Dutch Private Equity (PE) firm Waterland, ranked #1 in Europe and #2 worldwide, is buying stakes in medium-sized audit firms. PE firms are not philanthropists. They care about an exit within a “few” years. It’s hard to see that exit unless a major change in audit legislation will occur, which is not imaginary.
A recent interview in the Dutch Financial Times claimed that this PE move is not about adding a 5th member to the Top 4 in auditing: Deloitte, E&Y, KPMG and PWC. I doubt that. Game theory has established that you need at least 5 players for a level playing field (eg, example). Else, competition is imaginary.
Current audit legislation requires audit partners to own (and finance) their firm. These audit partners are (very) well compensated for running substantial financial risks. Not all (eg, audit, law, PE) partners have (global) equity stakes; some have national equity stakes, while others are salaried partners.
Waterland may be years ahead of a change in audit legislation. Their size allows this rather bold move. Proposed changes in UK audit legislation may predict what is coming:
- “To curtail the unhealthy dominance of the ‘Big Four’ audit firms, FTSE350 companies will be required to conduct part of their audit with a challenger firm.”;
- “The new regulator, ARGA, will also be given the power to make big audit firms keep their audit and non-audit functions operationally separate and to enforce a market cap if the state of the market doesn’t improve.”
The mandatory “challenger firm” concept is currently unknown in mainland Europe, as far as I’m aware of. This concept may explain why Waterland is threading beads onto a string (in Dutch: kralen rijgen).
The second bullet above hides something very important: advisory and audit may not be separated after all. Their future continued combination will allow them to retain their joint profitability. I fail to see how advisory and audit will be profitable enough for (standalone) survival without each other.
A split between partnership and equity contribution may be further away than ever. This might be for the best. There is an old saying: put your money where your mouth is. The financial risks that partners (eg, audit, law, PE) are running will force them not to be reckless with their advices and/or opinions.
Exit Music (For A Film) – 1997 – by Radiohead
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Note: all markings (bold, italic, underlining) by LO unless in quotes or stated otherwise.
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