in Auditing Large Public Companies: 

Figure 9: IPOs, 2003-2007: 

Figure 10: Midsize and Smaller Firms' Challenges in Auditing Small and 
Midsize Companies: 

Figure 11: 2006 Market Shares of Each of the Largest Firms Compared to 
Other Firms, as Measured by Audit Fees: 

Figure 12: Hirschman-Herfindahl Indexes, 2000-2006: 

Figure 13: Hirschman-Herfindahl Indexes, Markets Segmented by Industry: 

Figure 14: HHI with Simulated Firm Failure or Merger: 

Abbreviations: 

AICPA: American Institute of Certified Public Accountants: 

AMEX: American Stock Exchange: 

CAQ: Center for Audit Quality: 

CEO: chief executive officer: 

CFO: chief financial officer: 

CPA: certified public accountant: 

DOJ: Department of Justice: 

EDGAR: Electronic Data Gathering, Analysis, and Retrieval system: 

EITF: Emerging Issues Task Force: 

FASB: Financial Accounting Standards Board: 

FTC: Federal Trade Commission: 

GAAP: generally accepted accounting principles: 

GAAS: generally accepted auditing standards: 

GLS: generalized least squares: 

HHIL: Hirschman-Herfindahl Index: 

IOSCO: International Organization of Securities Commissions: 

IPO: initial public offering: 

NAICS: North American Industry Classification System: 

NASBA: National Association of State Boards of Accountancy: 

NYSE: New York Stock Exchange: 

OLS: ordinary least squares: 

OTCBB: Over the Counter Bulletin Board: 

PAR: Public Accounting Report: 

PCAOB: Public Company Accounting Oversight Board: 

SEC: Securities and Exchange Commission: 

United States Government Accountability Office: 

Washington, DC 20548: 

January 9, 2008: 

Congressional Addressees: 

Public and investor confidence in the reliability of financial 
reporting is critical to the effective functioning of the U.S. capital 
markets. Federal securities laws require that a company raising capital 
by issuing securities to the public have an independent public 
accountant perform an audit of the company's financial statements to 
provide reasonable assurance about whether the financial statements are 
fairly presented. Since the 1980s, a small number of large U.S. 
accounting firms have traditionally performed audits for the vast 
majority of the public company market (when measured by the share of 
total audit fees collected). Among the clients of these large firms are 
almost all of the largest U.S. companies.[Footnote 1] The small number 
of large accounting firms performing such audits has decreased as a 
result of mergers and the dissolution of one firm, falling from eight 
in the 1980s to four today.[Footnote 2] These four firms--referred to 
here as the largest firms--have thousands of partners, tens of 
thousands of employees, offices located around the world, and each had 
more than one thousand public company audit clients for 2006.[Footnote 
3] The next four largest accounting firms--referred to here as midsize 
firms--operate nationally, and to some extent, internationally but have 
substantially fewer employees and partners, and each had less than 500 
public company audit clients for 2006.[Footnote 4] All other accounting 
firms--referred to here as smaller firms--audit regional and local 
public companies and have fewer than 100 public company 
clients.[Footnote 5] 

With the audit market concentrated among the four largest firms, 
concerns have been raised about the number of choices that companies 
have when selecting an auditor and the extent of competition in the 
market. In 2003, we conducted a study (mandated by the Sarbanes-Oxley 
Act) on consolidation that had occurred in the accounting profession. 
Our study followed the dissolution of one of the then-five largest 
accounting firms, Arthur Andersen. At that time, we found that although 
audits for large public companies were highly concentrated among the 
largest accounting firms, the market for audit services appeared 
competitive according to various indicators.[Footnote 6] Given that 
several years have passed since the dissolution of Arthur Andersen and 
the passage of the Sarbanes-Oxley Act, which introduced reforms to 
public reporting and auditing, this report provides an update on the 
trends in the market for public company audits that we identified in 
2003 in the market for public company audits.[Footnote 7] Among the 
changes affecting the audit market that have occurred since our last 
report are additional requirements for public companies and auditors to 
assess, report on and attest to companies' internal control practices, 
restrictions intended to ensure the accounting firm's independence that 
limit public companies' ability to use their auditors for certain other 
services, and the creation of a new oversight body for accounting 
firms. 

We prepared this report under the Comptroller General's authority to 
conduct evaluations on his own initiative as part of a continued effort 
to assist Congress in reviewing concentration in the market for public 
company audits. Specifically, this report examines (1) the level of 
concentration in the market for public company audits and the impact of 
this concentration, (2) the potential for increased capacity among 
midsize and smaller accounting firms to ease market concentration, and 
(3) proposals that have been offered by others for easing concentration 
in the market for public company audits and the barriers facing midsize 
and smaller firms in expanding their market share for public company 
audits. 

To address these objectives, we collected data and analyzed changes in 
companies' choice of auditors and in audit fees, computed concentration 
ratios and other measures of concentration. We developed an econometric 
model to evaluate how various factors, including the level of market 
concentration, could explain fees that public companies paid to their 
auditors. To obtain the views of public companies and accounting firms 
on audit competition and challenges, we conducted two surveys. First, 
we surveyed a random sample of 595 of more than 6,000 publicly held 
companies, some of which had recently changed auditors.[Footnote 8] Our 
sample included large public companies (those in the Fortune 1000); 
midsize public companies (those outside the Fortune 1000 with market 
capitalizations--the value of the total outstanding shares of stock-- 
above $75 million); and small companies with less than $75 million in 
market capitalization.[Footnote 9] Our response rate for this survey 
was 73 percent.[Footnote 10] Because our survey was based on a random 
sample of the population, it is subject to sampling errors. The likely 
range of these errors for any survey statistics is no greater than plus 
or minus 12 percentage points, unless otherwise noted. In addition, we 
surveyed representatives of all 434 U.S. accounting firms that audited 
at least 1 public company in 2006 and were registered with the Public 
Company Accounting Oversight Board (PCAOB). Our response rate was 58 
percent.[Footnote 11]Results from our survey of accounting firms are 
limited to those midsize and smaller firms with five or more public 
company clients. Instead of surveying the four largest firms, we 
conducted separate structured interviews with representatives from each 
firm to obtain their views on the issues covered in the survey. This 
report does not contain all the results from the surveys, but the 
surveys themselves and a more complete tabulation of the results can be 
viewed at [hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-08-164SP]. 
We also interviewed staff from the Securities and Exchange Commission 
(SEC), PCAOB, Department of Justice (DOJ); academics; private 
consultants; trade associations; accounting firms; public companies; 
and insurance companies. To obtain information about the strengths and 
weaknesses of various proposals that have been offered to address 
concentration and the challenges that midsize and smaller firms face, 
we also held a roundtable discussion on July 10, 2007, involving 18 
market participants, including representatives of accounting firms, 
public companies, investors, academics, and insurers. For more 
information on our scope and methodology, see appendix I. 

We conducted this performance audit in New York City and Washington, 
D.C., from October 2006 to January 2008 in accordance with generally 
accepted government auditing standards. Those standards require that we 
plan and perform the audit to obtain sufficient, appropriate evidence 
to provide a reasonable basis for our findings and conclusions based on 
our audit objectives. We believe that the evidence obtained provides a 
reasonable basis for our findings and conclusions based on our audit 
objectives. 

Results in Brief: 

Although the market for small public company audits has become much 
less concentrated since 2002, the continuing concentration in the 
market for larger public companies limits these companies' auditor 
choices but does not appear to have significantly affected audit fees. 
According to our analysis, the largest accounting firms audit 98 
percent of the more than 1,500 largest public companies--those with 
annual revenues of more than $1 billion. In contrast, midsize and 
smaller firms audit almost 80 percent of the more than 3,600 smallest 
companies--those with annual revenues of less than $100 million. Larger 
public companies we surveyed indicated that the industry expertise and 
technical capability that they sought in an auditor generally meant 
that their choices were limited to the largest accounting firms. 
According to our survey of a random sample drawn from a population of 
more than 6,000 public companies, almost 60 percent of large companies 
indicated that the number of accounting firms from which they could 
choose was not adequate, although some company officials described 
taking steps to ensure that they would have at least one alternative 
firm they could use under the more restrictive auditor independence 
rules. In contrast, about 75 percent of the smallest public companies 
saw their number of auditor choices as sufficient. While audit fees 
have increased significantly in recent years, many market participants 
that we interviewed attributed fee increases to additional audit work 
and expanded accounting and audit requirements and higher costs to 
hire, train, and retain qualified staff. In addition, the econometric 
model we developed to evaluate the relationship between market 
concentration and audit fees indicated that factors other than 
concentration appeared to explain the recent fee increases. The level 
of market concentration also does not appear to be affecting audit 
quality as many of our survey respondents and those we interviewed said 
that audit quality had improved, which some attributed to the Sarbanes- 
Oxley Act. Although the current level of concentration does not appear 
to be having significant adverse effect, public company officials and 
others we interviewed indicated that a merger or the failure of one of 
the largest firms would further reduce companies' auditor choices and 
could potentially result in higher audit fees and fewer choices. The 
various federal organizations that have a role in overseeing activities 
in the audit market, including SEC, PCAOB, and DOJ, are prepared to 
take various actions to help minimize the disruption to the market if 
further concentration occurred. 

The concentration in the large public company audit market is also 
unlikely to be reduced in the near term by midsize and smaller 
accounting firms because a significant majority is not interested in 
auditing large public companies and those that are interested face 
various challenges in expanding their capability to do so. Over 70 
percent of midsize and smaller accounting firms indicated that they 
were not attempting to obtain large public company clients. 
Approximately 90 percent of large public companies we surveyed cited 
lack of capacity as a reason why they would not consider using midsize 
or smaller firms as their auditor. As a result, many of these firms 
would have to greatly expand their staffing and geographic capabilities 
to serve such companies. However, the most frequent impediment to 
expansion cited by accounting firms responding to our survey was 
difficulty finding staff. Smaller firms also saw their lack of name 
recognition and reputation as preventing them from obtaining more large 
public company clients. Other difficulties that some accounting firms 
cited in obtaining more public company clients included limited access 
to capital and difficulty complying with multiple state licensing 
requirements. Some firms have taken steps to address such challenges, 
such as mergers or joining networks. 

Various proposals by academics and business groups have been put forth 
to reduce the risks of current and further audit market concentration 
and the challenges facing midsize and smaller accounting firms, but 
each proposal also has disadvantages. For example, some have suggested 
that requiring one or more of the largest firms to spin off a portion 
of their operations to create more than four firms with the capacity to 
audit large public companies could ease current concentration. However, 
market participants we spoke with raised concerns that splitting up 
these firms could reduce their economies of scale and the depth of 
expertise that currently allow the largest firms to effectively and 
efficiently audit large companies. Some have also put forth proposals 
to reduce the risk of further concentration that could arise if one of 
the largest firms leaves the market as the result of a large litigation 
judgment or a regulatory action. Proposals to reduce this risk include 
placing caps on auditors' liability and having regulators or others 
take enforcement actions only against responsible partners or employees 
rather than the firm as whole. However, some of the academics and 
others we spoke with saw such liability caps and enforcement 
limitations as potentially reducing the incentives for auditors to 
conduct quality work. Other proposals have been offered to help midsize 
and smaller firms expand their market share, thus potentially easing 
concentration. These proposals include allowing outside ownership of 
these firms in order to provide capital to expand their operations, 
creating a group of accounting and auditing experts to provide needed 
expertise to smaller auditing firms, and establishing a professionwide 
accreditation program to help these firms overcome some of the name 
recognition and reputation challenges they face. However, while each 
action could offer benefits, market participants generally saw these 
proposals as having limited effectiveness, feasibility, and benefit. 

