Review of Accounting Studies
https://doi.org/10.1007/s11142-025-09871-x
Why did the Big Four get so large? Evidence from Australia
Colin Ferguson1 · Matthew Pinnuck1 · Douglas J. Skinner2
Accepted: 13 January 2025
© The Author(s) 2025
Abstract
We use a long time-series from Australia to shed light on economic factors that led
to audit market concentration and the Big N. We show that increases in the size
of a small number of public companies was an important factor that led to large
audit firms and market concentration. We also show that emerging Big N firms
made sunk cost investments, including in the ability to provide industry expertise
and non-audit services, which allowed them to retain clients, differentiate, and grow.
These changes occurred around the time the profession lifted restrictions on advertising, which helped facilitate differentiation, and that larger, more complex clients
switched to emerging Big N firms while smaller clients switched to non-Big N firms.
We do not find that increases in audit market concentration reduced competition; our
results instead suggest the audit market became more competitive over time.
Keywords Auditing · Audit market structure · Market concentration · Big Four · Big
N
JEL Classification L11 · L51 · M21 · M42
Colin Ferguson passed away in 2014, after the main ideas and evidence in the paper had been
established and working paper versions of the paper had been prepared.
We benefited from comments from the editor, anonymous referees, Mary Barth, Neil Fargher,
Joseph Gerakos, Jane Hronsky, Bill Kinney, Dan Simunic, Chad Syverson, Ross Watts, and
workshop participants at the AAA Annual Meeting, CAPANA conference, Chicago, Columbia,
Florida International, Ohio State, Melbourne, MIT, Penn State, Stanford, and UT-Dallas. Previously
titled “The Evolution of Audit Market Structure and the Emergence of the Big 4: Evidence from
Australia.”.
* Matthew Pinnuck
mpinnuck@unimelb.edu.au
1
Faculty of Business and Economics, University of Melbourne, Carlton, VIC, Australia
2
Booth School of Business, University of Chicago, Chicago, IL, USA
Vol.:(0123456789)
C. Ferguson et al.
1 Introduction
The economics of the Big Four firms that dominate global audit markets remains
controversial. Regulators have raised concerns about audit market concentration,
including its effects on audit market competition, since the 1970s.1 Yet there is limited evidence on the determinants and effects of audit market concentration (DeFond
and Zhang 2014).
We use 60-plus years of data from Australia to provide evidence on the determinants of audit market concentration. Our data begin in the 1960s, when the Australian audit market was fragmented, and extend through 2022, by which time the market was concentrated and the Big Four accounted for a large majority of the market.2
The literature contains little or no longitudinal evidence that spans the emergence of
the Big N.
Economists attribute concentration to three nonmutually exclusive forces: (1) random growth, under which some firms enjoy a sequence of positive shocks; (2) sunk
cost investments that allow firms to differentiate their offerings and grow; and (3)
mergers and acquisitions (M&A). Related to these arguments, papers in the audit
literature argue that the Big N emerged because of economies of scale and scope
(Dopuch and Simunic 1980; Eichenseher and Danos 1981) and that Big N size and
reputation allowed these firms to commit to higher audit quality (DeAngelo 1981b;
Watts and Zimmerman 1981, 1983), which helps explain audit market concentration
and Big N fee premia (the “Big N premium”). We use longitudinal data to provide
evidence on these arguments in a way not possible with cross-sectional data—we
provide evidence on dynamic aspects of market structure and competition over a
long period during which the audit market became concentrated.3
Audit market concentration increased markedly during the 60-plus years of our
sample period (Fig. 1). In the early 1960s, nine audit firms that ultimately became
the Big Four accounted for around 35% of the Australian audit market.4 The market share of these firms grew rapidly during the 1970s to exceed 70% by 1982 and
90% by 2002. (It subsequently declined, to just over 80%, by 2022.) Not all audit
firms grew—while the largest firms grew to become the Big Nine, median audit firm
1
See, for example, Government Accountability Office (GAO, 2003, 2008), European Commission
(2010), and Oxera (2006). More recent agency reports in the United Kingdom raise questions about
the links between audit market concentration and audit quality, with a focus on the Big Four. See Independent Review of the Financial Reporting Council (Kingman Report, 2018), Competition & Markets
Authority Statutory Audit Services Market Study (2019), House of Commons BEIS The Future of Audit
Report (2019); Report of the Independent Review into the Quality and Effectiveness of Audit (Brydon
Report, 2019).
2
In most countries the Big Four (Deloitte, EY, KPMG, and PwC) account for the large majority of the
market for public company audits. We also refer to this set of firms (and in some cases their predecessors) as the Big N.
3
Other papers explore the dynamics of audit market concentration (e.g., Aobdia et al. 2021; Kitto 2024)
but for periods after the emergence of the Big N.
4
This overstates the share of these firms because most Big N predecessor firms were not unified national
firms at this time, operating instead as affiliated but distinct firms based in the major Australian cities and
states.
Why did the Big Four get so large? Evidence from Australia
size is largely flat through 1970s and 1980s, such that a two-tiered market structure
emerged.
Second, we find that the size of public companies in Australia displays increasing
skew over the sample period, driven by the emergence of a small number of very
large companies, and that this increased concentration is associated with increases in
audit market concentration.5 We show that Big N firms primarily grew organically
as their existing clients grew. Relative to this organic growth, growth from client
switches is less important while growth from M&A is relatively unimportant.
Motivated by the “endogenous sunk cost” models of Sutton (1991), we investigate the sunk cost view, under which concentration can arise when firms invest in
sunk costs to differentiate their products, which allows them to grow and acquire
share. We therefore examine whether, over the period that concentration and a twotiered structure emerged, some audit firms engaged in a competitive “arms race” and
significantly increased their investment in sunk costs, including in the audit technology necessary to achieve economies of scale and scope, as well as investments in
brands, the capability to offer non-audit services, and industry expertise. We report a
number of findings consistent with this view.
First, we provide evidence of a substantial increase in the provision of non-audit
services by Big N (relative to non-Big N) firms as these firms grew and the audit
market became concentrated. For the median Big N client, non-audit fees increased
from 9.2% of fees over 1973–1979 to 22.4% in 1989–2022; the comparable numbers
for non-Big N clients were 3.5% and 8.6%, respectively. These numbers show that
the difference increased over time, consistent with the Big N firms making greater
investments in the capabilities necessary to deliver non-audit services such as tax,
IT, and management advisory services.6
Second, we find that, from 1980 to 1984, as the Big N was emerging, companies
that were larger, growing more quickly, and that demanded industry specialization
were more likely to switch to a Big N firm. We also exploit a 1984 change in Australian accounting profession rules that first allowed accounting firms to advertise
and promote their services.7 The rate of switching to the Big N increased after 1984,
with switches associated with higher utilization of non-audit services. This evidence
suggests a realignment under which companies sorted based on size, industry, and
growth, consistent with a demand-side explanation for audit market concentration.
Related, we show that part of what drove audit market concentration in Australia
was the formation of national firms during the 1970s as well as these firms’ adoption of the international Big N brands. Both the national reach and the brand names
helped these firms differentiate. Further consistent with differentiation through sunk
cost investments, during the 1980s we find increases in the ratio of staff-to-partners
5
We use “firm” to refer to audit firms and “company” to refer to publicly traded audit clients.
The larger revenues (and profits, given higher margins in non-audit services relative to audit) likely
helped the Big N finance their sunk cost investments. These investments likely have significant fixed cost
components, making it difficult for smaller, non-Big N firms to offer the same breadth of services.
7
Anecdotal evidence suggests the emerging Big N pushed for this change, which was resisted by the
smaller firms, consistent with the Big N seeking to differentiate and grow by attracting clients that had
the need for the differentiated services and capabilities.
6
C. Ferguson et al.
100%
90%
80%
70%
Other
Hungerfords
60%
Touche Ross (Spry Walker)
Andersen (Fuller King)
Coopers & Lybrand (Cooper Bros.)
50%
Deloitte (DH&S; Yarwood & Vane)
Ernst & Whinney (Fell & Starkey)
40%
E&Y (Arthur Young; E.V. Nixon)
KPMG (Peat Marwick; Smith, Johnson)
30%
PwC (Price Waterhouse; Flack & Flack)
20%
10%
0%
1962 1967 1972 1977 1982 1987 1992 1997 2002 2007 2012 2017 2022
Fig. 1 Concentration in the Australian audit market, 1962–2022 (based on audit fees paid by public companies)
(a proxy for the use of technology in auditing) for Big N but not non-Big N firms.
Thus, we offer a variety of evidence—on non-audit services, industry specialization,
increased use of technology, use of Big N global brands and networks—that collectively suggests a supply-side response, via sunk cost investments, by emerging Big
N firms to the changing nature of public companies and capital markets. We support
these interpretations with anecdotal evidence and examples.
Third, we show that audit pricing evolved differently for Big N and non-Big N
firms as the market became concentrated. Audit fees for both sets of firms were similar in the 1960s, at around 0.10% of client assets (medians across client companies;
no significant difference). This number increased over time for non-Big N clients, to
0.15% in the 1970s, 0.14% in the 1980s, and to around 0.30% in 1989–2022. (The
over-time increase is statistically significant.) While fees for Big N clients were similar in the 1970s (around 0.17%) and 1980s (around 0.14%), they are around 0.14%
in 1989–2022, substantially below those of the non-Big N. This suggests scale economies for audits by Big N but not non-Big N firms. It is also hard to reconcile with
the Big N leveraging increased market power to raise fees. Further, the decreasing
ratio of audit fees to client assets for Big N firms is associated with an increasing
ratio of non-audit fees to client assets for these firms, consistent with complementarities across audit and non-audit services.8
8
We also show, using firm level data, that there is a negative correlation between audit and non-audit
fees for the Big N from 1973 to 1988, further suggestive of complementarities between audit and nonaudit services. (There is a smaller negative correlation for non-Big N firms over this period.).
Why did the Big Four get so large? Evidence from Australia
Finally, we investigate whether the audit market became less competitive as concentration increased. We find little support for this. First, as noted above, there is
no evidence that audit fees (per dollar of client assets) increased for Big N firms;
in fact, audit fees for Big N clients decline relative to those of non-Big N clients.
Second, as another test of pricing power, we find that annual increases in audit fees
are lower and the frequency of fee reductions higher during recessions (1982–1983,
1991–1992 and 2008–2009) relative to non-recession years. Further, in these recession years there are no significant differences in the magnitude and extent of fee
reductions for Big N relative to non-Big N firms (in fact, in 2008–2009 fee decreases
are larger and more prevalent for Big N clients). Thus, there is little evidence that
Big N firms had market power that allowed them to sustain or increase fees, either
in absolute terms or relative to non-Big N firms. Third, the rate of client switching,
a measure of competitive intensity, increased over time and is highest in the most
recent (1989–2022) period, after the Big N emerged. The rate of audit switching
increases from 3.1% in the 1970s to 6.5% in the 1980s and 8.0% in 1989–2022;
for the Big N, the rate increases from 2.6% in the 1970s to 5.9% in the 1980s and
remains around this level (at 5.5%) in 1989–2022. Overall our evidence does not
support the view that the emergence of the Big N allowed these firms to exploit market power and reduce competition.
We make several contributions. First, and most important, there is little longitudinal evidence in the auditing literature, which makes it difficult to address how
or why the audit market became concentrated (DeFond and Zhang 2014). Our evidence helps fill this void. Our evidence complements recent work in economics that
shows increased concentration is pervasive (Autor et al. 2020; Kwon et al. 2023).
We show that concentration in the audit market is tied to both increased concentration in the economy generally and the “endogenous fixed costs” models of Sutton
(1991). This stands in sharp contrast to the view that concentration of the Big N
is due to mergers. The fact that concentration in the U.S. has increased for the last
100 years (Kwon et al. 2023) suggests the factors we discuss also help explain audit
market concentration in the United States and likely around the world.9
Second, our evidence has implications for audit market regulation. We provide
evidence on the economic forces that led to audit market concentration as well as
evidence that is hard to reconcile with the notion that the audit market became
less competitive as concentration increased. Our evidence shows that audit market
concentration is most likely due to the interaction of increased skewness in company size and an arms race in which some audit firms made sunk cost investments
to retain clients as they became larger and more complex. Policy discussions about
audit market concentration rarely discuss such factors and the positive externalities that arise from a competitive arms race in endogenous sunk cost investments.
