FTSE 100 and Big Four alumni survey 2018: who are the real power brokers?
Increasing focus on the quality of audit in the UK means that the Big Four audit firms are under severe pressure with threats of breakup and radical reform. In our exclusive annual FTSE 100 Big Four Alumni survey, Philip Smith analyses the inextricable link between UK boards and the top audit firms
31 Dec 2018
As the debate over competition and choice in the larger company audit market gathers pace, one area that demands attention is just how many former Big Four – PwC, Deloitte, EY and KPMG – partners and staff are now sitting in the boardrooms of the largest listed companies in the UK.
For not only have these giants of the auditing market achieved an oligopoly in the supply of audit services, they have also as good as sewn up the demand side, claiming almost two thirds of the FTSE 100’s CFOs and audit committee chairs as their own.
What is particularly noticeable is that the mid-tier firms, such as Grant Thornton and BDO, can claim precisely none of these positions – not one of the 100 CFO and audit committee chairs have a mid-tier firm on their CV.
According to Accountancy’s latest analysis of the FTSE 100 boardrooms, 64 audit committee chair positions are filled by someone who has passed through the doors of at least one of the Big Four or Arthur Andersen, the ‘Big Five’ firm that disappeared in the wake of the Enron scandal in 2002.
An identical number of CFOs have at some point in their career worked for one or more of these firms.
It does not stop there. Although not as prevalent, the Big Four can claim 12 FTSE board chairs as alumni.
Amid increasing scrutiny of the links between auditors and their clients, the proportion of Big Four alumni among the corporate governance triumvirate of chair, CFO and audit committee chair, has hardly shifted in recent years.
The dial has not moved at all since last year for CFOs, while there are now slightly more audit committee chair alumni this year compared with last year’s survey (61).
It is only among board chairs that there has been a fall, from 15 alumni in 2017 compared with 12 today.
‘This probably should not be a surprise, but it never ceases to amaze me what the percentages are, it is a real domination,’ says Roger Barker, head of corporate governance at the Institute of Directors.
‘Overall, I do not think this is very healthy, because it continues to create the impression that it is not an open market for audit services and that it is to some extent a closed shop, a closed group of people.’
Not a binary argument
However, it should be remembered that this is not necessarily a binary argument; there is a world of difference between a board director, whether that is the chair, CFO or audit committee chair, who qualified with one of the accountancy firms and then left to work in industry and worked their way up to board level, and a Big Four partner who is parachuted into a FTSE 100 board position after retiring from their audit firm.
‘It is not surprising that there are so many Big Four connections to FTSE 100 boards, in part because they have such a strong hold over the audit market,’ says Karthik Ramanna, professor of business & public at the University of Oxford’s Blavatnik School of Government.
‘Invariably, many of the best accounting graduates seek employment in the Big Four, and they will then either rise through the ranks to partner level or move into industrial and financial corporations.’
Ramanna agrees that not all connections should be seen as being equal.
‘Someone who leaves a firm early in their career would be quite different from someone who is a partner or director with a Big Four firm,’ he says. ‘It is important to understand the quality, depth and level of the connection.’
The links, however, can be even more subtle. All the Big Four, and indeed many of the mid-tier firms, run extensive alumni programmes that allow them to keep in touch with individuals who may have left the firm, perhaps many years previously.
The firms clearly see that it is worth their while to invest in such programmes and that there can be a good return on this investment, but it can still raise eyebrows.
Ramanna accepts that in business, relationships matter as they can mitigate ‘search costs’: ‘If you are trying to find the right person for the right job, and you let “best” be the enemy of “good,” you could spend forever trying to find the right person. So, you hire people you know.’
But the restricted nature of the audit market needs to be borne in mind. ‘As long as you are in a competitive market, this is not a big problem for society because if you fill your organisation with cronies, you will not be around very long.
‘What makes relationship-based recruiting particularly pernicious in the auditing eco-system is that it is not a competitive market. These relationships then have the potential to enable toxic behaviour that imposes costs on us all.’