In light of limited evidence that the currently concentrated market for 
large public company audits has created significant adverse impact and 
the general lack of any proposals that were clearly seen as effective 
in addressing the risks of concentration or challenges facing smaller 
firms without serious drawbacks, we found no compelling need to take 
action. As a result, this report does not include any recommendations. 
We provided copies of a draft of this report to SEC, DOJ, PCAOB, and 
the Department of the Treasury. SEC, PCAOB, and DOJ provided technical 
comments, which have been incorporated where appropriate. Treasury had 
no comments. 

Background: 

Following the 1929 stock market crash, legislation was passed that 
required companies seeking to raise funds from the public to provide 
audited financial statements to their investors. The Securities Act of 
1933 and the Securities Exchange Act of 1934 established the principle 
of full disclosure, which requires that public companies provide full 
and accurate information to the investing public. Under these federal 
securities laws, public companies are responsible for the preparation 
and content of financial statements that are complete and accurate and 
are presented in conformity with U.S. generally accepted accounting 
principles (GAAP). Financial statements, which disclose a company's 
financial position (balance sheet), stockholders' equity, results of 
operations (income statement), and cash flows, are an essential 
component of the disclosure system on which the U.S. capital and credit 
markets are based. 

Federal securities laws also require that public companies have the 
financial statements they prepare audited by an independent public 
accountant. The independent public accountant's audit is critical to 
the financial reporting process because the audit subjects companies' 
financial statements to scrutiny on behalf of shareholders and 
creditors to whom company management is accountable. The auditor is the 
independent link between management and those who rely on the financial 
statements. The statutory independent audit requirement, in effect, 
grants a franchise to the nation's public accountants, as an audit 
opinion on a public company's financial statements must be secured 
before an issuer of securities can go to market, have the securities 
listed on the nation's stock exchanges, or comply with the reporting 
requirements of the securities laws. 

Having auditors attest to the reliability of financial statements of 
public companies is intended to increase public and investor confidence 
in the fairness of the financial information. Moreover, investors and 
other users of financial statements expect auditors to bring integrity, 
independence, objectivity, and professional competence to the financial 
reporting process and to prevent the issuance of misleading financial 
statements. The resulting sense of confidence in companies' audited 
financial statements, which is key to the efficient functioning of the 
markets for public companies' securities, can exist only if reasonable 
investors perceive auditors as independent and expert professionals who 
will conduct thorough audits. In the event that companies are alleged 
to have misled the public or presented falsified financial information, 
the accounting firms that performed those audits are also sometimes 
included in suits brought by investors or actions pursued by 
regulators. 

Accounting Firm Structure: 

Most accounting firms that audit public companies in the United States 
are organized as partnerships. Unlike corporations, which generally 
issue stock to their shareholders in exchange for capital to conduct 
their operations, accounting firms structured as partnerships obtain 
capital from their partners. To conduct an audit of a public company, 
an accounting firm establishes an engagement team that is typically 
headed by a lead audit partner and includes a concurring audit partner, 
audit staff and managers, and, as needed, technical specialists. The 
lead audit partner has responsibility for decision making on 
significant auditing, accounting, and reporting matters that affect the 
financial statements; reviewing the audit work; and maintaining regular 
contact with management and the audit committee. The concurring audit 
partner is responsible for reviewing the audit.[Footnote 12] 

To provide technical assistance to engagement teams, the larger 
accounting firms have national offices staffed with experts in auditing 
and accounting standards. These national offices are made up of 
accounting and auditing technical specialists who assist engagement 
teams by responding to complex questions, researching answers, and 
providing guidance to individual audit teams. These specialists also 
provide guidance to the entire firm on handling issues that arise 
during the course of audits, including evaluating the fair presentation 
of the financial statements. 

Mergers and the Loss of a Major Firm Have Resulted in a National and 
International Market Dominated by Four Large Firms: 

Although the largest U.S. accounting firms have used mergers and 
acquisitions to help build their businesses and expand nationally and 
internationally since the early part of the twentieth century, in the 
late 1980s the eight largest firms--known as the Big 8--began merging 
with each other. As shown in figure 1, by 2000 various mergers among 
the largest accounting firms had left five large firms that accounted 
for the majority of audit revenues among firms auditing public 
companies. 

Figure 1: Significant Mergers of the 1980s and 1990s: 

This figure is a flowchart illustrating significant mergers of the 
1980s and 1990s. 

[See PDF for image] 

Source: Interviews with the four largest accounting firms and Public 
Accounting Report, 1986-2002. 

[End of figure] 

In 2002, the market consolidated further to 4 large firms after the 
Department of Justice criminally indicted Arthur Andersen on 
obstruction of justice charges stemming from the firm's role as auditor 
of Enron Corporation. The indictment and subsequent conviction of 
Arthur Andersen led to a mass exodus of its partners and staff, as well 
as clients. As a result, the firm was dissolved in 2002.[Footnote 13] 

[See PDF for image] 

[End of figure] 

Statutory Changes Affecting Requirements for Public Companies and Their 
Auditors: 

Public companies and the accounting profession have experienced many 
reporting and auditing changes in recent years. In the aftermath of 
various financial scandals at large public companies such as Enron and 
WorldCom in the early 2000s, new legislation was passed to help restore 
investor confidence in the nation's capital markets.[Footnote 14] The 
Sarbanes-Oxley Act of 2002 (the Act) introduced major reforms to public 
company financial reporting and auditing that were intended to improve 
the accuracy and reliability of financial reporting and enhance 
auditors' independence and audit quality. The reforms include the 
following: 

* Section 404(a) of the Act requires that in each annual financial 
report filed with SEC the management of public companies must (1) state 
its responsibility for establishing and maintaining an adequate 
internal control structure and procedures for financial reporting and 
(2) assess the effectiveness of its internal control structure and 
procedures for financial reporting. 

* Section 404(b) requires that each public company's accounting firm 
must attest to and report on management's assessment of the 
effectiveness of internal control over financial reporting. 

* A separate provision prohibits the company's auditor from providing 
certain nonaudit services, including bookkeeping, appraisal services, 
actuarial services, and internal audit outsourcing services. 

* Another provision requires the mandatory rotation of lead and 
reviewing audit partners after they have provided audit services to a 
particular public company for 5 consecutive years. 

The Act also established the PCAOB as a private-sector nonprofit 
organization subject to SEC oversight. PCAOB's mission is to oversee 
the audits of public companies in order to protect the interests of 
investors and further the public interest in the preparation of 
informative, fair, and independent audit reports. Table 1 shows other 
provisions affecting the corporate governance, auditing, and financial 
reporting of public companies. 

Table 1: Summary of Selected Sarbanes-Oxley Act Provisions Affecting 
Public Companies and Accounting Firms: 

Provision: Section 101: Public Company Accounting Oversight Board; 
Main requirements: Establishes the PCAOB to oversee the audit of public 
companies that are subject to the securities laws. 

Provision: Section 201: Services Outside the Scope of Practice of 
Auditors; 
Main requirements: Registered accounting firms cannot provide certain 
nonaudit services to a public company if the firm also serves as the 
auditor of the financial statements for the public company. Examples of 
prohibited nonaudit services include bookkeeping, appraisal or 
valuation services, internal audit outsourcing services, and management 
functions. 

Provision: Section 301: Public Company Audit Committees; 
Main requirements: Listed company audit committees are responsible for 
the appointment, compensation, and oversight of the registered 
accounting firm, including the resolution of disagreements between the 
registered accounting firm and company management regarding financial 
reporting. Audit committee members must be independent. 

Provision: Section 302: Corporate Responsibility for Financial Reports; 
Main requirements: For each annual and quarterly report filed with SEC, 
the chief executive officer (CEO) and chief financial officer (CFO) 
must certify that they have reviewed the report and, based on their 
knowledge, the report does not contain untrue statements or omissions 
of a material fact resulting in a misleading report and that, based on 
their knowledge, the financial information in the report is presented 
fairly. 

Provision: Section 404: Management Assessment of Internal Controls; 
Main requirements: This section consists of two parts (a and b). First, 
in each annual report filed with SEC, company management must state its 
responsibility for establishing and maintaining an adequate internal 
control structure and procedures for financial reporting, and assess 
the effectiveness of its internal control structure and procedures for 
financial reporting. Second, the registered accounting firm must attest 
to, and report on, management's assessment of the effectiveness of its 
internal control over financial reporting. 

Provision: Section 407: Disclosure of Audit Committee Financial Expert; 
Main requirements: Public companies must disclose in periodic reports 
to SEC whether the audit committee includes at least one member who is 
a financial expert and, if not, the reasons why. 

Source: GAO. 

[End of table] 

The PCAOB has several responsibilities, including: 

* registering public accounting firms that prepare audit reports for 
public companies; 

* establishing auditing, quality control, ethics, independence, and 
other standards relating to the preparation of audit reports for public 
companies; 

* conducting inspections of registered public accounting firms; and: 

* conducting investigations and disciplinary proceedings of registered 
public accounting firms and those associated with such firms. 

Under the Act, SEC was granted oversight and enforcement authority over 
PCAOB and must approve rules proposed by PCAOB for them to become 
effective.[Footnote 15] 

PCAOB is required to annually inspect registered accounting firms that 
provide audit reports for more than 100 issuers and at least 
triennially inspect firms with fewer issuers.[Footnote 16] It conducted 
its first accounting firm inspections during 2003, but these 
inspections were limited in scope and were performed only on the 
largest firms. Since 2004, PCAOB has conducted full scope inspections 
of accounting firms of all sizes. As required in the Sarbanes-Oxley 
Act, PCAOB has issued individual reports to the accounting firms 
explaining issues identified in the inspections and has also issued 
reports covering common observations from their inspection 
process.[Footnote 17] 

The Sarbanes-Oxley Act also mandated that we study (1) the factors 
contributing to the mergers among the largest accounting firms in the 
1980s and 1990s; (2) the implications of consolidation on competition 
and client choice, audit fees, audit quality, and auditor independence; 
(3) the effect of consolidation on capital formation and securities 
markets; and (4) barriers to entry faced by smaller accounting firms in 
competing with the largest firms for large public company audits. In 
2003, we issued our report Public Accounting Firms: Mandated Study on 
Consolidation and Competition (GAO-03-864). We concluded in 2003 that 
the audit market was in the midst of unprecedented change. The market 
had become more highly concentrated, and the largest firms, as well as 
other accounting firms, faced tremendous challenges as they adapted to 
new risks and responsibilities, new independence standards, a new 
business model, and a new oversight structure, among other things. In 
many cases it was unclear what the ultimate outcome of the changes 
would be, and we noted that past findings might not reflect the future 
situation. We also identified several important issues that we believed 
warranted additional attention and study by the appropriate regulatory 
or enforcement agencies, such as the effect of the existing level of 
concentration on audit price and quality. 

Significant Audit and Accounting Standards and Rules Changes Since 
2003: 

Since 2003, significant activity related to management reporting and 
auditing standards has continued to occur. In 2002, 2003, and 2004, SEC 
issued rules and guidance on implementing some of the Sarbanes-Oxley 
Act's provisions. Among these was the requirement that a public 
company's chief executive officer and chief financial officer certify 
in quarterly and annual reports issued after August 29, 2002, that 
their company's financial statements fairly present in material 
respects the company's financial condition (Section 302).[Footnote 18] 
In June 2003, SEC issued final rules to implement Section 404 of the 
Sarbanes-Oxley Act.[Footnote 19] Section 404(a) requires company 
management, in each annual report filed with SEC, to state their 
responsibility for establishing and maintaining an adequate internal 
control structure and procedures for financial reporting and to assess 
the effectiveness of its internal control structure and procedures for 
financial reporting. Section 404(b), which requires the registered 
accounting firm to attest to and report on management's assessment of 
the effectiveness of its internal control over financial reporting was 
implemented later. Public companies whose outstanding stock held by the 
public was valued at $75 million or more--known as accelerated filers-
-were first required to comply with Section 404(a) and (b) for fiscal 
years ending on or after November 15, 2004.[Footnote 20] Public 
companies with stock in public hands valued at less than $75 million-- 
called nonaccelerated filers--were granted several extensions but are 
now expected to comply with these Section 404 requirements over the 
next 2 years--for Section 404(a) in fiscal years ending after December 
15, 2007, and for Section 404(b) in the first annual filing after 
December 15, 2008. 