Our evidence casts doubt on what some regulators assume is a link between Big
9
Wootton and Wolk (1992) discuss the emergence of the Big Eight in the United States over 1900 to
1990 and offer much anecdotal support that the factors we document as important in Australia (growth in
client size and complexity, sunk cost investments in non-audit services, industry specialization, etc.) also
help explain the emergence of the Big Eight in the United States.
C. Ferguson et al.
Four market concentration and lack of competition and, in-turn, weaker audit
independence,lower audit quality, and audit failures, such as those at Enron, Carillion, and Wirecard.10
Third, we contribute to the audit pricing literature, the vast bulk of which is crosssectional. Our evidence shows that audit fees per dollar of assets for Big N versus
non-Big N clients diverged after the late 1980s: fees tended to increase for non-Big
N clients but were flat to declining for Big N clients. As a result, fees for non-Big
N clients have been higher than those for Big N clients since the early 1990s. This
suggests returns to scale in auditing, which advances a set of studies that attempt to
examine the pricing effects of economies of scale in cross-sectional settings (e.g.,
Fung et al. 2012). The fact that we also find a negative time-series relation between
audit and non-audit fees per dollar of assets suggests that audit and non-audit services give rise to synergies at the firm rather than client level, where the audit pricing literature fails to find a negative association (Causholli et al. 2010, p. 190). We
also document downward pressure on audit fees during recessions when arguably (if
sustaining quality is important) fees should increase.11
Fourth, we contribute to the literature on the joint supply of audit and non-audit
services with two new findings. First, we show that increases in non-audit fees are
associated with increases in market share. A significant stream of literature examines audit switching, focusing on client characteristics such as size and growth to
proxy for agency costs (Defond and Zhang 2014). Our evidence shows that companies also switch to obtain non-audit services, a result that is new (or underappreciated). Second, we find a negative association at the firm level between audit
and non-audit fees, suggesting complementarities between the two types of services
at the audit firm-level rather than the individual company level. Most studies that
examine the relation between audit and non-audit fees do so at the individual company level, with mixed results (Causholli et al. 2010). Because audit fees now represent less than half Big N revenues, better understanding the relationship between the
two types of services seems important.
Finally, we introduce the “endogenous fixed costs” models of Sutton (1991) to
the accounting and auditing literature as a parsimonious organizing model to explain
audit market concentration. The models of Sutton (1991) are widely used in the
economics literature to explain concentration but appear to be underappreciated in
10
These findings—that the underlying economic mechanism that is a partial explanation for concentration is investment in sunk costs (Sutton 1991, 2007)—have implications for policy in regard to recent
technological developments such as data science and AI (which resembles the emerging use of computers in the late 1970s in our data and period). Recent technological advances may give rise to similar
opportunities and thus an arms race of investment in sunk costs by professional accounting service firms,
with resulting benefits to the economy. This relates to the Demsetz (1973) critique, which argues that
large, dominant firms are more likely to be efficient and deliver higher quality products than other firms,
and that their success is due to this efficiency rather than market power. Because investments in sunk
costs are very risky (there can be only a few winners), it is important that incentives for an ex ante longrun return on investment to the accounting firms (and society) is not removed by regulatory concerns and
anti-trust intervention.
11
Evidence on the impact of recessions on fees is largely restricted to the Global Financial Crisis in the
United States (Krishnan and Zhang 2014; Ettredge et al. 2014).
Why did the Big Four get so large? Evidence from Australia
the audit and accounting literature. This framework offers useful implications for
addressing auditing research questions.12
Our evidence has certain limitations. First, its longitudinal nature makes it difficult to draw causal inferences, particularly since different explanations for audit
market concentration are complementary and overlapping.13 For example, we show
that the emergence of market concentration and the Big Four is associated with both
demand-side and supply-side factors, as detailed above. Second, we only have data
on audit firms’ public company clients; in Australia, many audit clients were (and
are) private entities, including government and quasi-government entities. However,
the public company sector is important in its own right, and we show, using data on
the total fees generated by these firms, that size rankings of audit firms using total
fees and fees only from public company clients are highly correlated.
Third, it is hard to be sure the forces that led to the Big N in Australia are the
same as those that led to the Big N elsewhere; it seems likely that links to Big N
firms in the United States and United Kingdom helped Australian firms grow. We
show, however, that some Australian firms became part of the Big N without international links, and that there is no difference in the growth rates of Big N predecessor firms with and without such links. As noted above, the Australian setting allows
us to provide longitudinal evidence on a central, longstanding, and unresolved issue
in the auditing literature that is simply not possible using data from other countries,
including the United States and United Kingdom.14 Wootton and Wolk (1992) and
Wootton et al. (2003) offer anecdotal evidence that forces similar to those we discuss
12
As a simple illustration, under the Sutton (1991) framework, the large audit firms will have significant
fixed sunk costs and lower marginal costs due, for example, to increasing investment in AI, data science, and information technology. Thus, any estimation of, for example, the determinants of audit pricing needs to have a regression model that reflects this type of fixed cost production function for Big N
firms. The audit pricing literature largely assumes that audit costs (and audit pricing) are variable. See
Berry et al. (2019, pp. 54–55) for an illustrative discussion of the use of the Sutton (1991) framework for
empirical economic questions.
13
As Gow et al. (2016) and Armstrong et al. (2022) point out, it is not always possible to obtain quasiexperimental evidence and often useful to provide descriptive evidence, especially as a complement to
other evidence.
14
Australia is perhaps the only market (and likely the only common law market) for which we have time
series data that pre-dates audit market concentration and the Big N. The Big Eight emerged before the
1960s in the United States and United Kingdom (Zeff 2003; Wootton and Wolk 1992). According to Zeff
(2003), the term “Big Eight” was first used (or popularized) in a 1960 article in Fortune. Recent evidence
from China is also helpful although the Chinese economy and capital markets are quite different from
those of common law countries, such as Australia, the United States, and United Kingdom. According
to Macve (2020), the central government in China played and continues to play an important role in the
development of the audit market in that country including the period during which that market became
concentrated. (He discusses a number of other unique features of the audit market in China.) Gong et al.
(2016) study audit firm mergers in China and find different results for mergers involving the international Big Four and the domestic “Big 10” firms. In discussing increased concentration since 2000, they
state, consistent with Macve, that the “change in the audit market is mainly promoted by the government
with the purpose of improving efficiency and core competency and protecting market shares (of domestic firms against the international Big 4)” (p. 466, emphasis added). Kitto (2024) also observes that the
Gong et al. (2016) results are unlikely to generalize outside China.
C. Ferguson et al.
were important in explaining the emergence of the Big N in the United States (and
globally).15 Our setting provides large sample support for these ideas.
2 Theories and testable predictions
The industrial organization literature provides three explanations for concentration: (1) random growth; (2) systematic economic mechanisms, including sunk cost
investments (Sutton 1991, 2007); and (3) mergers. We use these explanations as
a framework for our analysis of audit market concentration and also consider the
extent to which links to firms in the United States and United Kingdom explain the
emergence of the Big N in Australia, a complementary explanation.
2.1 Random growth
Skewness of firm size is one of the most robust regularities in economics. Economists put forward random growth, under which large firms grow through an ongoing
sequence of positive shocks, to explain why a few firms become very large.16
Under this view, audit market concentration occurs because some audit firms had
clients that grew large, and these firms grew to the scale necessary to service and
retain these clients.17 The argument is not that companies generally grew and that
this led to increases in audit firm size; rather, it is that a small number of companies
become large—it is an argument about increased concentration. This view implies a
natural connection between increased concentration in the underlying product (and
capital) markets and that in audit markets.18
2.2 Sunk costs
Industrial economists argue that the nature of costs helps determine industry structure. Sutton (1991) argues that concentration can arise when firms invest to differentiate their products, which allows them to grow and acquire share. Sutton refers
to sunk cost investments and argues that the nature of sunk costs in an industry
15
These authors point to size, geographic reach, and the types of sunk cost investments we discuss (e.g.,
in staff training, audit methods, industry specialization) as being important in explaining the emergence
and growth of the Big N in the United States.
16
The distributions of many economic variates are skewed, including income, wealth, city size, and
stock returns (Gabaix 2009).
17
This argument requires that audit engagements are not divisible. While dual auditors were a feature
of the audit market in Australia in the early part of our sample period, this practice was later eliminated,
strengthening the link between audit firm size and the size of clients.
18
See Kwon et al. (2023) for evidence on increased corporate concentration in the U.S. over the last 100
hundred years. Wootton and Wolk (1992) and Wootton et al. (2003) argue that the growth of clients led
to increased concentration in the U.S. audit market, which they support through examples and anecdotal
evidence. For example, Wootton et al. (2003, p. 33) discuss growth of the emerging Big N in the 1950s
and state: “It was also a period in which size became an important consideration for many firms because
of two factors. The first reason … was that greater size was needed to serve increasingly larger clients.”.
Why did the Big Four get so large? Evidence from Australia
determines its structure. He distinguishes exogenous from endogenous sunk costs.19
Exogenous sunk costs depend on technology and determine firms’ minimum efficient scale in each product market. If exogenous sunk costs are all that is important and technology is held constant, concentration declines as market size increases
(and more firms achieve minimum efficient scale). Alternatively, if improvements in
technology lead to economies of scale that increase minimum efficient scale, those
increases can outstrip growth in market size such that concentration increases with
market size. This argument likely applies to auditing (Dopuch and Simunic 1980;
Eichenseher and Danos 1981; Danos and Eichenseher 1986; Francis and Stokes
1986).
Sutton argues that endogenous sunk costs are also important in some industries
and points to advertising and R&D as examples. These costs are endogenous in the
sense they are firm choices and sunk in the sense they are irreversible.20 By incurring sunk costs firms differentiate their products, which increases demand. Sutton
describes an arms race in which firms aggressively increase spending to increase
market share.
If endogenous sunk costs are important, concentration increases with market size
because a larger market supports increased investment. We argue that endogenous
sunk costs are important in auditing and likely include investments in industry specialization, staff training and recruitment, non-audit services, brand, reputation, and
advertising—all of which allow firms to differentiate and grow. DeAngelo (1981a,
b) argues that large audit firms arose because they made client- and industry-specific
investments that helped differentiate their services, consistent with this story.
Investments in audit technology can also be seen as endogenous sunk costs. Kinney (1986) characterizes audit technology along a continuum from structured to
unstructured and finds that higher staff-to-partner ratios (“leverage”) are associated
with more structured technology (also see O’Keefe et al. 1994). Doogar and Easley (1998) predict and find a relation between audit firm production functions and
market concentration. These authors observe that audits are indivisible, so client
size directly affects audit firm size (as we argue above). Like Kinney, they use the
staff-to-partner ratio to proxy for audit technology.21 The idea is that leverage varies across firms, depending on the relative productivity of partners, which increases
with greater use of technology, and that concentration arises from the interaction of
client size distributions, audit technology, and the indivisible nature of audits. This
relates closely to our arguments about the importance of client size and sunk cost
investments and the relation between them.
19
The Sutton framework has been widely applied; Sirois and Simunic (2011) also apply it to auditing
while Dick (2007) applies it to banking and Ellickson (2007) to supermarkets.
20
As Breshnahan (1992) points out, these costs are also fixed. By way of example, in the early years of
the U.S. soft drink industry, Coke and Pepsi invested heavily in advertising to develop their brands and
differentiate their products, which led to a two-tiered structure (Sutton 1991).
21
Kitto (2024), discussed further below, provides recent evidence from the United States that uses this
measure. He shows that mergers between “fringe” non-Big Four firms result in improvements in audit
efficiency that is due to a reduction in partner hours relative to staff hours, consistent with enhanced audit
leverage.
C. Ferguson et al.
Explanations for audit market concentration are related and complementary.
For example, as audit firms hired more staff to increase capacity and retain larger
clients, they likely made sunk cost investments in technology, brands, and reputation (DeAngelo 1981b; Doogar and Easley 1998). These arguments are consistent
with anecdotal evidence from Australia during the relevant period.22 In relating the
history of Coopers & Lybrand in Australia, Falcus (1993, pp. 184–185) notes the
following23:
How can we account for Coopers & Lybrand’s impressive growth? Various
background factors, certainly, were favourable. For much of the 1970s and,
following a sharp recession in 1980-82, the 1980s, there was a high level of
economic activity in the Australian economy, and particularly rapid development of the mining and energy sectors. At the same time the corporate structure grew and became more complex, marked by numerous mergers, the
appearance of giant conglomerates and holding groups, and the increasing
presence of large multi­national corporations. All this meant growing demand
by major clients for the services of the leading accounting firms, often on
a scale where only the largest of the firms could provide the range of services required.