Limited talent pool?
Others, however, draw a distinction between perception and reality, and that the reality is that often, drawing an individual from this limited talent pool is the best option.
‘There are two issues here, one of perception and one of substance, and with substance it is not an issue,’ argues Jonathan Hayward, director of Independent Audit.
‘The audit committee holds the balance between the external auditor and the finance director.
‘Non-executive directors are committed to the company, but it is valuable for them to be able to see the external auditor’s point of view.
What’s the alternative?
Hayward asks what the alternative would be, suggesting that retired finance directors are the obvious alternative for audit committee chair positions, but this could throw up equally difficult conflicts.
‘Former audit partners know how auditors work, they understand the way that they think. So, there will be a trade-off between expertise and independence.’
Mark Freebairn, head of the CFO practice at recruitment consultancy Odgers Berndtson, goes further, saying categorically that is ‘rubbish’ to suggest that there can be any bias towards a CFO’s or audit committee chair’s former firm.
‘If anything, there will be some anti-bias,’ says Freebairn. ‘Many of these people will have left their former firms many years ago, it is too far back for them to be biased.’
‘You’d just be allowing the risk of a perception, not necessarily the reality, that the audit committee chairman is too aligned with the CFO, which is not obviously better for shareholders than being too aligned with the auditors,’ Hayward says.
‘How far do you have to change the reality of the situation in order to address the perception of the ill-informed? It falls to regulators, like the Financial Reporting Council, to try and maintain a quality reality.’
Which Big Four dominate FTSE 100?
So which firms are the most pervasive among the FTSE 100?
Perhaps unsurprisingly, given its size, PwC takes the lead, with 22 alumni as audit committee chairs, 26 CFOs and four board chairs.
In second place is KPMG, the smallest of the Big Four, with 19 audit committee chairs, 10 CFOs and four chairs.
Third is Deloitte with six audit committee chairs, nine CFOs and one chair, followed by EY with 13 audit committee chairs, nine CFOs and two chairs.
It is interesting to note that Arthur Andersen’s name continues to crop up in the CVs of 11 CFOs, though only in five audit committee chairs and just one chair.
What of the mid-tier firms?
But what is equally interesting is that there is not a single mention of any of the mid-tier firms – no audit committee chairs, CFOs or board chairs in the FTSE 100 are likely to be found at any of the mid-tier alumni events.
Is it any wonder, therefore, that these firms have not been able to make any inroads into the FTSE 100 audit market?
Lack of diversity
Aside from the serious competition and conflict questions that such a closed shop raises, there is the wider issue of boardroom diversity.
It is sobering to note that there are more knights than women who are FTSE 100 chairs.
At its most basic level, the position of CFO and chair remain male dominated – only 10% of CFOs are women, a figure that is even lower at chair level.
It is sobering to note that there are more knights than women who are FTSE 100 chairs.
The audit committee chair position offers a glimmer of hope with 19 now being held by a woman, up from 14 in last year’s survey.
Barker says: ‘We need to find a way of opening up the audit committee to a more diverse range of people, but the problem is that the audit committee is one of the more technical committees, requiring a certain amount of accounting and finance knowledge.
‘It is therefore natural that people with this kind of background are drawn in to serve on that committee.’
The view of the Institute of Directors is that head hunters and the nominations committees of the FTSE 100 need to scope out a wider pool for directors generally, but also at the same time there needs to be an increase in the underlying levels of financial literacy among all directors.
While it is reasonable that there is at least one person on the audit committee who is a financial expert but there is no reason why everyone on the committee should be.
‘Perhaps it would be beneficial if the chair of the committee is someone who is not the person with recent and relevant financial experience,’ Barker says.
‘That person could then be better at communicating about what is going on with the rest of the board, taking more of a non-expert perspective.’
Audit committee roles can be performed by individuals from lower levels in the corporate structure, such as a finance director from a division or subsidiary, rather than someone from a group board.