PCAOB issued its first audit standard on December 17, 2003, which the 
SEC approved on May 14, 2004, and, as of August 2007, has issued a 
total of five audit standards. On July 25, 2007, SEC approved Auditing 
Standard No. 5, An Audit of Internal Control Over Financial Reporting 
That is Integrated with an Audit of Financial Statements, to replace 
Auditing Standard No. 2, An Audit of Internal Control Over Financial 
Reporting Performed in Conjunction with an Audit of Financial 
Statements. According to PCAOB, Auditing Standard No. 2 was more costly 
than expected, and the related effort involved in complying with it 
appeared to be more than was necessary to conduct an effective audit of 
internal controls over financial reporting. Specifically, PCAOB noted 
that auditors were focusing on minutiae that were unlikely to affect 
the financial statements and that audit programs were not tailored to 
small companies. Auditing Standard No. 5, which is expected to address 
some of the cost issues, became effective for audits in fiscal years 
ending on or after November 15, 2007. 

Other accounting and financial reporting standards and requirements 
have been implemented in recent years. Between January 2003 and August 
2007, the Financial Accounting Standards Board (FASB), which issues the 
accounting standards that SEC recognizes as GAAP for public companies, 
issued 11 statements (Nos. 149 through 159) and revised statement 
number 123. These statements cover a range of topics including 
financial instruments, fair value, and pensions. In addition, other 
guidance has been issued by the FASB emerging issues task force (EITF), 
SEC, and other groups. For instance, FASB issued EITF Issue No. 06-6, 
"Debtor's Accounting for a Modification (or Exchange) of Convertible 
Debt Instruments" in November 2006. SEC issued Staff Accounting 
Bulletin Number 108 on September 13, 2006, summarizing the views of the 
staff regarding the process of quantifying financial statement 
misstatements. 

These recent changes to accounting and financial reporting standards 
and guidance add to an already highly complex set of standards and 
rules for public company financial reporting. Currently GAAP consists 
of more than 2,000 separate pronouncements issued in various forms by 
numerous bodies including SEC, FASB, American Institute of Certified 
Public Accountants (AICPA), and others. SEC Chairman Cox has stated 
that "our current system of financial reporting has become 
unnecessarily complex for investors, companies, and the markets 
generally."[Footnote 21] In June 2007, SEC established the SEC Advisory 
Committee on Improvements to Financial Reporting to study the causes of 
complexity and recommend ways to make financial reports clearer and 
more beneficial to investors, reduce costs and unnecessary burdens for 
preparers, and better use advances in technology to enhance all aspects 
of financial reporting. 

With Continued Audit Market Concentration, Large Public Companies See 
Limited Choices, but No Apparent Significant Effect on Fees: 

Despite some reduction since 2002, the overall public company audit 
market has remained highly concentrated. For large public companies, 
the market remains highly concentrated, with the four largest 
accounting firms auditing the financial statements of almost all large 
public companies. However, the audit market for smaller public 
companies has become much less concentrated since 2002. Larger public 
companies indicated that the industry expertise and technical 
capability that they sought in an auditor generally meant that their 
choices were limited to the largest accounting firms in this highly 
concentrated market. Those we spoke to and surveyed had mixed views on 
the extent to which the current level of concentration adversely 
affected choice, audit prices, and audit quality, but most participants 
did not see the current level of concentration as significantly 
affecting these aspects of competition. Although audit fees have 
increased and public companies' opinions of the adequacy of competition 
in the audit market varied, other factors appear to explain the recent 
fee increases. While the current level of concentration does not appear 
to be having significant adverse effect, the loss of another of the 
larger firms would further increase concentration and limit company 
choices and may affect price competition. Regulators overseeing the 
functioning of the audit market could take several actions in response 
to another large audit firm's leaving the market. 

Overall Market for Public Company Audits Remains Highly Concentrated: 

To assess the degree of concentration in a market, we used the 
preferred practice of examining the proportion of each competing 
seller's--in this case accounting firms--share of the overall revenue 
collected. In the case of accounting firms, the revenue measured is the 
total amount of fees these firms collected. Using data from Audit 
Analytics, which collects audit fee information from the filings public 
companies submit to SEC, we found that the largest firms collected 94 
percent of all audit fees paid by public companies in 2006, slightly 
less than the 96 percent they collected in 2002. As a result, the 
overall market continues to represent a tight oligopoly, which is a 
concentrated market in which a small number of firms have large enough 
market share to potentially use their market power, either unilaterally 
or through collusion, to greatly influence price and other business 
practices to their advantage.[Footnote 22] 

A key statistical measure used to assess market concentration and the 
potential for firms to exercise market power is the Hirschman- 
Herfindahl Index (HHI).[Footnote 23] The HHI for a market is calculated 
using the various market shares (in the case of the audit market, 
measured by total audit fees collected) of all the firms competing to 
offer services within that market. In 2006, the HHI for the overall 
market for public company audits was 2,300. According to guidelines 
issued jointly by the Department of Justice (DOJ) and the Federal Trade 
Commission (FTC), an HHI above 1,800 indicates a highly concentrated 
market. Analyzing the audit market by industry and region reveals that 
many industries have similarly highly concentrated audit markets. For 
example, in 2006 the HHI of the audit market in the utilities sector 
was over 3,500. The audit market was also similarly concentrated for 
companies across six major geographic regions of the country.[Footnote 
24] (App. II contains further discussion of overall market 
concentration.) 

In addition to the potential for dominant competitors to use their 
market power to charge uncompetitive prices, highly concentrated 
markets also raise other competitive concerns. For example, firms with 
significant market power have the potential to reduce the quality of 
their products or to cut back on the services they provide because the 
lack of competitive alternatives would limit customers' ability to 
obtain services elsewhere. Similarly, firms that dominate a given 
market may feel less pressure to introduce innovative products and 
services. Finally, a highly concentrated market increases the potential 
for the dominant firms to engage in coordinated actions that can harm 
clients, such as coordinating actions to influence the development of 
standards that raise costs for their customers. However, the presence 
of high market shares does not necessarily mean that anticompetitive 
behavior is occurring. Competition in an oligopoly can also be intense 
and result in a market with competitive prices, innovation, and high- 
quality products. 

Markets with a few large dominant firms can form for natural reasons 
and can also be beneficial. As we reported in 2003, several key factors 
spurred the increased consolidation in the market that resulted from 
the mergers of the eight largest accounting firms in the 1980s and 
1990s.[Footnote 25] For example, as U.S. corporations have increasingly 
expanded into global markets, their need for accounting firms with 
greater global reach also increased. Many public companies have 
developed more complex operations and financial transactions, such as 
the increasing use of derivatives and other financial arrangements, and 
these changes increased the need for auditors with specialized industry-
specific or technical expertise. 

Further, some accounting firms wanted to modernize their operations, 
build their staff capacity, and spread their risk over a broader 
capital base, and large firms can achieve greater economies of scale by 
spreading certain fixed costs, such as staff training, over an expanded 
client base. Therefore, the size of the largest firms may enable them 
to develop sufficient technical expertise and the ability to conduct 
work globally to meet the needs of complex multinational audit clients 
and to do so at a lower cost than could be provided by smaller audit 
firms. Some academic sources have also suggested that the size of the 
largest firms may give them the ability to resist potential pressure 
from large public company clients to reduce or compromise audit 
quality. 

Although Smaller Public Company Market Has Become Less Concentrated, 
Concentration in the Market for Large Companies Persists: 

Although the market is concentrated overall, the degree of market 
concentration, and, thus, the extent to which the largest firms 
dominate, declines with the size of public companies. As shown in 
figure 2, the proportion of large public companies audited by one of 
the largest accounting firms has not changed since 2002. However, the 
proportion of the smallest public companies that used the largest 
auditors fell by half from 2002 to 2006. Specifically, the share of 
public companies with less than $100 million in revenue audited by the 
largest firms decreased from 44 percent to 22 percent over this period. 
As figure 2 shows, smaller accounting firms now serve as auditors for 
many of the companies that had previously used the largest firms. The 
share of companies with revenues between $100 and $500 million that the 
largest firms audited also declined during this period from 90 to 71 
percent. Officials from the largest accounting firms and other market 
participants told us resource constraints in the aftermath of the 
Arthur Andersen collapse and the Sarbanes-Oxley Act led the largest 
firms to resign from auditing some smaller companies or raised their 
audit fees higher than some smaller companies were willing to pay. 

Figure 2: Public Companies and Their Auditors, 2002 and 2006: 

This figure is a bar graph showing public companies and their auditors, 
2002 and 2006. The X axis represents the year, and the Y axis 
represents the percentage. 

2002; 
Smaller firms: 45%; 
Midsize firms: 10%; 
Largest firms: 44%; 
Total companies: 3,617; 
Company revenue: <$100 million. 

2006; 
Smaller firms: 69%; 
Midsize firms: 10%; 
Largest firms: 22%; 
Total companies: 3,643; 
Company revenue: <$100 million. 

2002; 
Smaller firms: 5%; 
Midsize firms: 6%; 
Largest firms: 90%; 
Total companies: 1,329; 
Company revenue: $100 million-$500 million. 

2006; 
Smaller firms: 13%; 
Midsize firms: 16%; 
Largest firms: 71%; 
Total companies: 1,272; 
Company revenue: $100 million-$500 million. 

2002; 
Smaller firms: 3%; 
Midsize firms: 2%; 
Largest firms: 95%; 
Total companies: 522; 
Company revenue: $500 million-$1 billion. 

2006; 
Smaller firms: 2%; 
Midsize firms: 6%; 
Largest firms: 92%; 
Total companies: 522; 
Company revenues: $500 million-$1 billion. 

2002; 
Smaller firms: 1%; 
Midsize firms: 1%; 
Largest firms: 98%; 
Total companies: 1,241; 
Company revenue: >$1 billion. 

2006; 
Smaller firms: 0%; 
Midsize firms: 2%; 
Largest firms: 98%; 
Total companies: 1,544; 
Company revenue: >$1 billion. 

[See PDF for image] 

Source: GAO analysis of Audit Analysis data. 

Note: Totals do not always add to 100 percent due to rounding. 

[End of figure] 

As the share of smaller companies audited by the largest firms has 
declined, concentration in the audit market for these companies has 
eased significantly. By grouping public companies by their revenues and 
calculating HHIs for these groupings, we found that while the audit 
market for larger public companies with revenues greater than $500 
million remained highly concentrated, the market for smaller public 
companies with 500 million in revenue or less had become much less 
concentrated.[Footnote 26] As figure 3 shows, between 2002 and 2006 the 
HHI for the audit market for the smallest public companies--those with 
annual revenues of less than $100 million--declined from a level of 
1,400 to about 800. According to DOJ and FTC guidelines, a market with 
an HHI of less than 1000 is considered to be unconcentrated, and no 
competitor would likely have the ability to exert market power. The 
audit market for public companies with revenues between $100 million 
and $500 million also became less concentrated. The HHI for this market 
fell from a 2002 level indicating high concentration to a 2006 level 
indicating only moderate concentration. 

Figure 3: Hirschman-Herfindahl Indexes for Public Company Market 
Segments Grouped by Company Revenues: 

This figure is a bar graph showing Hirschman-Herfindahl indexes for 
public company market segments grouped by company revenues. The X axis 
represents company size by revenue, and the Y axis represents HHI. 