These, and other economic changes, brought demand for particular services
beyond the traditional confines of accounting firms. … All these services grew
strongly and there were opportunities for expansion into new areas... More
than ever partners were appointed as ‘specialists’ in particular areas. A
sign of the times came in 1978 with the identification of certain partners
as ‘industry specialists’ and over the next few years various specialist
industry groups (in mining, insurance, banking and finance, and so on)
were formed to supplement the technical divisions. At the same time the
computer revolution was changing the techniques of accountancy in both
traditional and new areas, bringing huge opportunities for further development (emphasis added).
22
Along with client company growth, clients were becoming more complex (in part because of acquisitions), which necessitated both larger audit firms and greater audit capabilities. Consider the following examples. According to CHARTAC​, an “independent, monthly digest of latest accounting news and
developments” (October 1976, No. 2, p. 4), Yarwood Vane audited CSR, Australia’s second largest public company at the time, for which the audit fee “rose sharply” due to CSR’s acquisition of Australian
Estates (the December/January 1976–1977 issue reports that the audit fee more than doubled in a year,
from $394,000 in 1975 to $897,000 in 1976). As another example, the February/March 1977 issue of
CHARTAC​reported that the Dunlop Group “would have possibly the biggest accounting bill in Australia
– $996,000 in the year to June.” According to its finance director: “It (the large audit fee) was not a matter of being overcharged but was rather a function of the complexity of the group. For a start there are
180 subsidiaries, all of which required audit. And the fact that Dunlop ran a number of major businesses
such as a chain of more than 200 tyre outlets nationally, a textile group … and Australia’s biggest footwear operation meant that the auditors had to visit about 1000 locations.”.
23
Coopers was the largest Australian firm in the early 1980s. Falcus (p. 184) provides a table that
reports, for Coopers, the number of offices, partners, and staff in 1976 (when the national firm was
founded), 1981, and 1985. Over this period, the number of offices grew from 25 to 47, the number of
partners from 94 to 198, and the number of staff from 1,120 to 1,891.
Why did the Big Four get so large? Evidence from Australia
We provide more specific examples from Australia from CHARTAC​ at various
points.24 Anecdotal U.S. evidence from Wootton and Wolk (1992) and Wootton
et al. (2003) suggests the factors we discuss—including M&A in the corporate sector and the growth and increased complexity of client companies—were also important in explaining the emergence of the Big Eight in the United States. Related, the
need for geographic reach—both within the United States and internationally—was
also important.25 Many of the larger firms merged with local firms to address this.
(This allowed them to obtain the necessary personnel, including their local knowledge, as well as their clients, which helped to finance expansion.)26 The Wootton
papers point to the fact that, in the 1940s, Chrysler effectively required its audit
firm to be a national organization to give it the necessary reach to audit its business:
“This stipulation, together with a shortage of personnel, encouraged Bailey to merge
his firm with two established firms” (p. 33).27
Recent evidence from the United States is further consistent with our interpretations and evidence. The general theme of this work is that the U.S. market for audits
has become more segmented over time, with greater differentiation between Big
24
Consider the following example from CHARTAC​ (July 1984, No. 86): “The decision by Duesburys
Melbourne to join E&W … was partly influenced by (its) bleak views about the ability to compete with
the large firms: ‘we see ourselves in a difficult intermediatory situation of having a big practice but not
having it big enough to provide all of the upmarket services that the big guys can do. That’s the guts of
it.’”.
25
CHARTAC​ (Nov. 90, November 1984) notes that Burns Philp, a large Australian shipping and merchant company that had operated across the South Pacific since the 1880s, put its audit work up for
tender in 1983–1984, and that Peat Marwick Mitchell & Co (a Big N firm) won the audit. The article
notes: “The audit is one of the biggest in Australia, one of the most complex and certainly the biggest
to go to tender.” Burns Philp had previously been audited by a smaller firm, Binder Hamlyn. The article notes that as part of the process Burns Philp’s audit fee was cut in half, from about $1.6 million to
$800,000. (Binder Hamlyn was subsequently acquired by Ernst & Whinney.) It goes on to explain that
the large reduction was possible due to “audit methodology” and that the “Big Nine … has modern sampling documentation and staff training systems” and that “(h)ad Binder Hamlyn applied latest techniques
the (Burns Philp) board may not have been obliged to seek a review.” The article then discusses how
Peat Marwick won the audit in competition with other Big Nine firms. The main factor was apparently
geographic reach and expertise across the Pacific: “Peat Marwick won the board vote mainly, it seems,
because of its ability to service offshore operations. While price was important, it was not the key factor.
Arthur Andersen, an early front runner … failed at the board level because the firm had limited offshore
presence. AA wanted the BP audit very keenly. It admitted up front it did not have the Pacific coverage.
But it pledged to BP that it would open offices in PNG (Papua New Guinea) and Fiji staffed by top people. BP was impressed but believed that AA would take time to gain local experience. While E&W has
offices in PNG and Fiji, it proposed to cover some BP operations (e.g., in the Solomons) through other
firms. This factor worked against it.”.
26
Audit firms, unlike corporate entities, could not easily obtain financing from the capital markets or
banks.
27
Wootton et al. (2003, pp. 38–39) attribute the following to Arthur Young’s senior partner in 1965:
“in today’s environment, any public accounting firm that serves large clients must itself be large” which
he attributed to two forces. First, the operations of large companies are spread throughout the world and
“highly skilled personnel [are needed] in each of the corporation’s key locations.” Second, to provide
such highly skilled personnel requires “an extensive program of recruitment and training… [such] programs are extremely costly, and without a large volume of business few firms would be able to support
them.”.
C. Ferguson et al.
Four and non-Big Four firms and their clients, with the mechanisms at play similar
to those we describe above.
Aobdia et al. (2021) show that, beginning in the late 1990s (and before the Sarbanes–Oxley Act of 2002 (SOX)), the U.S. audit market became increasingly bifurcated, with the Big N shedding “en masse” the smallest and riskiest public company
clients, which went to non-Big N auditors. They attribute this to a change in market
conditions (the dot-com bubble of 1998–1999 and crash in 2000–2001). The arguments and evidence are similar to those we advance and test during the transition of
the Australian capital market, particularly in the 1970s and 1980s.
Duguay et al. (2020) show that a positive demand shock to public company audits
due to SOX (i.e., the mandated expansion of public company audits to include testing of clients’ internal control environments) combined with an inelastic labor supply (qualified audit personnel) led to bifurcation of the audit market. They show that
private companies switched auditors, from large Big Four firms with public company clients to smaller audit firms that were less likely to have public company clients and so less subject to the demand shock and related capacity constraints. This is
consistent with our argument in that it indicates there is a natural matching of audit
firms and clients (and a natural bifurcation of the audit market) based on client characteristics that necessitate differentiated audit firm capabilities and technology. An
important feature of the market highlighted by Duguay et al. is the limited supply of
qualified audit personnel. There is anecdotal evidence of a similar phenomenon in
Australia during the late 1970s and early 1980s, when the Big N were emerging—
this helps explain why the Big N had to be selective in how they expanded (and why
there was acquisitions of smaller firms).28
Lawrence et al. (2011) argue and show that differences in measured audit quality
between Big N and non-Big N audits that previous authors attributed to higher quality Big N audits are in fact more likely due to differences in the clients themselves.
This is broadly consistent with our arguments and evidence in the sense that our
view, in brief, is that the Big N emerged due to the changes in the nature and size of
their clients. We are largely agnostic about audit quality–similar to Lawrence et al.,
there is nothing inherent in our arguments about Big N scale and sunk cost investments that necessarily implies they deliver higher audit quality. We view sunk costs
28
The September/October 1978 issue of CHARTAC​ contains an article that describes a report on the
“demand for and supply of accountants in Australia over the five years 1977–1982” titled “Demand/Supply 1977/82 Shortfall Predicted” which, among other things, noted that there were around 55,000 qualified accountants in Australia at that time and predicted that demand would exceed supply by 1982, with
excess demand of around 3,500. Consistent with this, a December 1981 CHARTAC​ article titled “Salary explosion-winners and losers” reported that “Arthur Young is privately telling selected clients that it
expects to lift salaries by 20 per cent in 1982. Other large firms are gearing for similar increases. At the
big-firm level, partners know that the salary increases are essential to keep and recruit staff… firms… are
having problems finding audit and accounting/tax staff…” and that they will “…offset some of the salary impacts with increased efficiency arising from new technology…” The January/February 1985 issue
noted “the demand for experienced accounting staff is currently outstripping supply.”.
Why did the Big Four get so large? Evidence from Australia
investments as being necessary to sustain (not necessarily increase) audit quality as
clients became larger and more complex.29
2.3 Mergers, acquisitions, and international links
The accounting literature tends to attribute audit market concentration to mergers,
perhaps because of the visibility of the mergers that resulted in the Big Four, which
raised concerns about the effects of these mergers on competition (e.g., Carmichael
1997; Minyard and Tabor 1991).
Although regulators generally, including in the auditing context, tend to view
mergers with suspicion because of concerns they are motivated by firm incentives
to gain market power, M&A can also be motivated by the economic forces we discuss above (including synergies and efficiencies due to greater scale). M&A is a
way to quickly increase an audit firm’s scale and capabilities, to expand (including
across different geographies) as well as a form of endogenous sunk cost investment,
for example, to acquire expertise in different services and industries. Anecdotal evidence supports this, both in the United States (Wootton et al. 2003) and during our
sample period in Australia.30
Kitto (2024) analyzes mergers among non-Big Four firms in the United States
from 2004 through 2016. He finds that these mergers increase competitiveness
between fringe non-Big Four firms and the Big Four, with a resulting improvement
in audit efficiency. (He finds that audit hours, measured at the client level, decline
after these mergers for in-market but not out-of-market mergers.) This evidence is
broadly consistent with ours in terms of mechanisms and findings. Specifically, he
argues that the mergers allow non-Big Four firms to acquire the scale necessary to
compete with the Big Four for certain types of clients in certain market segments
and finds that these mergers allow merging firms to better compete with dominant
firms, which previously held a competitive advantage in terms of lower costs or a
superior product.
Globalization likely also helps explain the emergence of the Big N as networks
that span many countries (Carson 2009). The existence of global networks is consistent with the sunk cost argument—by investing in links to firms in other countries, Big N firms in the United States and United Kingdom could retain and attract
29
Because of data limitations, we cannot provide evidence on audit quality (i.e., we simply don’t have
access to even rudimentary measures of audit quality, such as the data necessary to measure accruals,
restatements, etc.).
30
See the Burns Philp example above, which noted the merger between Binder Hamlyn Melbourne and
Ernst & Whinney (the smaller firm lost the Burns Philp audit due to lack of size, including geographic
reach, and lack of the audit technology the Big Nine could offer).
C. Ferguson et al.
multinational clients as these entities expanded across the world.31 This point is also
discussed in the literature (e.g., Wootton et al. 2003, pp. 31–32).
We argue that such international links cannot fully explain audit market concentration in Australia. While some Australian firms were affiliated with the Big Eight
in the United States or United Kingdom by the 1960s (Andersen, Cooper Brothers,
Peat Marwick Mitchell, and Price Waterhouse operated in Australia under some version of those names by the mid-1960s), others (Fell & Starkey, Hungerfords, and
Yarwood Vane & Co.) had no international links until the mid to late 1970s but nevertheless grew and competed with the other large firms. Appendix 2 Table 13 details
how the Big N firms in Australia evolved, including links to the Big Eight in the
United Kingdom and United States.32 Forces outside Australia are likely important
in explaining the transition from the Big Eight to the Big Four.33
Nevertheless, the tendency of the Big N in Australia to use international brands,
which all of them had adopted by the mid-1980s, is consistent with the importance
of branding to differentiate their services and so consistent with the endogenous
sunk cost view.34
2.4 Does increased concentration make the audit market less competitive?
Sutton (1991) describes investment in sunk costs as an arms race that leads to
increased market concentration but suggests this does not necessarily reduce
31
According to Falkus (1993, Ch. 4), in 1947 the Unilever group in the United Kingdom was jointly
audited by Price Waterhouse and Cooper Brothers & Co. Around this time there was the prospect of a
new U.K. Companies Act that would require consolidated accounts and gave “powerful impetus … to
appoint a single firm of auditors.” The Australian subsidiary of Unilever (the Lever Group) was the largest client of Allard, Way & Hardie, a Sydney-based firm affiliated with Coopers. This created the impetus
for Coopers and Allard Way & Hardie to formalize their relationship (and for Coopers U.K. to form links
with firms in other Australian states)—Allard Way & Hardie signed an agreement with Cooper Brothers and renamed itself Cooper Brothers, Way & Hardie on Jan. 1, 1948; Cooper Brothers made similar
arrangements with Allard Way affiliates in Perth and Brisbane. All of this was driven by the concern that
Price Waterhouse would be chosen as sole auditor of the Unilever Group in the United Kingdom and
Australia. (Price Waterhouse had joined with the “large interstate (Australian) firm of Flack & Flack” in
1947, likely for similar reasons.).