This would allow individuals from a more diverse background to gain the necessary experience to contribute at board level. ‘This is starting to happen, but while mindful of targets, people within these companies are trying to maintain the reality of good governance,’ Hayward says.
Freebairn agrees, arguing that the talent pool from which he is asked to search for candidates is being widened, albeit only slightly.
‘Because the diverse talent is not there yet on the main FTSE boards, and because there is more work to be done to aggressively drive the diversity agenda, what you are seeing is chairmen looking at a wider range of backgrounds. They are not just looking at main board candidates,’ Freebairn admits.
The reality is that this will not do a huge amount to shift the preponderance of Big Four candidates.
‘It may be a generalisation, but you could say the very best people will end up in the very best roles, which will be defined early on in a career by which firm they trained with, what they did in that firm and then which company they went on to join,’ he adds.
Charlie Grubb, managing director of Robert Half Executive Search says that he has found that non-executive roles are often filled by referral, and that by doing so, the talent pool can often be limited.
‘To increase the diversity of the candidates for non-executive level roles, I would advise shortlisting candidates with the same thorough search as for executive positions,’ Grubb says.
‘By doing so, the board will be able to access prospective audit committee chairs who might be outside their immediate awareness.’
Power of the ICAEW
In terms of qualification, the ICAEW qualification – ACA – remains the dominant signifier of recent and relevant financial experience.
More than half (51) of audit committee chairs are ICAEW-qualified chartered accountants, up by four on last year’s survey.
CIMA can claim 11 audit committee chairs, while ICAS has eight. ACCA has only three, down from last year’s five, while CIPFA has just one FTSE 100 audit committee chairs in its ranks.
Around one in five (22) FTSE 100 audit committee chairs have no formal accounting qualification, though four of these do possess an MBA qualification.
‘Fundamentally, the advantages an ACA-qualified accountant bring to the role of chair of the audit committee in a large organisation comes down to the type of work-place training received, combined with the technical examinations,’ Grubb says.
‘As the typical ACA starts in an accounting firm, they gain exposure and daily ins and out of audit through a varied client base over the course of several years.
‘The skills developed in this arena usually result in a keen sense of curiosity, using an enquiring mind to challenge and question.’
The figures for CFO are very similar. Some 46 are ICAEW-qualified, with nine from CIMA and six from ICAS.
There are 17 who have qualifications from overseas, such as Australia, the US, South Africa and Ireland, serving to underline the international nature of many FTSE 100 companies. There are, however 21 CFOs who do not appear to have a formal accountancy qualification, though eight of these are MBAs.
Of course, that is not to say that individuals with other accounting qualifications or MBAs will not have developed the necessary skills to succeed as either CFO or indeed audit committee chairs.
‘These qualifications often require risk and audit modules as part of their qualification,’ says Grubb, ‘but it is the hands-on, workplace experience that allows audit committee chairs the most exposure.’
Freebairn is more concerned about whether an individual is qualified than which body they qualified with.
‘When it comes to looking at their CVs, I do not notice their backgrounds, I am more interested in whether they are qualified and what they have been doing over the last 15 years,’ he says.
Looking at the chair of the board, 19 have an accountancy qualification (which incidentally is the same as the chief executive position, according to recruitment consultancy Robert Half) while a further 10 are MBAs. Seventy-one do not have an accountancy qualification, an increase of four over last year’s figure.
In time, the pool of talent will widen and attitudes may change, but as it stands Big Four alumni continue to be the go-to people to fill some of the most important, and arguable most challenging, corporate governance position in UK plc.
And it is a tie that many will continue to see as being too tight for comfort.
About the author
Philip Smith is contributing editor of Accountancy
For detailed analysis and league tables of the FTSE 100 and Big Four alumni, click here
Watch out for our exclusive follow-up report on the Big Four alumni and the audit regulator, the Financial Reporting Council, due for publication on 17 December