[See PDF for image] 

Source: GAO analysis of Audit Analysis data. 

[End of figure] 

In Concentrated Market, Some Companies Perceive Limited Auditor Choice: 

Many of the largest public companies--those in the Fortune 1000--told 
us that they generally found the audit firm attributes they sought only 
in the largest accounting firms, and as a result, many of these 
companies saw their number of auditor choices as insufficient. Midsize 
and small companies were generally more likely than large companies to 
report that they had more than three choices. 

Large Public Companies and Auditor Choices: 

In the current concentrated market, large companies perceived their 
choices as limited, in part because these companies generally said, if 
they had to choose a new auditor, they were not likely to use 
accounting firms smaller than the largest firms.[Footnote 27] Our 
survey of the audit committee chairs of almost 600 public companies 
based in the United States showed that 86 percent of large public 
companies in the Fortune 1000 were not likely to use a midsize 
accounting firm and that none were likely to use a smaller accounting 
firm as a new auditor of record.[Footnote 28] In explaining their 
position, these companies most frequently cited the auditor's ability 
to handle the size and complexity of their company's operations as 
being of great or very great importance (92 percent). In addition, 80 
percent cited the auditor's technical capability with accounting 
principles and auditing standards and 67 percent cited the need for 
industry specialization or expertise as of great or very great 
importance as reasons why they would not consider a midsize or smaller 
auditor. Similarly, in interviews and comments on our survey, some 
company officials noted that they chose the largest firms because they 
believed that these firms had the attributes the company needed, while 
midsize and smaller firms did not. For example, the audit committee 
chair of one large company commented that the company would not choose 
a midsize or smaller auditor because the company's industry was very 
complex, and, therefore, the company needed an auditor with specific 
industry experience. The chief financial officer (CFO) of another large 
public company noted that because of the company's size and 
international operations, the largest firms were the only viable 
options. 

The need to comply with independence standards and other factors can 
further limit the number of choices available to large public companies 
for their auditor of record. As required under the Sarbanes-Oxley Act, 
SEC rules, and auditing standards, a company's auditor must be 
independent. Public companies are prohibited from obtaining audits from 
firms that also provide the company with certain nonaudit services, 
including bookkeeping, design and implementation of financial 
information systems, valuation services, and internal audit outsourcing 
services.[Footnote 29] Ninety-six percent of large companies reported 
that they used one of the largest firms for some nonaudit services, 
potentially further reducing the number of choices for their auditor of 
record if they are precluded from using those firms due to independence 
rules. According to our survey data, 27 percent of large public 
companies that had not switched auditors since 2003 reported that the 
independence restrictions on using certain firms were of at least some 
importance in deciding to retain their current auditor, although only 9 
percent listed these restrictions as of great or very great 
importance.[Footnote 30] 

In interviews, officials from a few large public companies indicated 
that they maintained options while remaining in compliance with 
independence requirements by not using at least one of the largest 
firms for prohibited nonaudit services, in some cases by using smaller 
firms for these services. In this way, they hoped to ensure that they 
would have at least one independent firm to choose if they had to 
change auditors. Some interviewees we spoke with suggested that 
companies using only the largest firms for both audit and nonaudit 
services could be unnecessarily limiting their choices because many 
midsize and smaller firms were capable of handling certain nonaudit 
services. 

A few companies may feel constrained in their choice of auditors for 
other reasons. For example, some companies' desire to avoid using a 
competitor's auditor can reduce the number of choices they have, 
according to several industry participants. However, over 90 percent of 
the large companies that responded to our 2003 survey were willing to 
choose a firm as their auditor regardless of whether that firm also 
audited a competitor.[Footnote 31] Further, some market participants 
and regulators noted that in certain industries, large public companies 
may have more limited choices because one or more of the largest firms 
was not very active in those industries. For example, in 2006 one of 
the largest firms held 77 percent of the market for public company 
audits in the agriculture, forestry, fishing, and hunting industry, 
while another of the largest firms had only a 1 percent market 
share.[Footnote 32] 

Consistent with reporting that they were not likely to use midsize and 
smaller audit firms, large companies also indicated that they had a 
limited number of firms to choose from, and many believed that this 
number was generally insufficient. According to our survey, about 80 
percent of large public companies said that they would have three or 
fewer accounting firms (other than their current auditor of record) to 
choose from if they needed to change primary auditors. The proportion 
of large companies that reported having three or fewer choices was 
about the same for both domestic and multinational companies. 
Furthermore, over half (57 percent) of large public companies stated 
that the number of accounting firms that they could choose among was 
not adequate.[Footnote 33] Forty-three percent of large public 
companies that responded to the survey we conducted for our 2003 report 
indicated that they had insufficient choices for an auditor of record. 

Large public companies' preference for the largest audit firms was 
illustrated by the firms these companies choose when they changed 
auditors. Although some public companies maintain their relationships 
with the same audit firm for many years, there were almost 6,000 
changes in auditors between 2003 and 2007. We analyzed data from Audit 
Analytics and found that 102 large companies had changed auditors 
between January 1, 2003, and June 30, 2007.[Footnote 34] Of the 95 
large companies that were previously audited by one of the largest 
firms, 88 (93 percent) of these companies changed from one of the 
largest auditors to another of the largest auditors. Only seven 
switched to a midsize auditor. The remaining seven large companies that 
changed auditors during this period had been previously audited by a 
midsize or smaller auditor, but switched to one of the largest firms. 
(App. III shows more analysis of the data on auditor changes and the 
reasons these companies reported for changing auditors.) 

Midsize and Small Public Companies and Auditor Choices: 

Although many midsize public companies reported that their choice of 
auditors was limited, smaller companies generally reported having more 
choices than larger companies, if they had to change auditors. For 
example, among midsize companies, 59 percent of multinational and 52 
percent of domestic companies reported that their choices were limited 
to three or fewer firms (fig. 4). In contrast, only about one-third (34 
percent) of small companies indicated that they were restricted to 
three or fewer accounting firms and over 40 percent said that they had 
six or more choices. 

Figure 4: Percentage of Midsize and Small Companies That Reported 
Having Three or Fewer Choices for Auditor: 

This figure is a bar graph showing percentage of midsize and small 
companies that reported having three or fewer choices for auditor. The 
X axis represents percentage, and the Y axis represents midsize 
companies. 

[See PDF for image] 

Source: GAO. 

Note: The estimate for small multinational companies is subject to a 
sampling error of +/-16 percentage points. 

[End of figure] 

Based on our survey, midsize and small public companies were more 
likely than large companies to consider using midsize or smaller 
accounting firms if they had to choose a new auditor. About half (51 
percent) of midsize companies would consider using midsize firms and 16 
percent would consider using smaller firms. Further, 74 percent of 
small public companies would consider using smaller firms. 

In addition, compared with large companies, more midsize and small 
companies were satisfied with the number of choices they had for 
possible auditors. As shown in figure 5, about half of midsize and less 
than a fifth of small companies reported that the number of choices 
they had was not enough. 

Figure 5: Percentage of Small and Midsize Companies Reporting They Did 
Not Have Enough Choices for Auditor: 

This figure represents percentage of small and midsize companies 
reporting they did not have enough choices for auditor. The X axis 
represents percentage, and the Y axis represents midsize companies. 

[See PDF for image] 

Source: GAO. 

Note: The estimate for small multinational companies is subject to a 
sampling error of +/-14 percentage points. 

[End of figure] 

However, about 60 percent of midsize multinational companies reported 
that they would have three or fewer choices if they had to change 
auditors and about half said the number of choices was not enough. 

Our analysis also showed that many midsize and small public companies 
have moved to midsize or smaller auditors. Since 2003, over 1,400 
midsize and small companies that had been audited by one of the largest 
firms have changed auditors. Of these, almost 1,100 (about 74 percent) 
engaged midsize or smaller firms as their new auditors and about 360 
(about 25 percent) chose another one of the largest auditors (fig. 6). 
In contrast, only 13 percent of midsize and small companies that left 
midsize auditors and 3 percent of midsize and small companies that left 
smaller auditors subsequently engaged one of the largest firms. 

Figure 6: Changes in Auditors among Small and Midsize Public Companies: 

This figure is a combination bar chart showing changes in auditors 
among small and midsize public companies. 

Midsize and small companies; 
Former auditor by size: Largest: Moved to largest firms: 25%; 
Former auditor by size: Largest: Moved to midsize firms: 34%; 
Former auditor by size: Largest: Moved to smaller firms: 40%; 
Total number of changes: 1,434. 

Midsize and small companies; 
Former auditor by size: Midsize: Moved to largest firms: 13%; 
Former auditor by size: Midsize: Moved to midsize firms: 13%; 
Former auditor by size: Midsize: Moved to smaller firms: 74%; 
Total number of changes: 341. 

Midsize and small companies; 
Former auditor by size: Smaller: Moved to largest firms: 3%; 
Former auditor by size: Smaller: Moved to midsize firms: 4%; 
Former auditor by size: Smaller: Moved to smaller firms: 93%; 
Total number of changes: 2,373. 

[See PDF for image] 

Source: GAO analysis of Audit Analysis data. 

[End of figure] 

Although Opinions on the Impact of Concentration in the Large Public 
Company Market Varied, Other Factors Appeared to Account for Recent Fee 
Increases: 

Opinions varied on the effect of concentration on competition and on 
the sufficiency of competition in the market for public company audits. 
Many of the market participants we interviewed felt that competition 
was quite strong and not significantly affected by concentration. For 
example, representatives of the largest firms told us that they 
competed intensely with each other. Some of the public company 
officials we spoke with also saw the audit market as competitive. For 
example, the audit committee chair of one large public company said 
that although a major competitor was lost when Arthur Andersen 
dissolved, the market had adjusted and was still competitive. However, 
several companies we surveyed commented that, with few firms to choose 
from, the market did not have enough competition. For example, the CFO 
of a midsize company said that consolidation in the market had led to a 
decline of value-added services by auditors and an escalation of audit 
pricing. Another company official that responded to our survey stated 
that the audit market was an oligopoly with little price competition 
and too little concern for service. The CFO for another company 
commented on our survey that something needed to be done to force more 
competition, while a different CFO commented that although more 
competition was desirable, action to break up the largest firms was not 
warranted. 

Based on the results of our survey, 57 percent of public companies 
thought that the level of competition for audit services for their 
company was sufficient. However, while about 70 percent of small 
companies saw the level of competition as adequate, only about 40 
percent of large Fortune 1000 companies shared this view (fig. 7). 
About half of midsize companies saw the level of competition as 
adequate. 

Figure 7: Percentage of Public Companies Indicating That the Level of 
Audit Market Competition Was Sufficient: 

This figure is a bar graph showing percentage of public companies 
indicating that the level of audit market competition was sufficient. 
The X axis represents percentage, and the Y axis represents companies. 

[See PDF for image] 

Note: Of the 6,906 companies in our survey population, 12.6 percent 
were large, 46.5 percent were midsize, and 40.9 percent were small. 

[End of figure] 

Factors Increasing Audit Fees: 

Although highly concentrated markets typically raise concerns about 
price competition, our analysis indicated that other factors appeared 
to explain the increases in audit fees in recent years. Data on audit 
fees paid by public companies show that these fees have increased 
substantially since 2000, a period that included the dissolution of 
Arthur Andersen and the passage of the Sarbanes-Oxley Act. Audit fees 
have risen for companies of all sizes and across industries and 
regions. However, the fee increases, as a percentage of client company 
assets, were most dramatic for smaller companies. Between 2000 and 
2006, median fees as a percent of assets more than quadrupled (a 334 
percent increase) for companies with less than $100 million in revenue, 
more than tripled (a 239 percent increase) for companies with revenue 
between $100 million and $1 billion, and almost tripled (a 190 percent 
increase) for companies with revenue over $1 billion. After these 
increases, median fees were about $111,000 for companies with less than 
$100 million in revenue, $900,000 for companies with revenue between 
$100 million and $1 billion, and $3,156,000 for companies with revenue 
greater than $1 billion. Although audit fees increased significantly on 
average for all sizes of firms, the amount that companies spend on 
audit fees generally remains a small portion of their overall revenues. 