32
Before the 1960s, Australian firms’ links to the Big Eight internationally were simple “fees for service” arrangements. Most Australian firms with links to the Big Eight remained regional firms until the
1960s and 1970s; with the exception of Andersen, Big N predecessor firms in Australia did not become
unified national firms until the 1970s. For example, Cooper Brothers operated as a loose network of separate firms in the main cities in the 1960s and first half of the 1970s and did not become a unified national
firm until 1976 (Falkus 1993). Abrahams (2006) tells a similar story for firms in each state that operated
under the Edwin V. Nixon name and eventually became part of EY.
33
The global networks did not fully emerge until the late 1970s. Although the Big Eight emerged in the
United States and United Kingdom before the 1970s, these were not always the same firms across countries. Wootton et al. (2003) discuss how Deloitte, Haskins, & Sells was formed in 1978 by the merger of
Deloitte, Plender, Griffin, & Co. (United Kingdom) with Haskins & Sells (United States). In 1979, Ernst
& Ernst (United States) merged with two U.K. firms, Whinney, Murray & Co. and Turquand, Barton,
Mayhew & Co., to form Ernst & Whinney.
34
Hungerfords did not use an international brand until 1990, when it joined KPMG Peat Marwick. Ernst
& Whinney adopted the international brand name in 1984, and Deloitte, Haskins & Sells in 1980. See
Appendix 2 Table 13 for details.
Why did the Big Four get so large? Evidence from Australia
competition. Economic theory also recognizes that concentration does not necessarily reduce competition (Baumol et al. 1982; Stiglitz 1997; Satterthwaite 1979).
Similarly, papers in the auditing literature argue that increased concentration may
not reduce competition (Simunic 1980; Gerakos and Syverson 2015). However, little
work directly examines the implications of audit market concentration for competition and pricing, and those studies that do exist are primarily cross-sectional.35
3 Summary and predictions
Based on the above, we test the following principal predictions, acknowledging that
most of our evidence is descriptive due to its longitudinal nature, and that different
explanations for audit market concentration are related.
• We expect that, if technology or other sunk cost investments allow some firms
to differentiate their services and expand as the market grows, concentration
increases and leads to a two-tiered market structure. Further, as market size
increases, we expect mean audit firm size to increase while median audit firm
size (a proxy for minimum efficient scale) stays constant.
• To investigate the relation between client size and audit firm size, we analyze
sources of audit firm growth, and predict that organic growth (from existing
clients) will be relatively more important (than mergers) if audit firms grow
because some clients become very large.
• We expect that the emergence of concentration (and the Big N) is associated
with firm investments in endogenous sunk costs, including non-audit services,
advertising, technology (measured by leverage), and industry specialization.
• We expect that, if increased concentration reduces competition, it will be associated with lower rates of client switching and a lower propensity for Big N firms
to be price-takers in the market for audit services. We present evidence on trends
in audit fees (per dollar of client assets) to examine whether prices change to
reflect changes in production costs, as expected in a competitive market, as well
as on audit switching.
4 Sample and data
Australia mandated the disclosure of audit fees beginning in 1962, followed by
non-audit fees in 1973.36 We obtain these data, along with data on public companies’ auditors, total assets, and other variables from (a) the AGSM database,
35
Pearson and Trompeter (1994) find that audit market concentration is negatively associated with audit
fees while Bandyopadhyay and Kao (2004) find no association and Willekens and Achmadi (2003) find a
positive association. Numan and Willekens (2012) examine spatial competition in the United States and
find that audit fees increase in distance to the closest competitor. We discuss more recent work, such as
Aobdia et al. (2021) and Kitto (2024), above.
36
The Australian states adopted the Uniform Companies Acts in 1961 and 1962, which mandated disclosure of audit fees in 1962. Similar legislation mandated disclosure of non-audit fees in 1973.
C. Ferguson et al.
from 1950 to 1985; (b) the Craswell (1999) database, from 1980; (c) Morningstar, from 198537; (d) auditor names from Jobson’s yearbooks, from 1959 until
1979; and (e) company annual reports (if data not available elsewhere), from
2000 onward. Appendix 1 Table 12 provides definitions and sources for variables used in our analyses.
AGSM oversampled larger companies before 1977. We address this in two ways.
First, we perform a number of tests from 1973 to 1988 to limit the impact of years
before 1977. Second, we conduct some tests solely in the post-1977 period not
affected by this issue.
Our analyses are limited to audit firms’ public company clients—we cannot obtain data on audits of unlisted entities. To partially address this issue,
we obtained data from CHARTAC​ on total fees from all clients for the largest
10 audit firms in Australia (available in certain years), which we compare to
our public company data. These data show that rankings of audit firms by
fees are highly correlated whether one looks at public company fees or fees
from all clients. 38
5 Evidence
We present evidence in four subsections. We first report on how audit market structure changed over the 61-year sample period (1962–2022), including
the emergence of concentration and the Big N and how this relates to changes
in the company size distribution, in particular skewness. Second, we present
evidence on how audit firms grew over time and examine the three primary
explanations for concentration: (1) random growth; (2) sunk cost investments
by the Big N predecessor firms, which we measure using the provision of nonaudit services, industry specialization, advertising, and investments in technology; and (3) mergers. Third, we provide evidence on Australian firms’ links to
the Big N in the United States and United Kingdom. Finally, to shed light on
whether increased concentration made the market less competitive, we present
evidence on audit pricing and the extent of switching over time.
37
Aspect Huntley (now owned by Morningstar) is a standard financial database for Australian public
companies.
38
CHARTAC​ data from 1977 provides estimates (from nonpublic data) of total billings of the 10 largest audit firms at that time. (This set, ranked by size, is Coopers & Lybrand, Peat Marwick Mitchell,
Price Waterhouse, Yarwood Vane, Touche Ross, Arthur Young, Arthur Andersen, Hungerfords, Fell &
Starkey, and Irish, Young & Outhwaite.) According to CHARTAC​, this group had total billings of $125
million; when we compare this to our data (audit and non-audit fees for public company clients), the coverage is 31% overall and ranges from 19% (Arthur Anderson) to 45% (Touche Ross). The correlation in
size rankings of firms based on CHARTAC​and in our data is 0.92. Similar data from February 1984 (for
1983 billings) yields a correlation of 0.89.
Why did the Big Four get so large? Evidence from Australia
5.1 Audit market structure, concentration, and company size
5.1.1 Audit firm size and concentration
We first present evidence on the structure of the Australian audit market from 1962
to 2022. Table 1 reports the number and size of audit firms along with measures
of concentration. To measure audit firm size, we aggregate audit fees by firm (in
constant 2022 Australian dollars) and report results for five-year subperiods:
1962–1965, 1966–1970 … 2016–2020, 2021–2022.39
Table 1 shows two distinct patterns that indicate a systematic increase in audit
market concentration over the sample period. First, the number of audit firms
declines by over 60%, from 187 in 1962–1965 to 68 in 2021–2022. Second, there
is a consistent, substantial increase in average but not median audit firm size over
this period. (Median firm size increases through the early 1970s, declines through
the early 1990s, and then stabilizes before increasing after 2005.) Fig. 1 shows the
market share of Big N (including predecessor) firms over this period, which, consistent with Table 1, shows that the Australian Big Nine emerged during the 1970s
and early 1980s.
Table 1 reports two measures of concentration—the Herfindahl Index and Big N
market share—calculated using audit fees. (We obtain similar results using number
of clients or client assets.)40 We plot these series in Fig. 2. The Herfindahl Index
increases from 0.02–0.03 in the 1960s to 0.16 by the early 1990s and 0.23 by the
2000s—clear evidence that the audit market went from little or no concentration in
the 1960s to significant concentration later in the sample period.
The market share numbers in Fig. 1 depict the role of the Big N in the increased
concentration evident in Table 1. The nine firms that become the Big N account for
around 35% of the market in the early 1960s, although this overstates concentration because at that time these firms operated in different cities as separate, loosely
affiliated firms.41 By 1977 the combined share of these firms had jumped to 65%
and most were integrated national firms. By 1992, the Big Six share was over 80%
and by 2002, after the demise of Andersen and the PwC merger, the Big Four share
exceeded 90%. After 2002, the Big Four share levels off or falls.42
39
This excludes non-audit fees, which were not available until 1973. We report shorter subperiods at the
beginning and end of the sample period.
40
Prior research also uses the Herfindahl-Hirschman index (HHI) to measure audit market concentration
(e.g., Duguay et al. 2020). The index is computed as the mean of the sum of squared market shares of all
firms measured using audit fees. The U.S. Department of Justice considers 0.15 to 0.25 to indicate moderate concentration.
41
For example, each office/location had its own billing and partner compensation systems. Falkus
(1993, Ch. 8) reports that it took more than a decade for the various Coopers affiliates in different states
and territories to combine into a national firm (Coopers & Lybrand) in 1976. Similarly, Abrahams (2006,
p. 73) states: “Until 1969, each of the offices of Edwin V. Nixon & Partners operated as an independent
entity, linked by their mutual use of the Nixon name …” (This firm subsequently became part of Arthur
Young and ultimately EY.).
42
The slight decrease in the Big N share of the market since 2002 is partly due to a strategy by two midtier firms, BDO and Grant Thornton, to grow via mergers and acquisitions. The BDO/Grant Thornton
percentage share of listed audit fee market has grown from 1.5% in 2002 to 6.4% in 2022. This is simi-
C. Ferguson et al.
This evidence shows that the Australian audit market started to become concentrated in the mid to late 1970s.43 Qualitative evidence from contemporaneous
sources confirms the Big N had emerged and were recognized as such by the early
1980s. Based on a review of CHARTAC​, the first references (to the Big 10 in Australia) occur in 1977, with more frequent references by 1981 and 1982 and frequent
references (to the Big Nine) by 1983 and 1984.44 As a result, we take the mid-1980s
as the time by which these firms had emerged.45 Appendix 2 Table 13 provides a
chronology of the adoption by Australian firms of the international Big Eight names
(as they existed at that time) and shows the Australian firms were using these names
by the mid-1980s. Also consistent with this, the Herfindahl Index had increased to
above 0.15 (the U.S. Department of Justice concentration threshold) by the early
1990s.46
5.1.2 Client company size and audit market concentration
The explanations for concentration—random growth, sunk costs, and mergers—are
underpinned by an increase in both overall market size and skewness in company
size. In this section, we document the increase in skewness and investigate whether
it is associated with increased concentration and the growth of non-audit services, a
proxy for endogenous sunk cost investments.
Table 2 reports on the size distribution of Australian public companies from 1962
to 2022, with size measured as total assets.47 We report mean, median, and skewness, along with aggregate market size, by subperiod. We measure skewness as:
[(
) (
)]
SKEW i = Qi75 − Qi50 − Qi50 − Qi25 ∕QRi,
Footnote 42 (continued)
lar to the phenomenon recently documented by Kitto (2024), discussed above, in the United States. The
decline in the Big Four share during the 2000s is generally consistent with what is observed in the United
States (e.g., Aobdia et al. 2021). The increase in median firm size after 2005 evident in Table 1 suggests
consolidation among the largest non-Big N firms, as has occurred in the United States.
43
These numbers likely understate the level and trend in concentration because they exclude non-audit
fees, which become both substantial and disproportionately attributable to the Big N, as we show below.
44
This is based on a count of references to the Big 10, Big Nine, etc., in articles in CHARTAC​. Before
1977 there was no mention of Big N; in 1977, 1978, and 1979 there was one mention each year.
CHARTAC​was first published in 1976.
45
A history of Coopers & Lybrand in Australia refers to the Big Nine in Australia in 1982 (Falkus
1993). We take the nine firms (including their antecedents) included there as the Big N in Australia from
1962 through 1982; see Appendix 2 Table 13 for details. By 1982, these nine firms had an aggregate
share of just over 70% (Fig. 1).
46
Using the data that underlies Table 1 and Fig. 2, the Herfindahl index jumps from 0.10 in 1989 to 0.15
in 1990.
47
In constant 2022 Australian dollars. As discussed above, before 1977 the sample used in this table
comprises only 30% to 40% of listed Australian companies; in constructing its sample over this period,
the AGSM database over-sampled larger firms. Because of this, the trends we report in this section likely
understate the extent to which average company size and the skewness of the company size distribution
increases over time.
Why did the Big Four get so large? Evidence from Australia
Table 1 The size of Australian audit firms and audit market concentration, 1962–2022
Market
Audit Firm Characteristics:
Period
Average Number Mean ($A)
of Firms
1962–1965
187
1966–1970
192
1971–1975
Concentration:
Median ($A)
Herfindahl Index
Big-N Share
325,235
92,134
0.0227
0.2717
491,645
116,278
0.0317
0.4090
177
992,005
186,494
0.0459
0.5128
1976–1980
186
1,553,197
144,493
0.0604
0.6379
1981–1985
158
2,111,538
103,027
0.0721
0.6888
1986–1990
154
2,860,477
93,429
0.1078
0.7254
1991–1995
127
3,049,866
86,436
0.1554
0.8413
1996–2000
111
3,569,521
92,966
0.1759
0.8957
2001–2005
103
4,973,774
93,937
0.2304
0.9092
2006–2010
95
8,791,341
149,057
0.2355
0.8966
2011–2015
83
8,769,511
147,803
0.2227
0.8868
2016–2020
77
9,668,357
148,852
0.2125
0.8678
2021–2022
68
11,760,615
237,850
0.1970
0.8465
Table reports number and size of audit firms in Australia along with two measures of market concentration over the 1962 to 2022 period. Audit firm size is measured in each year as the sum of audit fees from
public company clients. Average number of firms is the number of audit firms in a given year averaged
over the years in each subperiod. Market concentration is measured using the Herfindahl Index and Big
N market share calculated using audit fees. The Big N is defined as the largest nine audit firms in Australia in 1982 and predecessor firms in years before 1982. Amounts are constant 2022 Australian dollars
where IQRi = Qi75 − Qi25 and SKEW is normalized to between − 1 and + 1; 0 indicates a symmetric distribution.48
Table 2 shows that skewness of company size is largely unchanged during the
1960s and 1970s: mean and median company size show no clear trend, and SKEW
(plotted in Fig. 2) stays around 0.5 (which indicates the expected right-skew). Skewness increases thereafter, to around 0.6 in the 1980s and to 0.70 in the early 1990s,
0.74 in the early 2000s, and 0.78 by 2016–2020. These trends are also evident in
increases in the mean and standard deviation and a decline in the median through
2011–2015.
Table 2 shows that the overall size of the market, measured by aggregate client
assets (in constant 2022 dollars), increases substantially from the 1960s through
2006–2010. As discussed in Sect. 2, if minimum efficient scale does not change,
one would expect concentration to decline as the market grows and more firms enter.
This is not the case here. As evident in Table 1, even though median audit firm
size (a proxy for minimum efficient scale) shows little clear trend over much of the
48
This measure is also used by Konstantinidi and Pope (2016) and Correia et al. (2018). See Hinkley
(1975) and Kim and White (2004).
C. Ferguson et al.
1.0000
0.9000
0.8000
0.7000
0.6000
0.5000
0.4000
0.3000
0.2000
0.0000
1962
1963
1964
1965
1966
1967
1968
1969
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
2022
0.1000
Herfindahl Index
Skew
Big N Share
Fig. 2 Skewness of company size and measures of audit market concentration: 1962–2022
sample period,49 concentration increases steadily through the early 2000s. This suggests that a simple growth in company size/economies of scale story cannot explain
audit market concentration, an important result.
Figure 2 plots SKEW along with the Big N market share and Herfindahl index
numbers from Table 1. SKEW jumps from 0.51 in 1977 to 0.61 in 1981, which is
notable because it means this increase is not an attribute of data availability. (The set
of available company data changes in 1977, as discussed above.) This timing—from
the late 1970s to early 1980s—coincides with the increase in Big N market share
and our qualitative evidence on the emergence of the Big 9 discussed above and suggests these trends are related.
To investigate this further, Table 3 reports OLS regressions that provide evidence
on the over-time relation between concentration, SKEW, and a proxy for endogenous
sunk cost investments. We estimate time-series regressions of concentration (Herfindahl Index) on three lagged regressors: SKEW, the ratio of market-wide non-audit
fees to total fees (NAF/Allfees), and median audit firm size (to proxy for minimum
efficient scale). We estimate these regressions over 1973 to 1988, the period concentration emerges. (Non-audit fee data are not available before 1973.) Because these
variables evolve slowly, these regressions should be viewed as descriptive.
Table 3 first reports a simple regression of concentration on SKEW. The coefficient on SKEW is positive and highly significant and the R-squared is 0.57, consistent with SKEW and audit market concentration moving together over time. Column
49
Economists use median plant or firm size to proxy for minimum efficient scale (e.g., Davies 1980;
Sutton 1991, p. 99).
Why did the Big Four get so large? Evidence from Australia
Table 2 Size (total assets) of Australian public companies, 1962–2022
Aggregate
Period
Companyyears
1962–1965
1,467
1966–1970
2,010
1971–1975
Mean ($K)
Median ($K)
Std. Devn. ($K)
Skew
Market
($M)
314,198
78,754
1,266,474
0.508
115,232
521,008
94,999
2,854,378
0.507
209,445
2,293
799,354
124,418
4,665,930
0.478
366,584
1976–1980
3,763
649,212
76,521
4,232,682
0.505
488,597
1981–1985
4,268
836,125
57,172
6,590,254
0.638
713,716
1986–1990
6,485
1,004,127
43,367
9,654,536
0.625
1,302,353
1991–1995
5,238
1,519,311
35,437
13,760,377
0.704
1,591,630
1996–2000
5,747
2,269,548
54,975
21,246,722
0.680
2,608,618
2001–2005
6,535
2,630,674
37,338
27,387,276
0.738
3,438,292
2006–2010
7,892
3,343,799
42,708
38,244,031
0.722
5,237,059
2011–2015
7,319
3,778,023
33,014
50,518,362
0.745
5,530,270
2016–2020
7,389
3,772,511
25,360
53,412,996
0.783
5,575,016
2021–2022
2,897
3,717,231
35,102
53,919,174
0.750
5,384,409
Table reports descriptive statistics, computed in periods indicated, on the size of Australian public companies, measured as total assets in thousands of constant 2022 Australian dollars over the 1962 to 2022
period. Aggregate Market is the aggregate total assets for all public companies in a given year in $ millions of constant 2022 Australian dollars. The sample comprises all public companies with available data
on total assets in the years indicated
(2) regresses concentration on NAF/Allfees. The coefficient on NAF is positive and
highly significant and the R-squared is 0.78, evidencing a strong over-time relation,
as expected if endogenous sunk costs drive concentration. When we include both
variables (Column (3)), the coefficient on SKEW remains positive but is no longer
significant (t = 1.61), while that on NAF remains positive and significant, consistent with the simple regressions; the adjusted R-squared is 0.83.50 Column (4) adds
median firm size to test for an overall scale effect on concentration. Consistent with
our argument that increased concentration is not simply a scale/size story, this variable is insignificant.51 Taken together, these results suggest that increases in SKEW
and NAF lead increases in concentration, as expected if increases in the size of a
small number of clients (increased capital market concentration) and endogenous
sunk costs drive audit market concentration.
50
These variables are likely collinear, which would explain the drop in coefficient size for SKEW. The
correlation between SKEW and NAF is 0.68, between SKEW and MES is -0.54, and between MES and
NAF is -0.09.
51
This result is not surprising: as evident from Table 2, median audit firm size declines and then flattens
from the early 1970s through the early 2000s. As discussed in Sect. 2, under a simple economies-of-scale
argument, one would expect median firm size to increase through the period over which the market grew,
which is not what we observe.
C. Ferguson et al.
5.2 Explanations for audit market concentration
5.2.1 How did audit firms grow?
We next report on how Big N predecessor firms grew, to assess the relative importance of (i) growth due to increases in the size of existing clients, (ii) growth due to
client switching, and (iii) growth due to audit firm mergers. Observing growth that is
mainly organic is consistent with our prediction that Big N firms grew due to growth
of their clients.
We measure firm growth as the percentage change in total audit fees for each
firm-year, separated into four categories:
1. Growth from existing clients: measured as the change in fees from existing clients;
2. Growth through mergers and acquisitions: two (or more) existing firms combine
and adopt a shared or new name, or increases in fees from firms acquired during
the year (all clients of an existing firm switch to the firm during the year and
existing firm ceases to exist);
3. Switch gains: growth due to client switches to the firm;
4. Switch losses: negative growth due to client switches away from the firm.
We report these measures for 1962–1979, 1980–1988, and 1989–2022, which
separates the pre/emerging Big N period (1962 to 1988) from the post-emergence
Big N period.
Table 4 first reports mean (median) growth rates for the Big N (including predecessor firms) over the three subperiods. We find that average (median) equalweighted annual growth is 21.6% (21.5%) over 1962–1979, 21.4% (16.6%) over
1980–1988, and 10.3% (10.1%) over 1989–2022.52 The first two subperiods show
strong growth, reflecting increases in the size of the largest public companies and
audit firms documented in Tables 1 and 2, and (underlying both) that the Australian economy grew rapidly over the late 1960s and 1970s, in part due to the mining
boom and a proliferation of M&A among listed companies.53
Growth from existing clients is the largest source of growth for Big N firms
in all periods, especially in the first two subperiods as the Big N emerged. For
1962–1979, growth due to existing clients averages 14.8% annually, compared to
52
These growth rates are in nominal terms and include the effect of inflation which, based on the CPI
produced by the Australian Bureau of Statistics, was 1.6% (1962–1979), 2% (1980–1988), and 2.8%
(1989–2012). Results are similar if we measure growth using client assets rather than fees (untabulated).
53
Falkus (1993, pp. 94–95) writes: “It is crystal clear that an even more profound turning point (in firm
growth) had occurred during the period of about five years between 1969 and 1973. These years witnessed a huge growth in the volume of business, stimulated by a mining boom and a wave of corporate
activity.” As one example, audit fees for BHP, one of Australia’s largest companies, grew from $139,000
in 1972 to $581,000 in 1976, a CAGR of 43% (CHARTAC​, October 1, 1976, p. 3). Also consistent with
the high growth rates shown in the table, there was a 39.7% increase in the total fees (including audit
fees) paid to the firms that audited Australia’s “10 major industrial companies” from 1975 to 1976
(CHARTAC​, December/January 1976–1977, No. 4, p. 5).
Why did the Big Four get so large? Evidence from Australia
Table 3 Time-series determinants of audit market concentration, 1973 to 1988
Parameter
Intercept
Estimate
Estimate
Estimate
Estimate
(1)
(2)
(3)
(4)
−0.038
0.033
(1.71)*
Skewt-1
(0.69)
0.188
(4.62)***
NAF/AllFeest-1
0.072
0.021
(1.61)
(0.30)
0.246
0.192
0.186
(4.97)***
(3.05)***
(2.93)***
MedianAuditFirmsSizet-1
0.000
(0.97)
R-Square
0.573
0.782
0.827
0.837
Obs
16
16
16
16
Table
reports
specifications
of
the
following
time-series
regression:
Concentrationt = α + β1Skewt-1 + β2Non_AuditFees/TotalFeest-1 + β3MedianAuditFirm_Sizet-1 + ε, where Concentration is the annual audit market concentration in year t (annual Herfindahl Index measured using audit
fees), Skew is skewness of the company size distribution in year t-1 based on total assets, MedianAuditFirm_Sizet-1 is the median audit firm size in year t-1, and NAF/AllFees is ratio of the sum of market wide
non-audit fees to market wide total (audit and non-audit) fees. t-statistics based on Newey-West standard
errors are reported in parentheses. ***, ** or * indicates significance at 0.01, 0.05, or 0.10 levels, respectively
4.7% from mergers and 2.6% from switches. (Medians are not markedly different.)
For 1980–1988, growth due to existing clients is again the most important source
of growth, averaging 15.8% annually, with 7.3% due to inbound switches and only
1.7% due to mergers. (Medians are again similar.) For 1989–2022, growth from
existing clients continued to be the most important source of growth but is smaller
(6.1%), followed by inbound switches (4.0%) and M&A (2.7%).