Market participants and others cited various factors that had 
contributed to recent fee increases. The most significant factors that 
staff from the largest firms cited in interviews were the increasing 
complexity of accounting and financial reporting standards and the 
additional requirements of new auditing standards that had increased 
the amount of work involved in audits and the need for technical 
expertise. For example, one of the largest firms noted that the number 
of experts on staff at the firm more than doubled between 2003 and 
2007. Many market participants noted similar factors as impacting fees. 
The largest firms also cited the increased costs of attracting and 
retaining talented staff and specialists. Similarly, midsize and 
smaller firms reported on our survey that the top four factors 
increasing their costs since 2003 were complexity of accounting 
principles and auditing standards, additional requirements of new 
standards, the time and effort necessary to prepare for PCAOB 
inspections, and the costs incurred to hire and train staff. 

In particular, the Sarbanes-Oxley Act, which increased the amount of 
audit work performed at public companies, was frequently cited as one 
of the major factors in the recent fee increases. This legislation 
introduced a number of new requirements for audits of public companies, 
and many market participants told us that the new requirements 
accounted for much of the fee increases since 2002. Representatives 
from some audit firms we spoke to said that section 404 of the act had, 
where implemented, substantially increased their workload and costs for 
implementing new methodologies and staff training. (Section 404 
requires the accounting firm to attest to, and report on, management's 
assessment of the effectiveness of its internal control over financial 
reporting.) In addition, 84 percent of companies reporting that their 
audit fees had increased since 2003 indicated on our survey that the 
audit of internal control over financial reporting was one of the 
reasons for the increase. To date, only larger public companies--which 
SEC calls accelerated filers--have had to comply with the new 
requirements for assessing these internal controls. Smaller public 
companies--those considered nonaccelerated filers--are scheduled to 
fully comply with the new audit requirements in annual filings after 
December 15, 2008, potentially resulting in further increases in these 
companies' audit fees. 

Independence requirements may also have changed the way some firms 
price audits, resulting in rising fees. DOJ officials and others stated 
that audit firms were now less likely to price audits as a loss leader 
in order to sell nonaudit services because of these requirements in the 
Sarbanes-Oxley Act. 

Effects of Concentration on Fee Increases: 

The results of an econometric model we developed to assess the extent 
to which various factors could be influencing audit fees in recent 
years also indicated that factors other than concentration appear to 
explain audit fees.[Footnote 35] Our model analyzes the extent to which 
audit fees paid by public companies appear to be explained by a variety 
of factors that could affect those fees. For example, our model 
included such variables as the concentration within the audit market 
for a particular industry (as measured by HHI), the size of the 
company, whether the company's fiscal year ends during a busy period, 
whether the company completed a Sarbanes-Oxley Section 404 internal 
control audit, the number of times the company changed auditors, and 
other factors that could affect the company's audit fees. Appendix V 
explains our model in detail. 

The results of our model suggested that higher audit market 
concentration across individual industries was not associated with 
higher audit fees. Specifically, our model found that, in general, 
public companies operating in industrial sectors with more concentrated 
audit markets were not paying higher audit fees than companies in 
sectors with less concentrated audit markets. However, for the largest 
companies we found some evidence that audit market concentration within 
an industry did have a very small effect on fees.[Footnote 36] More 
precisely, after isolating the effect of other factors, our model 
results indicated that large companies in industries with audit markets 
that were 10 percent more concentrated than the average industry sector 
(as measured by HHI) paid on average about half a percent more in audit 
fees than other large companies. By comparison, the model results also 
indicated, after controlling for other factors, that companies that 
completed the Sarbanes-Oxley section 404 internal control audit, which 
increased the amount of work done by auditors, paid roughly 45 percent 
more in audit fees than companies that did not complete the internal 
control audit. This finding was consistent with estimates from other 
studies that examined the effect of the implementation of this 
requirement. Although factors other than concentration appeared to 
explain audit fee levels, the available data did not allow us to 
conclude that audit fees were competitive overall or to determine 
whether individual companies were charged competitive fees.[Footnote 
37] 

In addition, the analysis we conducted with our model indicated that 
individual accounting firms appeared to charge higher fees when they 
controlled a large portion of the audit market within a particular 
industry, but this finding did not appear to be the result of 
anticompetitive pricing. Rather, it appeared that these firms may have 
been charging a premium for their industry expertise. We found that the 
price premiums received by accounting firms that collected a large 
share of the revenues from audits conducted within an industry sector 
were similar across all sizes of companies, including those small 
companies that typically have many accounting firms to choose from. 
This suggests that higher fees are more likely the result of these 
firms being able to charge premiums as the result of their industry 
expertise rather than of anticompetitive pricing.[Footnote 38] For 
example, a firm with industry expertise may develop and market audit 
services that are specific to clients in the industry and that provide 
a level of service exceeding that provided by other firms in the same 
industry. If this is the case, the higher fees these firms may charge 
could reflect the specialized service they offer rather than 
anticompetitive pricing. 

Other Potential Effects of Concentration: 

While some market participants expressed concern that concentration in 
the audit market could negatively affect audit quality, others said 
that the quality of audits had improved in recent years. According to 
DOJ and FTC guidance on analyzing market competitiveness, sellers with 
market power may lessen competition on dimensions other than price, 
such as product quality, service, or innovation. However, even in 
highly concentrated markets, including oligopolies, competition among 
sellers may lead to innovation and high-quality products. The effect of 
concentration on audit quality is difficult to measure empirically. 
However, we asked market participants about their views on several 
aspects of audit quality, including the experience and technical 
capability of their accounting firm's partners and staff, the firm's 
ability to efficiently respond to client needs, and its ability and 
willingness to appropriately identify and surface material reporting 
issues in financial reports. Most market participants who commented on 
audit quality in our interviews and many on our survey said that audit 
quality had improved, which some attributed to the Sarbanes-Oxley 
Act.[Footnote 39] However, four others, including some academics, a 
former regulatory official, and an industry consultant with whom we 
spoke, expressed concerns that concentration was affecting the quality 
of audits. For example, one said that that having only four firms in 
the market resulted in low-quality audits that harmed investors. 
Appendix IV provides more information on trends in audit costs and 
quality. 

High concentration may also diminish competition because dominant 
sellers, in this case accounting firms, may be more likely or more able 
to engage in coordinated interaction in ways that can affect auditing 
practices or prices. Some market participants we interviewed expressed 
concern that the prevalence of the largest firms on advisory panels or 
standard-setting bodies enabled them to coordinate actions to influence 
the development of new standards in a way that hampered competition or 
otherwise disadvantaged public company audit clients. However, most 
market participants we spoke to did not express such concerns. 

Further Concentration Could Adversely Affect Audit Fees and Limit 
Choices: 

Although the current level of concentration does not appear to be 
having significant adverse effect, the potential for further 
concentration in the audit market did raise concerns. Further 
concentration could arise as a result of several events. For example, 
audit firms face the risk that civil litigation could result in their 
insolvency or inability to continue operations. Since 1998, audit firms 
may have paid at least ten settlements or awards of $100 million or 
more that have resulted from private litigation.[Footnote 40] In 
addition, a jury recently found BDO Seidman, the sixth-largest 
accounting firm, liable for $521.7 million in damages, although BDO 
Seidman plans to appeal the verdict. Several officials we spoke with 
commented that litigation increases during periods of high market 
volatility. As a result, litigation-related costs to auditors could 
increase in the case of an economic downturn. Officials from the 
largest firms told us that litigation costs have significantly 
increased since 2003. Some officials we interviewed from the largest 
firms and the insurance industry told us that the largest firms do not 
have insurance coverage to protect against the largest claims, both 
because insurance at that level is not available and because of fear 
that having more insurance could induce plaintiffs to seek higher 
awards. However, full information on litigation risk and costs and 
accounting firms' insurance coverage is not publicly available, so we 
could not identify the magnitude of the risk that litigation poses to 
these firms. Some officials we spoke with also suggested that 
litigation could damage a firm's reputation, causing the firm to fail 
if its clients began seeking other firms for their audits. For example, 
according to some academics, Laventhol & Horwath, the seventh-largest 
accounting firm in 1990, declared bankruptcy that year in part due to a 
series of class action lawsuits that resulted in a loss of reputation 
and the firm's inability to attract new work.[Footnote 41] 

Firms also face the risk of failure from federal or state regulatory 
action and criminal prosecution, among other reasons. State Boards of 
Accountancy can revoke accounting firms' licenses to practice in their 
state for violating board rules or for other reasons. Under SEC rules, 
convicted felons shall be suspended from practicing before the SEC, so 
an accounting firm convicted of a felony could not continue to audit 
its SEC-registered clients and would likely fail. Further, an 
indictment for a felony could contribute to a firm's failure if clients 
began leaving in anticipation of a potential conviction. For example, 
many of Arthur Andersen's clients had changed to a different auditor 
even before Arthur Andersen was convicted of obstruction of justice for 
destroying Enron-related documents in 2002. The market for public 
company audits could also become significantly more concentrated if any 
of the existing largest or midsize firms chose to discontinue 
operations for other reasons. Mismanagement of a firm's financial 
obligations could also lead to its bankruptcy. 

As has happened in the past, a merger could also lead to further 
concentration in the market. DOJ and the Federal Trade Commission 
published Horizontal Merger Guidelines for use in determining whether a 
merger is likely substantially to lessen competition. The guidelines 
include steps for assessing whether the merger would significantly 
increase concentration, the potential for any of the firms to exercise 
market power after the merger, and the difficulty of entry into the 
market for new firms. Concerns that DOJ raised about a proposed merger 
of accounting firms in the late 1990s suggest that the agency would be 
less likely to approve any future mergers among the largest accounting 
firms. In 1997, shortly after two of the six largest firms at the time, 
PriceWaterhouse and Coopers & Lybrand, announced their intention to 
merge, two of the other six largest firms, KPMG Peat Marwick and Ernst 
& Young, also announced plans to combine their operations. According to 
the DOJ Antitrust Division's 1999 Annual Report, these two firms 
abandoned their plans to merge after DOJ raised concerns that this 
merger would have "adversely affected competition by reducing the 
already limited number of firms providing auditing services to Fortune 
1000 companies."[Footnote 42] 

The loss of another large accounting firm from the audit market could 
significantly increase the level of concentration. If one of the 
largest firms failed or left the market, concentration would increase 
if many of this firm's public company clients engaged one of the 
remaining three largest audit firms. To illustrate the effect of such 
an event, we simulated the effect of the failure or exit of the 
smallest of the largest firms. To redistribute the clients of this 
firm, we assigned them to other firms in the same proportion as the 
clients of Arthur Andersen were distributed after that firm 
dissolved.[Footnote 43] Under this scenario, the resulting HHI of the 
overall audit market would rise from 2,300 to roughly 3,000, 
substantially above what DOJ considers to be a highly concentrated 
market. The increase in HHI would likely be even greater in the large 
public company market. Higher concentration could increase the risk 
that the remaining large accounting firms would exercise market power 
to raise prices and coordinate their actions among themselves to the 
detriment of their clients. Appendix II contains more information on 
our simulations of the result of the loss of one of the largest firms 
through a failure or a merger. 