These results show that the main source of growth for the Big N in Australia was
from existing clients, consistent with these firms growing to retain their largest clients. While this is broadly consistent with random growth, our evidence (including
that below) also suggests these firms made sunk cost investments that helped them
retain large clients. It is difficult to separate cause from effect: did audit firms invest
to keep large clients and grow, or did keeping these clients (and growing) allow them
to invest? Both channels are consistent with the arguments presented in Sect. 2.
5.2.2 Endogenous sunk cost investments
We next provide evidence on whether the growth of Big N predecessor firms and
the resulting market concentration was associated with sunk cost investments. We
use four proxies for sunk cost investments: non-audit services fees; leverage (ratio
of staff-to-partners, a proxy for audit technology), industry specialization, and advertising. We first examine, at the firm level, whether the emerging Big N firms made
larger investments in non-audit services and audit technology than non-Big N firms.
Second, we examine whether switching increases after 1984, when the profession first
C. Ferguson et al.
Table 4 Sources of growth for Big N audit firms (including predecessor firms), 1962 to 2022
1962–1979
Overall growth, equal-weighted
Overall growth, value-weighted
1980–1988
1989–2022
21.6
21.4
10.3
(21.5)
(16.6)
(10.1)
19.3
20.2
11.2
(16.5)
(18.2)
(10.5)
Sources of growth:
Existing clients
Mergers and acquisitions
Switches incoming
Switches outgoing
14.8
15.8
6.1
(15.0)
(14.1)
(5.8)
4.7
1.7
2.7
(4.3)
(0.8)
(1.1)
2.6
7.3
4.0
(1.1)
(6.4)
(3.8)
−0.5
−3.3
−2.5
(−0.4)
(−2.2)
(−1.9)
Table reports mean (median) annual growth rates, in percent, calculated using total audit fees for each
audit firm-year. Acquisitions occur when all clients of an existing firm switch to a firm during the year
and the existing firm ceases to exist. Mergers occur when two or more existing audit firms combine and
adopt a shared or new name. Equal-weighted growth rates are computed by equal weighting individual
growth rates of each firm. Value-weighted growth rates are computed by weighting the growth rate of
each firm based on its size (measured as fee revenues). Sources of growth are equal-weighted
allowed audit firms to advertise and promote their services.54 We then use companylevel data to examine whether these endogenous sunk costs investments are associated with switches to the Big N, an analysis that also folds in industry specialization.
Most of the analyses focus on the period from 1973 to 1988, when the Big N
emerges; we predict an increase in sunk costs investments across this period by the
emerging Big N firms.
Differentiation through investment in non‑audit services We use the relative size of
non-audit services fees at the audit-firm level to proxy for investment in non-audit
services (the capability to deliver non-audit services) beginning in 1973, when nonaudit fee data become available.55 Figure 3 plots cumulative percentage growth in
median firm non-audit fees for Big N and non-Big N firms from 1973 to 1988, with
54
We do not expect a clean effect of this change in the profession’s rules and do not interpret this as
an exogenous regulatory shock—the profession in Australia consisted of the firms themselves, and we
expect that, as the Big N emerged in the later part of the 1970s and early 1980s, these firms pushed for
rules that facilitated their ability to differentiate. There is anecdotal evidence (from CHARTAC​ issues
one to two years before the rule change) that larger firms were (mostly) pushing for these changes while
smaller firms resisted such changes.
55
Previous work examines the impact of non-audit services on audit fees in the cross-section at the individual company (i.e., client) level, with mixed results (e.g., Causholli et al. 2010, p. 192). A possible
explanation for the mixed results is that decisions to invest in the capability to provide non-audit services
are made at the audit firm level because the benefits accrue to firms through the development of expertise
and production efficiencies (and resulting reputational effects) as expected under the arguments in Sect. 2.
Why did the Big Four get so large? Evidence from Australia
1973 as the base. Table 5 compares non-audit fees across Big N and non-Big N
firms as well as mean and median ratios of non-audit fees to total fees at the client
level, all for the three subperiods, 1973–1979, 1980–1988, and 1989–2022.
Figure 3 shows substantial growth in non-audit fees from 1973 to 1988 for firms that
emerged to become the Big N; non-audit fees for non-Big N firms also grow but not
to the same extent. This timing coincides with the emergence of the Big N in the mid
to late 1970s. Table 5 shows that, measured in 2022 Australian dollars, between 1973–
1979 and 1980–1988 median non-audit fees for Big N (non-Big N) firms increased
from $3,091,000 ($14,500) to $7,458,000 ($19,900), and so by 141% (38%). Differences between Big N and non-Big N firms and across subperiods are significant at the
5% level or better.56 Further, we find that Big N firms generate this growth as the result
of increasingly concentrated non-audit fees from their largest clients: the top 10% of
these firms’ clients generated 53% of non-audit fees in the 1973–1979 period, 66% in
the 1980–1988 period, and 76% in the 1989–2012 period. Figure 3 plots this fraction
against the growth in non-audit fees and shows how they tend to move together—this
is important, because it links the client size effect to the endogenous cost argument
and shows that part of the mechanism behind the relation between increases in capital
market and audit market concentration is endogenous sunk costs (i.e., the emerging
Big N firms invested in non-audit services to retain clients, especially large ones).
Table 5 also reports client-level ratios of non-audit fees, which tell a similar story.
For 1973–1979, the median non-audit fees fee ratio is larger for Big N firms (9.2%
versus 3.4%). The difference becomes larger in 1980–1988 (20.1% versus 14.0%)
and larger still in 1989–2022 (22.4% versus 8.6%). Differences between mean and
median ratios for Big N and non-Big N firms are highly significant in all subperiods.
All of this supports our prediction that sunk cost investments by Big N firms played
an important role in their growth and the associated increase in concentration.
Differentiation through technology: Leverage effects The literature contains little
direct evidence on audit production functions, which are mostly unobservable. Previous authors use staff-to-partner ratios to proxy for the use of technology to leverage partner time (Kinney 1986; Doogar and Easley 1998).57 Because investment in
technology represents a sunk cost, we predict that staff-to-partner ratios increase for
Big N firms relative to those of non-Big N firms around the time they emerge.
We obtain staff-to-partner ratios for the top 20 Australian firms from 1980 to 1996
and compare ratios for Big N and non-Big N firms over this period.58 The results
56
These statistics are likely inflated due to non-independence of the pooled firm-year observations.
Kitto (2024) provides more recent evidence that mergers among non-Big Four audit firms led to more efficient audits and reports that this increase in efficiency was reflected in an increase in the staff to partner ratio.
57
58
Data from CHARTAC​. These data are not available beyond this period and are missing for 1981–1983.
Anecdotal evidence supports our view that these ratios were important in practice. In discussing the proposed merger between Price Waterhouse and Deloitte, Haskins, & Sells, CHARTAC​ (September 1984,
No. 88) observed: “As the table on page 3 shows, DH&S is less efficient. The firm has a relatively poor
staff/partner ratio … From PW’s point of view DH&S is over-partnered.” The table shows a staff/partner
ratio of 9.1 for PW versus 6.6 for DH&S, lowest of the Big Nine. The October 1984 (No. 89, p. 2) issue
reports an average ratio of 6.3 for the 11 “top second tier” firms versus an average of 8.5 for the Big Nine
consistent with the Big N using technology to a greater extent.
C. Ferguson et al.
(Table 6) are consistent with the predicted difference emerging over this period. In
1980, average staff-to-partner ratios for Big N and non-Big N firms are about the same,
at around eight and not reliably different at the 5% level. In 1984, the next year with
data, the ratio is higher for Big N firms, at 9.4 versus 6.2 (difference significant at the
5% level). The ratio continues to increase for Big N firms through 1989, after which
it stabilizes (at around 12). In contrast, for non-Big N firms the ratio remains between
six and eight for most of the period and is significantly smaller (at the 1% level or better) than for Big N firms in all years after 1984. The over-time increase (from 1980 to
1985–1988) is statistically significant for Big N but not non-Big N firms. These differences are also economically significant and suggest the Big N invested in technology
that allowed them to enhance audit efficiency relative to non-Big N firms.
Differentiation through advertising and promotion The Australian accounting profession removed restrictions on advertising and promotion in 1984. We expect this
allowed Big N firms to further differentiate their services, and that this, in turn, led
to switching as larger, more complex clients switched to the Big N while smaller,
less complex clients switched away from the Big N to avoid fee premia.59,60
Table 7 reports rates of switching to Big N and non-Big N firms before and after
advertising restrictions were lifted in 1984. Switching rates were relatively low
before 1984, at around 2% to 3% for Big N and non-Big N firms. The rate of switching increased after 1984, as we expected. The rate of switching to Big N (non-Big
N) increased from 2.5% (2.1%) the year before the change to 4.3% (3.9%) the year
after, with both changes significant at the 5% level. The numbers for two-year periods before and after are similar: rates of switching increased from 2.4% (2.5%) to
4.5% (4.1%), with changes significant at 1% (5%). If we look at five-year periods,
the difference remains about as large for Big N firms (increase from 2.3% to 4.3%,
significant at the 1% level) but is no longer significant for non-Big N firms. This evidence supports the prediction that switching generally increased and provides some
support for the idea that switching increased more for Big N firms.
Are switches to the Big N associated with investments in endogenous sunk
costs? The evidence above suggests that emerging Big N firms made larger investments in non-audit services and technology than non-Big N firms, consistent
with the endogenous sunk cost argument, and that client switching to Big N firms
increased after 1984. We next investigate whether these results are related—we
59
There was no specific restriction against audit firms soliciting clients during this period although
anecdotal evidence from CHARTAC​ suggests this was unusual and seen as unprofessional through the
early 1980s, before the removal of these restrictions. These data also suggest that tendering was quite
common later in the 1980s.
60
Audit switching results from audit firm-client mismatch due to either client-specific changes (demandside effects) or changes in the services offered by audit firms (supply-side effects). Most prior work is
cross-sectional and focuses on auditor switching due to demand-side changes in client characteristics
such as size (e.g., Johnson and Lys 1990; Brown and Knechel 2016). Research that examines supply-side
effects is limited to a few studies that examine changes in strategy of the audit firm (e.g., Shu 2000).
Why did the Big Four get so large? Evidence from Australia
0.8
1400%
1200%
0.7
800%
0.6
600%
0.5
400%
Portfolio Concentratiom
Growth in Agregate NAF
1000%
200%
0.4
1988
1987
1986
1985
1984
1983
1982
1981
1980
1979
1978
1977
1976
1975
1974
1973
0%
-200%
0.3
Cumulative % Growth in NAF for Non-Big N
Cumulative % Growth in NAF for Big N
Big N Portfolio Concentration
Fig. 3 Cumulative Percentage Growth in Non-Audit Fees and Portfolio Concentration. Figure reports,
on left-hand scale, cumulative percentage growth (from a base in 1973) of median annual aggregate nonaudit fees per audit firm (in 2022 real Australian dollars). Audit firms are partitioned into Non-Big N and
Big N. Figure also reports, on right-hand scale, client portfolio concentration for Big N firms, measured
as percentage of annual non-audit fee revenue produced by the largest 10% of clients
expect clients that are larger, growing, and with more demand for non-audit services
and industry expertise are more likely to switch to Big N firms, and vice versa.61
We estimate multinomial switching regressions over 1973 to 1988, coding each
company/year observation as no switch, switch to Big N, or switch to non-Big N. In
our base regression the regressors are percentage change in non-audit fees from year
t-1 to year t + 2 (%ChgNAF), a dummy that turns on if the switch is to an industry
specialist (Industry_Spec), company size (Size), and growth of company assets over
the prior three years (Growth). We expect these variables all drive switches to the Big
N. We also include percentage change in audit fees (from year t-1 to year t + 2) but
offer no prediction on sign.62 We estimate an enhanced specification that includes a
dummy for years after 1984 (Post84) along with associated interactions and predict
a positive coefficient due to the expected increase in switching after restrictions on
advertising were lifted and that related effects are larger for Big N firms.
We measure industry expertise using audit firms’ within-industry market-share
and client portfolio-share, based on audit fees (Audousset-Coulier et al. 2016;
61
The notion that auditing particular industries requires industry-specific expertise and helps differentiate the Big N is well established (Eichenseher and Danos 1981; Hogan and Jeter 1999). A stream of
literature examines audit switching, with a primary focus on the role of client firm characteristics, such
as size and growth, which proxy for demand for audit services to address agency costs (e.g., Francis and
Wilson 1988; DeFond 1992; DeFond and Subramanyam 1998).
62
DeAngelo (1981a) and Chan (1999) show that, if the market is competitive, initial audit fees are discounted. However, companies switching to a Big N firm may pay a premium to obtain differentiated or
higher quality services.
C. Ferguson et al.
Table 5 Growth of non-audit fees, 1973–2022
Test of Differences
1973–1979
1980–1988
1989–2022
1980–88
1989–2022
vs. 1973–79
vs. 1973–79
Audit-Firm Year Observations
Median Annual Aggregate Non-Audit Fees per Audit Firm
Non-Big N
$14,469
$19,944
$24,830
(3.0)***
(4.7)***
Big N
$3,091,102
$7,458,357
$58,382,278
(5.3)***
(8.5)***
Difference
$2,076,633
$7,438,413
$58,357,448
Z-stat for difference
(7.5)***
(9.2)***
(13.0)***
Obs. non-Big N firms
1,053
1,352
3,237
Obs. Big N firms
54
80
160
Company-Year Observations
Mean Non-Audit Fee/Total Fees
Non-Big N
0.115
0.207
0.164
(18.3)***
(13.3)***
Big N
0.136
0.250
0.279
(21.9)***
(29.1)***
Difference
0.021
0.043
0.115
t-stat for difference
(4.6)***
(8.6)***
(47.6)***
Median Non-Audit Fee/TotalFees
Non-Big N
0.034
0.141
0.086
(14.1)***
(10.0)***
Big N
0.092
0.201
0.224
(18.6)***
(27.1)***
0.057
0.061
0.138
Z-stat for difference
(8.8)***
(8.8)***
(48.9)***
Non-Big N obs
2,984
3,588
24,768
Big N obs
2,380
5,383
25,862
First panel reports median annual aggregate non-audit fees per audit firm (in constant 2022 Australian
dollars). Subsequent panels report mean and median ratios of non-audit fees to total fees for Australian companies across subperiods, partitioned according to whether they audited by Big N or Non-Big N
firms. t-statistics and Wilcoxon Z-statistics for differences in means and medians, respectively, between
periods and between Big N and non-Big N firms. ***, ** and * denote significance at the 0.01, 0.05 or
0.10 levels, respectively
Minutti-Meza 2013; Neal and Riley 2004). For the within market-share approach,
we define industry specialists as firms with the largest market share in a given
industry-year and for portfolio-share as industry-years in which a firm is among the
three largest in the portfolio.63 We follow Neal and Riley (2004) to combine these
approaches, designating firms as specialists if they qualify under both criteria. We
63
∑J
Skij
i=1
j=1 Skij
For each firm-year industry market share is measured as MarketShareki = ∑I j=1
∑J
. MarketShareki is
the market share of auditor i in industry k, Skij represents the total assets of client firm j in industry k
audited by auditor, J represents the number of clients served by audit firm i in industry k, and I is the
∑J
Skij
number of audit firms in industry k. PortfolioShare = ∑K j=1
where PortfolioShareki is the portfolio
∑J
ki
share of industry k for auditor i.
k=1
j=1 Skij
6
5
1995
1996
205
193
185
169
173
185
185
164
137
138
120
120
115
90
Average Partners
(2.23)**
15
14
14
14
14
14
14
12
12
11
11
11
11
11
Number Firms
Non-Big N
29
41
40
45
47
50
51
51
51
48
47
45
38
29
Average
Partners
139
282
290
346
353
381
422
431
402
352
326
295
231
211
Average Staff
(1.16)
−0.68
4.86
7.11
7.58
7.90
7.91
7.86
8.24
8.02
7.45
7.10
6.62
6.40
6.20
7.58
Average
Staff/Partner
(2.55)**
3.02
5.20
4.69
3.78
4.25
4.38
4.40
5.89
4.93
4.89
4.24
4.26
3.49
3.21
1.21
Staff/Partner
Difference:
(5.87)***
(5.47)***
(3.67)***
(3.69)***
(3.61)***
(3.85)***
(3.98)***
(4.64)***
(3.63)***
(2.97)***
(2.96)***
(2.28)**
(2.49)**
(1.42)
t statistic
Table reports average number of staff and partners for top 20 audit firms from 1980 to 1996 partitioned into Big N and non-Big N firms. Average partners (staff) is annual
average number of partners (staff) in Big N and non-Big N audit firms. Underlying data are from CHARTAC​ (various issues). Data are not available for 1981–1983 inclusive. t-statistics for tests of differences between average staff/partner ratios of Big N and non-Big N firms reported in parentheses. ***, ** or * denotes significance at the
0.01, 0.05 and 0.10 levels, respectively
2.33
10.06
11.80
11.36
12.15
12.29
12.26
14.13
12.95
12.34
11.34
10.88
9.89
9.41
8.78
Average Staff/Partner
t stat
2049
2255
2097
1976
2040
2167
2365
1985
1568
1426
1197
1059
976
783
Average Staff
1985–1988 versus 1980
Tests of Difference Across Time
6
6
1993
1994
6
6
1991
1992
8
6
1989
1990
9
8
1987
1988
9
9
1985
1986
9
9
1980
1984
Number Firms
Year
Big N
Table 6 Staff-to-partner ratios for Big N and non-Big N audit firms in Australia, 1980–1996
Why did the Big Four get so large? Evidence from Australia
C. Ferguson et al.
Table 7 Rate of auditor switching before/after restrictions on advertising were lifted in 1984
5 years before/after
2 years before/after
1 year before/after
Switches to Big N audit firms
Period before:
Number of switches
92
40
21
Total company/years
3,988
1,685
843
Rate
2.30%
2.40%
2.50%
Period after:
Number of switches
237
74
37
Total company/years
5,541
1,638
852
Rate
4.30%
4.50%
4.30%
Chi-square test
26.4***
10.9***
2.1**
Switches to Non-Big N audit firms
Period before:
Number of switches
111
42
18
Total company/years
4,007
1,687
840
Rate
2.80%
2.50%
2.14%
Period after:
Number of switches
175
67
33
Total company/years
5,479
1,564
848
Rate
3.20%
4.10%
3.89%
Chi-square test
1.28
6.34**
2.1**
Table reports number and percentage of client companies that switched to Big N and non-Big N auditors
in years before and after 1984, when restrictions on promotion/advertising were lifted by the Australian
profession. ***, ** or * indicate statistical significance for Chi-square tests of differences between rates
of switching at 0.01, 0.05 and 0.10 levels, respectively
code the industry-specialist variable as 1 if the new auditor was an industry specialist in the client industry in the year of the switch and 0 otherwise.
Column (1) of Table 8 presents results of the base regression while Column (2)
reports the specification that includes the post-1984 dummy. The analysis spans
1973 to 1988 when the Big N emerges and we expect most switching to occur.
The results generally support our predictions. The results in Column (1) show
that size (negatively associated with switches to non-Big N firms), growth (positively associated with switches to Big N), and industry specialization (negatively
associated with switches to non-Big N) are statistically significant in the expected
direction. In addition, the percentage change in non-audit fees (%ChgNAF) is positively associated with switches to the Big N. In Column (2), we find a positive
coefficient on Post84, which is significantly larger for Big N than non-Big N firms,
indicating a higher rate of switching to the Big N after 1984 (also supported by
the finding that the coefficient on the interaction between Post84 and %ChgNAF is
larger for the Big N than the non-Big N, although this is only significant at the 10%
Why did the Big Four get so large? Evidence from Australia
level). We find some evidence that industry specialization is positively (negatively)
related to switches to the Big N (non-Big N), as expected if this was important
to clients and supplied by the Big N (both significant at the 10% level). Finally,
we find a positive coefficient on the percentage change in audit fees (%ChgAF) for
switches to the Big N, which suggests that companies that switch to the Big N are
willing to pay higher fees, presumably because these firms provide differentiated
services, consistent with our arguments. Overall, these results support our arguments for Big N differentiation playing a role in the growing concentration of the
audit market.
5.3 Mergers and international links
Table 4 shows that mergers were not an important source of growth for the Big N in
Australia. Nevertheless, it could be that links to Big N firms in the United States and
United Kingdom explain which firms emerged as the Big N. While this mechanism
seems likely to have been important for some firms, the question is whether it was
necessary–could firms become part of the Big N without such links?
To investigate this, we compare growth rates of Big N predecessor firms that had
links to Big N firms in the United States or United Kingdom to those of Big N predecessor firms without such links from 1965 (by which time some firms had such
links) through 1979.64 We classify Price Waterhouse, Peat Marwick, Andersen, and
Cooper Brothers as firms with international links in the 1965–1979 period and Yarwood Vane, Fell & Starkey, and Hungerfords as firms without such links (Appendix 2 Table 13). We classify E. V. Nixon & Partners as being without links through
1973 (the year before it joined Arthur Young) and Spry Walker & Co. as without
links through 1974 (the year before it joined Touche Ross).
The results (untabulated) indicate that mean (median) annual growth rates are
23.3% (18.3%) for firms without international links versus 24.0% (17.5%) for firms
with international links, with differences not significant at the 5% level.65 We also
examined whether there were differences in merger activity or rate of client switching. Using univariate and multivariate tests (untabulated), we find no reliable differences in the rate of switching to firms with and without international links, and
that merger activity is greater for domestic firms than firms with international links.
This evidence is inconsistent with the idea that international links were necessary
for Australian firms to become part of the Big N.
64
Using this period results in an approximately equal number of firms with and without international
links. In 1980 (1984) Yarwood Vane (Fell & Starkey) established links to Deloitte Haskins & Sells
(Ernst & Whinney) internationally.
65
These firms were different in size at the start of the sample period in 1965. Firms with international
links had mean size of $173,000 versus $113,000 (in 1965 dollars) for firms with no international links,
which are statistically different at conventional levels. These differences are consistent with international
links contributing to firm growth prior to our sample period, international firms selecting larger Australian firms as affiliates, or both.
C. Ferguson et al.
5.4 Audit market competitiveness
We next examine how increased audit market concentration affected competition.
First, we provide evidence on how the rate of audit switching changed as the market
became more concentrated (switching indicates the availability of substitutes and so
of market competitiveness; e.g., Ghosh and Lustgarten 2006). Second, we examine
how audit pricing was affected by recessions. (If firms are price-takers, it is more
likely the market is competitive.) Third, we provide evidence on how audit pricing
(fees) evolved for Big N relative to non-Big N firms as the market became more concentrated over the sample period.
5.4.1 Audit switching
Table 9 reports overall rates of switching as well as rates of switching to Big N
and non-Big N firms over the 1962–1969, 1970–1979, 1980–1988, and 1989–2012
subperiods. For the market as a whole, the rate of switching increases from 1.75%
in the 1960s to 3.13% in the 1970s, 6.47% in the 1980s, and 7.96% over 1989–2022,
inconsistent with a decline in competitiveness. The table shows similar results for
Big N and non-Big N firms considered separately.66
5.4.2 Audit fee changes during recessions
Research shows that client pressure during the Global Financial Crisis led to a
reduction in audit fees (Krishnan and Zhang 2014; Ettredge et al. 2014). Following
this work, we expect that recessions reduce the fees clients are prepared to pay for
audit services. More important, we examine whether there is a difference in the ability of Big N versus non-Big N firms to resist this fee pressure and if any such differences increased across time as concentration increased. (If increased concentration
increases the market power of Big N firms, they should be better able to resist fee
pressures during recessions.)67
There were three recessions in Australia during the sample period, in 1982–1983,
1991–1992, and 2008–2009 (Stonecash et al. 2018, p. 376). To estimate fee pressure, we compare mean and median changes in annual audit fees as well as the fraction of clients for which fees declined in recession and non-recession years (from
1962 to 2022).68
66
Chi-squared tests indicate that differences in rates of switching between the most recent subperiod
and the 1960s and 1970s (but not 1980s) are statistically significant at better than 1% for the market as a
whole as well as for Big N and non-Big N firms considered separately.
67
Many audit pricing studies examine audit fee premia, for example, for industry specialization and in
general, but because price–cost margins are not observable and due to endogeneity, it is difficult to distinguish the effects of payments for expertise or quality from the effects of market power on pricing (Hay
et al. 2006; Causholli et al. 2010, p. 198; Numan and Willekens 2012; Gerakos and Syverson 2017).
68
We winsorize this measure (at the first and 99th percentiles) to minimize the influence of extreme
changes due to small denominators. The conclusions are the same if we do not winsorize these data.