Further concentration could have various other negative effects on 
public companies and their investors. While many public companies and 
other market participants indicated that there were enough auditors to 
choose from, further concentration would leave large companies with 
potentially only one or two choices for a new auditor, as our survey 
indicated that 86 percent of large companies would likely only use one 
of the largest auditors if they had to switch auditors. Many 
interviewees said that this would not be enough choices. As in the 
current market, independence rules that prevent companies from using as 
their auditor firms that provide them with certain nonaudit services 
could further limit these choices. Also, companies in specialized 
industries could have fewer choices if some accounting firms do not 
operate in those industries. Many we interviewed also suggested that 
further concentration would reduce competition and potentially increase 
the cost of an audit. 

Further, public company officials stated that changing auditors could 
be costly for the companies involved. According to our survey results, 
44 percent of large companies that had not recently changed auditors 
reported that the burdens of time, effort, and cost were of great or 
very great importance in their decision not to change auditors. In 
addition, only 102 large (Fortune 1000) public company auditor changes 
occurred between January 2003 and June 2007, suggesting that large 
companies preferred to use the same auditor from year to year. If the 
market were further concentrated among three large firms, the affected 
companies would need to change auditors and incur the associated costs. 
Similarly, to the extent the remaining largest firms resigned as 
auditors for smaller clients as they absorbed the failed firm's larger 
clients, these small companies would incur the costs of finding a new 
auditor. Finally, the market disruption caused by a firm failure or 
exit from the market could affect companies' abilities to obtain timely 
audits of their financial statements, reducing the audited financial 
information available to investors. 

Regulators Could Act to Mitigate the Effects of Further Concentration: 

If the number of large accounting firms were to decrease, the 
organizations with oversight responsibility for the public company 
audit market could act to mitigate the effects on the market. The 
organizations that have a role in overseeing aspects of the public 
company audit market include SEC, PCAOB, and DOJ. SEC is responsible 
for protecting investors, maintaining efficient markets, and 
facilitating capital formation and also oversees PCAOB. Similarly, 
PCAOB is responsible for overseeing the auditors of public companies in 
order to protect the interests of investors and further the public 
interest in the preparation of informative, fair, and independent audit 
reports. In the event of the loss of one of the largest firms, the 
agencies' actions could vary according to the facts and circumstances 
of the situation, such as the size of the affected firm, the reason the 
firm left the market, or the degree to which an orderly transition of 
audit services was available. For example, in order to support its 
mission and address temporary market disruptions and difficulties 
companies had in meeting financial reporting deadlines when Arthur 
Andersen was indicted in 2002, SEC issued a number of measures 
providing guidance and regulatory relief to Arthur Andersen's clients. 
This rulemaking provided Arthur Andersen clients with extended 
deadlines to submit audited financial statements and hotline numbers 
for companies and investors to call with questions.[Footnote 44] 
Through the International Organization of Securities Commissions 
(IOSCO), SEC is also working with other securities regulators around 
the world to identify possible actions regulators could consider in 
responding to events affecting the availability of audit services and 
to develop information for regulators to consider in contingency 
planning and crisis management. 

Although it does not have a direct role in addressing the loss of a 
large accounting firm from the market, DOJ would have a role in 
reviewing proposed mergers involving accounting firms. As part of 
ensuring competition in the U.S. economy, the Antitrust Division of DOJ 
is responsible for enforcing antitrust laws. Under DOJ merger 
guidelines, the division would challenge any merger likely to 
substantially lessen competition. DOJ officials explained that action 
on their part would only occur if a merger among current competitors 
was proposed or if an antitrust or criminal case was brought against 
one of the firms. As a result, the division has not been formally 
reviewing trends in the market. When asked whether the Antitrust 
Division might review the competitiveness of the market if one of the 
largest firms exited the market for reasons other than a merger, an 
official stated that the division might analyze the market using 
publicly available information and offer its expertise and advice to 
other regulators. However, the division does not have the authority to 
formally investigate the market or request proprietary information from 
firms or companies in such a situation. 

Midsize and Smaller Firms Face Challenges Auditing Public Companies, 
and Growth in These Firms Is Unlikely to Ease Concentration in the 
Large Public Company Audit Market: 

Growth in the capacity of midsize and smaller audit firms is unlikely 
to reduce concentration in the large company audit market, at least in 
the near term, for two reasons. First, our survey and interviews with 
representatives of these firms suggest that over 70 percent of midsize 
and smaller firms are not interested in expanding their market share by 
adding additional large public company audit clients because they would 
face additional risks and give up existing profitable activities to do 
so. Second, firms that do want to audit large public companies continue 
to face challenges to expanding their public company practices. Chief 
among these challenges are having adequate capacity (e.g., staff and 
geographic coverage) to audit large public companies, acquiring the 
needed technical capability and industry specialization, and developing 
name recognition and a reputation for this kind of work. Similar 
challenges also affect midsize and smaller firms that audit small and 
midsize public companies. Some firms are taking actions to reduce 
certain challenges, such as increasing their geographic reach by 
joining networks and affiliations. But many firms and market 
participants we interviewed also said that the growth of smaller firms 
was unlikely to ease concentration in the market for auditors of large 
public companies. 

Midsize and Smaller Firms Face Several Disincentives and Challenges to 
Entering the Large Public Company Audit Market: 

While most midsize and smaller audit firms expect to grow in the next 
five years, only a small number want to enter or expand their share of 
the large company audit market, in part because they would face 
additional risks and forego currently profitable nonaudit activities to 
do so. According to our survey of the 118 accounting firms with at 
least 5 public company clients, the 4 midsize firms and 79 percent of 
the smaller firms that responded expected to increase the number of 
public companies they audited in the next 5 years.[Footnote 45] 
However, when asked if they would consider expanding their market share 
if they had the opportunity to add acceptable clients, 74 percent of 
both midsize and smaller firms said that they were not interested in 
serving as auditor for additional large public companies.[Footnote 46] 
Some firms and market participants told us that the possibility of 
being sued created a disincentive against entering or expanding in the 
audit market for large companies because the failure of one large 
client could jeopardize the audit firm. Large companies can pose a 
greater financial risk to their auditors than smaller clients. The 
amount shareholders recovered in settlements of class action lawsuits 
against public companies and their auditors tends to increase in 
proportion to the company's market capitalization. Midsize and smaller 
firms also may not be seeking to perform audits of large public 
companies, because they have had new opportunities to provide companies 
of all sizes with nonaudit services, such as consulting, since 2003. 
The Sarbanes-Oxley Act's independence standards prohibit firms from 
providing clients whose financial statements they audit with some of 
the nonaudit services that they were accustomed to providing. As a 
result, many smaller firms have moved into this area. However, 21 
percent of midsize and smaller firms said that they would be willing to 
enter or expand their share of market for auditing large companies, 
given the opportunity and acceptable potential clients, but emphasized 
the challenges they faced in doing so. 

Firm Capacity to Audit Larger Companies: 

According to midsize and smaller firms responding to our survey, their 
capacity to audit large public companies poses the greatest challenge 
to them entering this market and reducing its concentration. According 
to our survey, the firms' capacity is the top reason that large public 
companies give to explain why they would not consider using a midsize 
or smaller firm. Specifically, 92 percent of those companies said that 
the inability of midsize and smaller firms to handle their company's 
size and complexity was of great or very great importance in their 
unwillingness to consider them (fig. 8).[Footnote 47] For example, the 
audit committee chairman of a large technology manufacturing company we 
interviewed said that an auditor smaller than the company's current 
large firm could not audit a business of his company's size. Similarly, 
the audit committee chair for a large automobile manufacturer told us 
that large companies did not consider using midsize firms because those 
firms did not have the number of experienced staff that the firms had. 

Figure 8: Firms' Challenges in Auditing Large Public Companies: 

This figure is a combination of two bar graphs. 

Reasons large public companies are unlikely to use midsize and smaller 
firms; 
Ability to handle size and complexity of company operations: 92%; 
Technical capability with accounting principles and auditing standards: 
80%; 
Industry specialization or expertise: 67%; 
Geographic presence: 66%; 
Reputation or name recognition: 65%; 
Expectations or requirements of share-holders, banks, lenders, or 
underwriters: 54%. 

Reasons midsize and smaller firms interested in auditing large public 
companies cited as impediments to expanding their market share; 
Ability to recruit/retain qualified staff: 58%; 
Complexity of accounting principles and auditing standards: 21%; 
Specialized technical and/or industry expertise: 17%; 
Firm's international reach: 33%; 
Name recognition or reputation with potential clients: 50%; 
Name recognition or credibility with financial markets and investment 
bankers: 54%; 

[See PDF for image] 

Source: GAO. 

[End of figure] 

To meaningfully reduce concentration in the large public company 
market, then, midsize and smaller firms would need to staff audit teams 
that were large enough to serve multiple large public companies. 
However, these firms face challenges recruiting and retaining staff. As 
we reported in 2003, it is not uncommon for an audit of a large 
national or multinational public company to require hundreds of staff, 
and most midsize and smaller firms do not have the staff resources 
necessary to commit hundreds of employees to a single client. As table 
2 illustrates, the largest firms have significantly more capacity, in 
terms of staff and partners than midsize and smaller firms. 

Table 2: Largest, Midsize, and Smaller Accounting Firm Capacity, 2006: 

[See PDF for image] 

Source: Public Accounting Report, 2006-2007. 

[A] Equity partners, including those who do not work on audits. 

[B] Nonequity partners and professionals. 

[C] RSM McGladrey and McGladrey & Pullen are affiliated through an 
alternative practice structure. The number of offices includes those 
for RSM McGladrey, which is a subsidiary of H&R Block and performs tax 
and consulting services and for McGladrey & Pullen, which performs 
audit services. 

[D] Sample of smaller firms that audit at least one public company. 

[End of table] 

To approach the capacity of the largest firms, midsize and smaller 
firms would have to grow substantially. The gap between the largest and 
midsize firms is significant, however. Combined, the four midsize firms 
still have over 2,600 fewer professional staff than the smallest of the 
largest firms, KPMG. The midsize firms also have significantly fewer 
public company clients. But midsize and smaller firms told us that 
obtaining additional staff to expand their audit practices was 
difficult. Specifically, 58 percent of midsize and smaller firms 
responding to our survey that want to audit large public companies said 
that the ability to recruit and retain qualified staff was a great or 
very great impediment to expansion. While the representatives from the 
largest firms told us that they also faced this challenge, one smaller 
firm representative said obtaining sufficient numbers of staff was 
particularly difficult for smaller firms, which have fewer resources 
(salaries and benefits) to use in competing for talent with the largest 
firms, the public companies themselves, and others needing public 
accountants. According to many market participants we interviewed, the 
demand for qualified accountants has increased significantly in recent 
years because accounting firms, including the largest firms, need 
additional staff to conduct the audits of internal controls required in 
section 404 of the Sarbanes-Oxley Act. Firms are not only competing 
with each other for staff, but also with public companies that need 
additional accounting staff to comply with certain requirements of 
Sarbanes-Oxley. In addition, firms are competing with regulators who 
need more staff to oversee the accounting profession. In the face of 
this increased demand, hiring such staff has become more expensive. 

Constraints on midsize and smaller firms' geographic reach also reduced 
the likelihood that the growth of these firms will reduce concentration 
in the large company market. As table 2 shows, midsize and smaller 
firms generally have fewer offices than the largest firms. Accounting 
firm representatives also told us that these firms have a smaller 
presence in foreign countries than the largest firms. According to our 
survey, 66 percent of large companies that would not consider using a 
midsize or smaller firm said that these firms' geographic presence was 
of great or very great importance in explaining their unwillingness to 
do so. Large multinational companies in particular need auditors that 
have a presence in all of the countries in which they operate. While 
many midsize and smaller firms partner with other independent firms to 
expand their geographic reach, a few company officials we interviewed 
said that most of the international networks these firms belong to are 
not extensive enough to meet their companies' needs. In addition, many 
market participants we interviewed were concerned that the quality 
standards, practices, and internal controls of these networks and 
affiliations might be less uniform than those prevailing in the 
international networks of the largest firms. 

Accounting firm representatives we interviewed had mixed views on the 
global capabilities of midsize and smaller firms. In spite of 
companies' views on the importance of firms' abilities to provide 
global services, only one-third of midsize and smaller firms responding 
to our survey that want to audit large public companies said that their 
firms' international reach was a great or very great impediment to 
expansion. For example, one accounting firm official told us that 
midsize firms and affiliations had good global capabilities and global 
operations. However, another accounting firm official told us that the 
global networks used by midsize and smaller firms needed to add 
standardized quality controls in order to improve. 

Technical Capability and Industry Specialization: 

The technical capabilities and specialized industry knowledge of 
midsize and smaller firms that want to enter the large public company 
market can also limit these firms' ability to enter this market and 
reduce its concentration. According to our survey, 80 percent of large 
public companies that would not consider using a midsize or smaller 
firm said that such firms' technical capabilities with accounting 
principles and auditing standards was a great or very great reason why 
they would not do so. One official from a large public company whom we 
interviewed said that accounting firms' technical capabilities 
differentiate the largest and smaller firms and that smaller firms did 
not have the resources to keep up with changing auditing standards and 
increasingly complex accounting rules around the world. Other company 
officials we interviewed also said that technical capabilities were an 
important reason why large and complex companies do not use midsize and 
smaller firms. 

Several representatives of smaller accounting firms also told us that 
their firms had difficulty maintaining their technical capabilities. 
For example, one representative of a smaller firm noted that his firm 
had less depth in terms of technical expertise than larger firms 
especially when it came to complex transactions. Other firms said that 
maintaining technical expertise was time-consuming and costly. Two 
representatives of smaller firms noted that keeping up with new 
standards and guidance from multiple sources was also difficult, 
requiring the firms to revise guidance for their staff as new standards 
were implemented or to purchase costly prepared guidance materials from 
external sources. However, firms see this as less of an issue than do 
their clients. Only 21 percent of accounting firms responding to our 
survey that want to audit large companies said that the complexity of 
accounting principles and auditing standards were a great or very great 
impediment to expansion, compared to 80 percent of clients. 

In addition, having sufficient industry expertise can be challenging 
for firms that want to audit large public companies. According to our 
survey, 67 percent of large public companies that would not consider 
using midsize and smaller firms said that such firms' industry 
specialization or expertise was of great or very great importance in 
their unwillingness to do so. Some large public companies told us that 
they needed this kind of industry expertise in their auditor. For 
example, the audit committee chairman for a large insurance company 
told us that when he chooses an audit firm, industry expertise was the 
most important factor he considered. He said that his company's audit 
firm must have experience with other companies in the insurance 
industry and doubted that midsize or smaller firms could meet these 
requirements. 

Several representatives of smaller accounting firms whom we interviewed 
said that industry expertise was a significant barrier to auditing 
large public companies. For instance, a representative of one smaller 
accounting firm noted that before accepting a new client, her firm was 
very careful to ensure that it has the right expertise to do the audit. 
She said that since the firm's expertise was in distribution and 
manufacturing, the firm would not accept a financial institution 
client. An official from another midsize firm told us that industry 
specialization was important because audits were not commodities. 
Instead, these accounting firms specialized in certain industries and 
had particular areas of expertise. This emphasis on industry expertise 
can limit midsize and smaller firms' ability to expand their businesses 
to serve companies that operate in industries outside of their 
specialty. However, only 17 percent of accounting firms responding to 
our survey that want to audit large companies said that specialized 
technical or industry expertise was a great or very great impediment to 
expansion. 

Accounting Firm Reputation: 

Another major barrier to midsize and smaller firms' ability to obtain 
large company clients is that these auditors do not have the 
reputations the largest firms enjoy. According to our survey, 65 
percent of large companies that would not consider using a midsize or 
smaller firm said that reputation or name recognition were great or 
very great reasons that they were unwilling to do so. In addition, 
company officials told us that they were confident that the largest 
firms could meet their companies' audit needs because these auditors 
had well-established reputations for quality. These officials were less 
familiar with the smaller firms' work and thus were uncertain about the 
ability of such a firm to adequately serve their companies. Market 
participants told us that conducting due diligence on unfamiliar firms 
was time-consuming, in part because information was not readily 
available. Furthermore, although PCAOB has begun inspecting accounting 
firms' audit work, many market participants we interviewed said that 
the information currently available from the PCAOB inspection reports 
was not sufficient to judge a firm's audit capabilities. For example, 
some noted that part of the inspection results were not published, 
inspection reports were not always timely, and PCAOB did not make an 
overall judgment on a firm's quality.[Footnote 48] 

Companies are also responding to their perceptions of investors' 
preferences when they choose one of the largest auditors. According to 
our survey, 54 percent of large companies that would not consider using 
a midsize or smaller firm said that the expectations or requirements of 
shareholders, banks, lenders, or the underwriters that help the company 
raise capital were of great or very great importance in their 
unwillingness to do so. Institutional investors and investment banks 
often use a company's financial statements and audits as the starting 
point in an investment decision and want to have confidence in the 
auditor that reviewed the financial statements. Similarly, 
representatives from an investment bank and an institutional investor 
told us that they preferred auditors with established reputations 
because of a lack of familiarity with capabilities of most midsize and 
smaller firms. One company official we interviewed said that she did 
not know why a larger company would not want to use one of the largest 
firms, given that these firms' name recognition provided underwriters 
with a certain comfort level. In addition, investment bank 
representatives told us that they want companies to use auditors with 
sufficient financial resources to withstand a liability judgment 
against them. For example, if an investment deal falters, the 
investment bank or underwriter may have to assume more of the 
settlement costs if the audit firm cannot bear its share. Furthermore, 
one investor told us that the largest firms' greater financial 
resources made them better able to survive a large client's failure. 

Midsize and smaller firms agree that name recognition and reputation 
pose a challenge to entering the audit market for large companies. 
Fifty percent of accounting firms responding to our survey that want to 
audit large companies said that name recognition or reputation with 
potential clients was a great or very great impediment to expansion. 
Similarly, 54 percent of these firms cited name recognition or 
credibility with financial markets and investment bankers as a great or 
very great impediment to expansion. In addition, some accounting firm 
representatives we interviewed said that midsize and smaller firms have 
had fewer opportunities to compete with the largest firms for large 
companies' business and do not have well-established reputations. 
However, one midsize firm representative noted that reputation should 
become less of an impediment as more companies moved from the largest 
firms to smaller firms and these firms' work became better known. 

An analysis of data on firms that audit initial public offerings (IPOs) 
illustrates investors' preferences for the largest firms in certain 
situations. While midsize and smaller firms' combined share of the IPO 
market has grown progressively, rising from 18 percent to 40 percent 
since 2003, the largest firms have consistently audited the majority of 
IPOs (fig. 9). Staff from some investment firms that underwrite stock 
issuances for public companies told us that in the past they generally 
had expected the companies for which they raised capital to use one of 
the largest firms for IPOs but that now these organizations were more 
willing to accept smaller audit firms. For example, an official from 
one investment firm told us that the firm now generally accepted two of 
the midsize audit firms for IPOs or securities issuances. However, as 
figure 9 shows, most of the companies that went public with a midsize 
or smaller auditor were smaller. In addition, these firms' share of 
IPOs of larger companies (those with revenues greater than $150 
million) rose from none in 2003 to about 13 percent in 2007. 

Figure 9: IPOs, 2003-2007: 

This figure is a combination of two graphs. One graph is a bar graph 
representing largest farms, midsize farms, and smaller farms. It is 
entitled "IPOs by audit firm size." The X axis represents the year, and 
the Y axis represents the percentage. 

The second graph is a line graph, with one line representing revenue 
less than $15 million, one line representing revenue $15-$150 million, 
and another line representing revenue more than $150 million. The X 
axis represents the year, and the Y axis represents the percentage. The 
title of this graph is percentage of companies audited by midsize and 
smaller firms, by company revenue. 

[See PDF for image] 

Source: GAO analysis of IPO data from EDGAR. 

Note: Changes in the business environment and audit market during this 
period make judgments based on year-to-year comparisons difficult. 

[End of figure] 

Midsize and smaller firms responding to our survey indicated that they 
had had mixed experiences assisting clients with IPOs. All of the 
midsize firms and 82 percent of smaller firms responding to our survey 
had assisted new and existing clients with an IPO or subsequent 
securities issuance. However, two of the four midsize firms, as well as 
36 percent of the smaller firms, reported losing clients that wanted 
another firm, often one of the largest firms, to help them prepare for 
an IPO or subsequent securities issuance. 

Similar Challenges Affect Midsize and Smaller Accounting Firms in the 
Market for Small and Midsize Companies: 

Midsize and smaller accounting firms responding to our survey said that 
they faced challenges even in competing in the market for smaller 
public company audits. Our survey respondents in this market generally 
reported that the challenges they faced were significant impediments to 
increasing the number of public companies they served. As shown in 
figure 10, these challenges, such as firms' capacity, global reach, and 
technical capability or expertise, are similar to those facing midsize 
and smaller firms that want to audit large companies. 

Figure 10: Midsize and Smaller Firms' Challenges in Auditing Small and 
Midsize Companies: 

This figure is a bar graph. 

Reason small and midside public companies are unlikely to use midsize 
and smaller firms; 
Ability to handle size and complexity of company operations: 65%; 
Technical capacity with accounting principles and auditing standards: 
57%; 
Industry specialization: 49%; 
Reputation or name recognition: 46%; 
Expectations or requirements of share-holders, banks, lenders, or 
underwriters: 45%; 
Geographical presence: 33%. 

Reasons midsize and smaller firms cited as impediments to auditing 
small and midsize public companies; 
Ability to recruit/retain staff: 65%; 
Complexity of accounting principles and auditing standards: 29%; 
Specialized technical and/or industry expertise: 23%; 
Name recognition or reputation with potential clients: 37%; 
Name recognition or credibility with financial markets and investment 
bankers: 50%; 
Firm's international reach: 29%; 
Firm's national reach: 14%.

[See PDF for image] 

Source: GAO. 

[End of figure] 

To increase their capacity and geographic reach, accounting firms need 
the financial capital to hire new staff or acquire other audit firms, 
but capital constraints and expansion costs pose an impediment to 
growth for some midsize and smaller firms. While this constraint could 
affect firms of all sizes, midsize and smaller firms have fewer 
partners from whom they can obtain capital. Of the midsize and smaller 
firms responding to our survey that focus on smaller companies, 65 
percent said that the costs of hiring and training additional staff 
were a great or very great impediment to expansion. According to an 
accounting firm representative we interviewed, some smaller firms can 
be constrained from raising capital to expand their businesses because 
of the partnership structure, which requires individual partners to 
pool their own assets or assume debt for acquisitions and other growth 
activities, such as hiring new staff. However, one midsize firm 
representative said that raising capital for expansion was not an 
impediment for his firm. 

Smaller firms responding to our survey also told us that complying with 
the many different requirements individual states impose could hinder 
their efforts to audit clients with operations in multiple states. Each 
of the 50 states and 5 U.S. territories have state boards of 
accountancy that have sole authority for establishing licensing 
requirements for certified public accountants in their jurisdictions. 
If a company's business operations extend across state lines, auditors 
may need to get temporary certifications in each of the states where 
they will conduct audit work. These requirements can range in 
complexity and cost among the several states. Some firms we interviewed 
said that complying with multiple state licensing requirements was 
difficult and often expensive. However, only 27 percent of midsize and 
smaller firms responding to our survey that focus on smaller companies 
said that varied state licensing requirements were great or very great 
impediments to expansion. Furthermore, some representatives of 
accounting firms whom we interviewed said that multiple state 
requirements did not stop them from competing for new clients. 

Smaller Audit Firms Are Taking Actions to Expand Their Market Share, 
but Challenges Remain: 

Many midsize and smaller firms have taken steps to reduce the 
challenges that they face and have successfully expanded their share of 
the audit market for small and midsize companies somewhat in recent 
years. In some cases, these firms have expanded their audit practices 
in niches that allow them to use their expertise, rather than 
attempting to serve clients in new industries. Some midsize and smaller 
firms told us that, while having staff with a certain type of expertise 
could be a barrier in trying to serve all types of companies, it did 
not hinder them if they focused on a more select set of industries. 
They said that this approach had allowed them to build their 
reputations in specialty areas, which may enable them to acquire 
progressively larger clients, and grow incrementally. Other firms told 
us that they had expanded their practices through mergers and 
acquisitions, adding new industry expertise, increasing their capacity, 
and extending their geographic reach. Smaller firms that responded to 
our survey generally viewed this approach as effective for increasing 
the number of companies they audited, with 73 percent saying that it 
was at least somewhat effective. Some representatives of midsize firms 
whom we interviewed also said that acquisitions were an effective way 
to expand into regions where they did not already have an office. 

While funding for expanding midsize and smaller accounting firms 
typically came from loans from financial institutions, merging with 
other accounting firms, or the personal resources of the firm's 
partners, a small number of firms are using a different method of 
increasing their access to capital. These firms have established 
alternative practice structures, in which the firm engaged in attest 
services is closely aligned with another organization that performs 
other nonaudit services. One example is where owners of the accounting 
firm sell the nonaudit portion of their practice to a new entity, which 
may be publicly or privately owned. The work the firm previously 
conducted is then essentially divided into two separately controlled 
entities, one of which conducts most of the firm's nonaudit and attest 
work, while the other conducts audits. Owners of the audit firm are 
also employees of the nonaudit entity, and the audit firm generally 
leases employees, office space, equipment, administrative support, and 
other services from this entity. Audit firms gain additional access to 
capital from the initial sale of the nonaudit entity or loans from the 
new entity that they can use for acquisitions and other growth 
activities. However, some firms with alternative practice structures 
told us that getting approval for their organizations from some states 
was challenging and that they were subject to additional scrutiny 
because their uncommon structure raised concerns about 
independence.[Footnote 49] In addition, 63 percent of midsize and 
smaller firms responding to our survey said that alternative practice 
structures would only be slightly or not at all effective in helping 
them increase their market share. 

Finally, according to representatives of two accounting firm networks 
and affiliations of independent firms, these organizations help midsize 
and smaller firms deal with some of the challenges they face. As we 
have seen, some midsize and smaller firms join these networks in order 
to extend their geographic reach. In two cases that we reviewed, we 
found that the structure of these organizations varies widely. One 
organization was described as having a focused mission and high 
standards that member firms must continuously meet, while a 
representative from another said that the organization functioned 
primarily as a vehicle to share best practices and refer business to 
other member firms. All midsize firms and over 60 percent of smaller 
firms responding to our survey belonged to a network or affiliation, 
generally to increase competitiveness with larger firms and extend 
their national and international reach. One network representative we 
spoke to told us that the network's main benefit was its ability to 
serve clients that were expanding, especially internationally, by 
partnering with other firms in the network. In interviews, officials 
from two smaller firms also told us that networks and affiliations 
provided opportunities to serve new clients either by partnering with 
other firms or through referral services. 

Midsize and smaller firms that responded to our survey had mixed views 
about the ability of these networks and affiliations to help increase 
their market share. Some market participants thought that networks' 
value could be limited because, unlike the global networks of the 
largest firms, the member firms of these networks and affiliations did 
not share a common set of methodologies or internal controls. In 
general, the firms in networks wanted to maintain their individuality 
in order to avoid being held liable for another firm's audit work. In 
addition, officials from two smaller firms that are members of a 
network expressed concern that the proposed independence standards of 
the International Federation of Accountants--the global organization 
for the accounting profession that develops international standards on 
ethics, auditing and assurance, education, and public sector accounting 
standards--could present additional challenges for networks because of 
the broad way that the standards define networks.[Footnote 50] 
Officials with the International Federation of Accountants told us that 
the standards were still under consideration and that comments and 
concerns from accounting firms on this issue were still under review. 

While the practices discussed above have helped smaller accounting 
firms to reduce some of the challenges they face, certain barriers are 
likely to persist, particularly in the market for large company audits. 
While focusing on niche markets can deepen a firm's expertise, just as 
mergers, acquisitions, and networks can increase firms' capacity and 
geographic reach, midsize and smaller firms are still much smaller than 
their large firm competitors and have much less experience in the large 
company audit market. Some market participants think that building up 
smaller firms' capacity, experience, and reputation to serve large 
companies is likely to be a long-term process, thus their growth is 
unlikely to ease concentration. 

Proposals for Addressing Concentration and Increasing Market Share for 
Smaller Auditors Have Significant Disadvantages: 

Over the years, academics, industry groups, and other market 
participants have offered a range of proposals that are intended to 
reduce the risks of current and further concentration, or address the 
expansion challenges facing midsize and smaller audit firms. We 
considered a number of these proposals and found that, while each could 
offer certain benefits, each proposal also presents at least some 
significant disadvantages, and market participants generally saw these 
proposals as having limited effectiveness, feasibility, and benefit. 
Since the current level of concentration does not appear to be having 
significant adverse effect, and the proposals we reviewed were 
generally not seen as effective in addressing the risks of 
concentration or challenges facing smaller firms without serious 
drawbacks, we found no compelling need to take action. 

Proposals Others Have Made for Reducing the Risks of the Current Level 
of Concentration Involve Trade-offs: 

Several proposals have been offered to reduce the risks of the current 
level of concentration, including mandatory audit firm rotation, audit 
firm financial statement disclosure, and breaking up the largest firms 
into more firms. 

Mandatory Audit Firm Rotation: 

Some academic and industry sources have suggested that requiring public 
companies to periodically change auditors could reduce the current 
level of concentration. Such mandatory audit firm rotation would limit 
the period of years that an accounting firm could serve as the auditor 
for a particular public company. Our survey results show that companies 
often retain their auditors for long periods of time.[Footnote 51] For 
example, according to our survey results, approximately 40 percent of 
public companies had used their current auditor for at least 5 years, 
and almost a quarter had used their current auditor for at least 10 
years.[Footnote 52] While generally proposed as a means of enhancing 
auditor independence by periodically bringing in a new auditor for a 
"fresh look" at a company's financial statements, mandatory rotation 
could potentially reduce concentration to the extent that it provided 
more opportunities for midsize and smaller firms to compete to provide 
audit services to public companies. 

Although mandatory auditor rotation would increase opportunities to 
compete, it would not increase the number of viable competitors, and 
views on its effectiveness as a means of reducing concentration were 
mixed. For example, 44 percent of midsize and smaller firms responding 
to our survey stated that mandatory rotation would be at least a 
somewhat effective way for their firms to gain more public company 
clients, and 52 percent of respondents thought that it would be only 
slightly or not at all effective.[Footnote 53] One person we 
interviewed noted that mandatory rotation might not be feasible, since 
some companies had very limited choices due in part to the restrictions 
of independence requirements. Another market participant noted that 
mandatory rotation would not necessarily reduce concentration because 
large public companies would likely just rotate to another one of the 
largest firms. In a 2003 report on the potential effects of mandatory 
audit firm rotation, we found similar results.[Footnote 54] Based on 
surveys we conducted for that report, 83 percent of accounting firms 
that audit 10 or more companies and 66 percent of Fortune 1000 public 
companies stated that under mandatory auditor rotation, the market for 
public company audits would either become more concentrated or remain 
about the same. Further, more than half of accounting firms that audit 
10 or more companies felt that mandatory audit firm rotation would 
reduce the number of firms willing and able to compete for public 
company audits. 

In addition, market participants we spoke with raised other concerns 
about mandatory audit firm rotation. Some said that mandatory rotation 
would increase both audit firms' and public companies' costs. In our 
2003 report, we found that many audit firms and large companies 
surveyed believed that mandatory rotation would increase initial year 
audit-related costs by more than 30 percent. For example, we reported 
that audit firms could incur higher marketing costs as they increased 
efforts to acquire or retain clients. With new auditors every few 
years, public companies also would incur higher support costs for 
assisting the new audit firm in understanding the companies' 
operations, systems, and financial reporting practices. Others 
expressed concern that new audit firms would need a period of time to 
become fully familiar with a client's operations. Lacking knowledge, 
and the time that would be required to acquire it, could increase the 
risk of an auditor not detecting financial reporting issues that could 
materially affect the company's financial statements. 

Other recently implemented regulatory changes may have already provided 
at least one of the benefits this proposal is designed to provide. The 
Sarbanes-Oxley Act requires mandatory rotation of lead and reviewing 
audit partners after they have provided audit services to a particular 
public company for five consecutive years. Many market participants we 
interviewed for our 2003 report suggested that this requirement, when 
fully implemented, could achieve some of the independence benefits 
related to a new auditor's having a fresh look at a company's financial 
statements.[Footnote 55] 

Audit Firm Financial Statement Disclosure: 

Another proposal that has been offered would require public company 
auditors to provide financial information that could also be used to 
assess the competitiveness of audit fee levels. Some market 
participants and others advocate requiring accounting firms that audit 
public companies to disclose detailed financial information, such as 
their own revenues and profits. They have noted that providing this 
information could increase the transparency of the market and help 
participants evaluate its profitability, and the information could also 
help market regulators and others evaluate whether firms were charging 
prices above competitive levels. 

Jurisdictions outside the United States have begun requiring audit 
firms to disclose some financial information, but the results have been 
unclear. In the United Kingdom, audit firms are required to file 
financial information. However, because U.K. accounting firms provide 
many services, some find the consolidated financial statement to be of 
limited usefulness in assessing the economics of the firms' audit 
services. As a result, based on the advice of a group of market 
participants, the U.K. Financial Reporting Council recommended that 
audit firms disclose the financial results of their work on statutory 
audits and directly related services, so that "clearer and more 
comparable information on the profitability of audit work" would be 
available.[Footnote 56] In addition, beginning in 2008, audit firms 
that carry out statutory audits in the European Union are required to 
file information on fees charged for audits and other services, as well 
as data on the basis for partners' compensation. 

Most market participants we interviewed on this proposal did not 
believe that requiring audit firms to publicly disclose their financial 
results would be very effective in reducing the risk of anticompetitive 
pricing among the largest accounting firms. Some market participants we 
spoke with indicated that such financial statements would not provide 
useful information for evaluating whether firms were charging fees 
above competitive levels. Others familiar with the accounting 
profession have commented that regulators already had the authority to 
request certain financial information from firms if needed. Therefore, 
this proposal might not have any direct effect on market competition. 

Breaking Up the Largest Firms into More Firms: 

Some academics and former regulators have suggested that requiring one 
or more of the largest firms to spin off a large portion of their 
operations to create more than four firms with the capacity to audit 
large public companies could ease current concentration. Breaking up 
the largest firms would at least temporarily decrease concentration and 
mitigate the adverse effect of one of the firms exiting the market or 
failing. Firms in other markets have been split up in the past--for 
example, Standard Oil and the American Tobacco Company in 1911; 
meatpacking firms in 1920; and AT&T, which owned all regional operating 
telephone companies, in 1984. In some of these cases, some of the 
resulting companies merged in later years after market or technological 
changes. 

Market participants we spoke with expressed concerns about the 
potential adverse effects of forcing the largest firms to divest 
themselves of some of their operations. For example, several indicated 
that splitting the firms could entail significant costs and diminish 
the economies of scale and depth of expertise that currently allow the 
largest firms to audit large public companies with complex technical 
needs and worldwide operations. The result could be increased audit 
costs and decreased quality of audits performed. In the public co