Why did the Big Four get so large? Evidence from Australia
Table 8 Multinomial regressions of audit switching decisions over the period from 1973 to 1988
Column (1)
Column (2)
Switch to Big N
Coeff
Z-stat
Coeff
Z-stat
Constant
−4.23
8.77***
−4.44
8.73***
Size
0.02
0.69
0.00
0.07
Growth
0.08
2.81***
0.07
2.21**
%ChgNAF
0.12
3.00***
−0.04
−0.35
%Chg AF
0.08
2.44**
0.15
2.81***
Industry Spec
0.29
1.16
0.62
1.76*
1.07
5.37***
Post84
%Chg NAF*Post84
0.14
1.25
% Chg AF*Post84
−0.11
−1.60
Industry Spec*Post84
−0.59
−1.10
Switch to Non-Big N
Constant
−2.68
8.34***
−2.68
7.67***
Size
−0.05
2.73***
−0.06
3.03***
Growth
0.02
0.65
0.03
0.98
%ChgNAF
0.07
1.54
0.11
1.34
%Chg AF
0.04
1.28
−0.07
−0.94
Industry Spec
−1.68
2.88***
−1.04
1.75*
Post84
0.44
2.44**
%Chg NAF*Post84
−0.12
−1.18
% Chg AF*Post84
0.14
1.61
Industry Spec*Post84
−13.95
−0.02
Number of obs
Pseudo-R2
6,902
6,398
0.022
0.037
p-values from the following coefficient comparisons between Big N and non-Big N:
Size
0.03
Growth
0.17
%ChgNAF
0.37
Industry Spec
0.00
Post84
0.02
%Chg NAF*Post84
0.08
Industry Spec*Post84
0.99
Table reports results from the following pooled multinomial regression estimated over the 1973 to 1988
period:
Switch = α + β1Size + β2Growth + β3%ChgNAF + β4%ChgAF + β5IndustrySpec + β5Post84 + β6%ChgAF*Post84 + β7%ChgNAF*Post84 + ε, where Switch for company i in year t is coded no switch,
switch to Big N audit firm, and switch to non-Big N audit firm. Independent variables: Size is client company log total assets in year t-1; Growth is client company percent growth in total assets over the three
years ended in year t; %ChgNAF is percentage change in non-audit fees (NAF) measured from end of t-1
to t + 2; %ChgAF is percentage change in audit fees (AF) measured from end of t-1 to t + 2; IndustrySpec
is a dummy variable set to 1 if the new auditor is an industry specialist (details provided in text). Post84
is a dummy variable set to 1 for years after 1984. ***, ** or * indicates significance at the 0.01, 0.05 and
0.10 levels, respectively
C. Ferguson et al.
Table 9 Audit switching, 1962–2022
1962–1969
1970–1979
1980–1988
1989–2012
All firms
0.0175***
0.0313***
0.0647
0.0796
Non-Big N
0.0171***
0.0355***
0.0727
0.1057
Big N
0.0187***
0.0260***
0.0593
0.0545
Table reports fraction of companies that switch auditors by subperiod partitioned into swtiches to nonBig N and Big N auditors. *** denotes significance at 0.01 level for a Chi-square test of differences in
frequency of switching in a given subperiod relative to 1989–2022 subperiod
Table 10 presents the results. For non-recession years, the mean (median) change
in audit fees is 14.5% (7.4%), and fees decline in 28% of company-years. Increases in
fees are lower in all three recessions, suggesting that clients extract fee concessions
(smaller increases or reductions) during recessions, consistent with the work cited
above. For the three recessions, the mean (median) change in audit fees is 12.1%
(6.9%), 7.9% (2.4%), and 11.4% (5.1%), respectively, all of which are lower than in
non-recession years; all differences (versus non-recession years) are significant at
better than 1% (except the median for the 1982–1983 recession). The percentage of
fee reductions tells a similar story—for the three recessions, fees decline in 29.6%,
40.0%, and 37.0% of company-years versus 28.4% in non-recession years, with differences again significant at the 5% level. Overall there is no evidence that the extent
of fee concessions in recessions declines as market concentration increased.
The table also reports differences between Big N and non-Big N firms. Differences are insignificant in the 1982–1983 and 1991–1992 recessions but are significant in the Global Financial Crisis. In the crisis, audit fees increased significantly
less for Big N clients (mean and median of 6.2% and 2.0%) than non-Big N clients (15.7% and 8.8%), and a significantly larger fraction of Big N clients received
reductions (43.4% versus 31.7%). This is the opposite of what would be expected if
the Big N exercised market power to influence prices. Overall there is no evidence
that the Big N has greater ability (due to purportedly greater market power) to resist
downward fee pressure than non-Big N firms.69
69
These results might be explained by differential changes in client characteristics over time and across
Big N and non-Big N firms. To address this, we estimated an audit fee model (e.g., Hay et al. 2006): ∆l
nFeeit = α + βitRECESSIONit + βiBIGNit + βitRECESSION*BIGNit + γ.Controlsit + εit. where ∆lnFeeit is the
log-change in audit fees for firm i in year t. RECESSION is set to 1 in recession years and 0 otherwise. A
negative coefficient on this variable indicates an abnormal decrease in audit fees during recession years.
BIGN is set to 1 for companies audited by a Big N firm and 0 otherwise. Following the audit fee literature, we control for the level and change in total assets, profitability, leverage, ARINV (the sum of
receivables and inventory on total assets), and a loss dummy. Standard errors are clustered by year and
audit firm. Conclusions remain the same. The coefficient on RECESSION is negative and statistically
significant for all three recessions. The coefficient on RECESSION*BIGNit is not statistically different
from zero for the 1982–1983 and 1991–1992 recessions but is negative and significant for the 2008–2009
recession, consistent with the Big N making larger fee concessions during the Global Financial Crisis.
Why did the Big Four get so large? Evidence from Australia
5.4.3 Levels of audit pricing
In general, firms earn normal returns (no economic rents) under competition. The
market for Big N audits could be competitive, even if these firms earn Big N
fee premia if those premia reflect normal returns on different cost structures that
reflect larger sunk cost investments, which gives rise to two predictions.70 First,
in a competitive market, as cost structures change, pricing should also change.
Second, if the Big N emerged due to sunk cost investments that gave rise to different cost structures, differential pricing would naturally also emerge. To test
this, we next present evidence on audit costs, proxied by company-year level
audit fees deflated by total assets; see Table 11 and Fig. 4, which plots median
ratios by year.
Figure 4 and Table 11 clearly show that, although the trend is not monotonic, audit
fees for non-Big N firms tend to increase over the sample period, with the median
increasing from 0.094% in 1962–1969 to 0.153% in 1970–1979, falling to 0.142% in
1980–1988, before increasing to 0.303% after 1988. The overall increase is substantial
in economic terms and suggests fixed costs increasing relative to variable costs (i.e., an
increase in per unit costs that manifests more strongly for small company audits).
In contrast, audit fees for the Big N generally display a flat to declining pattern
after the 1970s, and the two series diverge strongly in the late 1980s (Fig. 4). In
the 1962–1969 period, audit fees are 0.10% and close to those for the non-Big N
(differences not statistically significant). Similar to non-Big N firms, these numbers
increase (to 0.17%) in 1970–1979. After this, however, fees for Big N firms decline,
to around 0.14% in 1970–1979 and then to 0.13% in the 1989–2022 period, less than
half of that for the non-Big N (of 0.30%); this difference is highly significant.71 This
difference is consistent with differential cost structures emerging over time for Big
N and non-Big N firms, as expected if these firms have increasingly differentiated
products and production functions, as suggested by our earlier evidence.72
The relatively lower per unit fees for Big N audits may seem inconsistent with
the notion that endogenous sunk costs are larger for Big N firms. Relatively lower
fixed costs for Big N audits can arise for two reasons. First, clients of non-Big N
firms tend to be smaller companies for which fixed audit costs are relatively large.
Second, the Big N may be better able to exploit economies of scale that arise, at
least in part, from sunk cost investments. The fixed costs of auditing large public
companies are likely to be greater in absolute terms. To efficiently audit these
companies requires that Big N firms make larger investments in sunk costs that
70
The evidence above is generally consistent with this. For example, our evidence on the emergence
of differences in staff-to-partner ratios for Big N versus non-Big N firms is consistent with Big N firms
investing in technology to enhance staff utilization (efficiency), implying differences in production functions and cost structures.
71
Z-statistics for differences are likely overstated due to the non-independence of company-year observations. However, annual differences in median per unit fees between Big N and non-Big N are statistically significant for most years after 1988.
72
The evidence can only suggest differences in cost structures, given that we can only observe prices.
C. Ferguson et al.
Table 10 Impact of recessions on audit fees, 1962–2022
%Chg Audit Fee
%Decrease
Recession Period
Obs
Mean
Median
AF
No Recession
33,181
0.174
0.103
0.245
1982–1983
1,511
0.296
0.121
0.069
(5.76)***
(5.22)***
(3.7)***
0.024
0.400
1991–1992
1,655
0.079
(9.38)***
(10.54)***
(11.15)***
2007–2008
2,788
0.114
0.051
0.370
(7.61)***
(11.15)***
(7.66)***
Incidence of audit fee reductions for clients of Big N and Non-Big N firms during recessions:
1982–1983
Non-Big N
608
0.124
0.064
0.305
Big N
903
0.119
0.071
0.291
(0.24)
(0.71)
(0.45)
Non-Big N
619
0.074
0.0093
0.417
Big N
1,036
t-stat
1991–1992
t-stat
2007–2008
0.081
0.0283
0.391
(0.34)
(1.02)
(0.80)
Non-Big N
1,502
0.157
0.088
0.317
Big N
1,286
0.062
0.020
0.434
(6.29)***
(5.39)***
(4.87)***
t-stat
Measures of percent (and incidence) of changes in audit fees for recession and nonrecession years over
1962–2022 (recession periods are 1982–1983, 1991–1992, and 2008–2009). %ChgAuditFee is annual
percentage change in audit fees; we report means and medians for all company-years. %DecreaseAF is
percentage of companies for which audit fees decline. Test statistics from tests of differences between
recession and nonrecession years and between Big N and Non-Big N are reported in parentheses.***, **
or * indicates significance at the 0.01, 0.05 or 0.10 levels, respectively
can be leveraged using their greater scale, consistent with our evidence that Big
N firms have higher leverage than non-Big N firms.
We next examine the relation between audit and non-audit fees over time. A
significant stream of audit literature examines the relation between non-audit and
audit services, premised on Simunic’s (1984) argument that the joint supply of
audit and non-audit services requires client-specific knowledge. Most studies analyze cross-sectional data at the company level and overall find mixed and inconclusive results. As noted by Causholli et al. (2010), the prediction is that there is
a negative relation between audit fees and non-audit fees because the efficiencies
and complementarities that result from the provisions of both types of services
result in lower costs, which are passed along to clients. They discuss the difficulty
of testing this and the mixed evidence. We argue that these efficiencies are likely
most important at the audit firm level (e.g., because the firm has to invest in the
talent, training, and infrastructure necessary to deliver non-audit services) rather
Why did the Big Four get so large? Evidence from Australia
Table 11 Evidence on audit pricing (fees), 1962–2022
1962–1969
1970–1979
1980–1988
1989–2022
All firms
0.00095###
0.00158###
0.00138
0.00200
Non-Big N
0.00094###
0.00153###
0.00142
0.00303
Big N
0.00100###
0.00167###
0.00135
0.00127
Z-stat for difference
1.15
2.91***
1.64*
33.55***
Table reports median ratios of audit fees to total assets for Australian public company clients of NonBig N and Big N audit firms, partitioned by subperiod. ***, ** or * indicates statistical significance
from Wilcoxon tests of differences in medians between Big N and non-Big N firms at the 0.01, 0.05 and
0.10 levels, respectively. ###, ##,# indicates statistical significance from Wilcoxon tests of differences
in medians for a given subperiod relative to the 1989–2022 subperiod at the 0.01, 0.05, and 0.10 levels,
respectively
0.0060
0.0050
0.0040
0.0030
0.0020
0.0000
1962
1963
1964
1965
1966
1967
1968
1969
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
2022
0.0010
Non-BigN
Big N
Fig. 4 Audit Fees/TotalAssets. Figure reports annual median ratio of audit fees to total assets for Australian companies partitioned into clients audited by Non-Big N and Big N firms, 1962–2022
than the client level, acknowledging that familiarity with the client is also likely
to offer efficiencies. Our data allow tests through time at the audit firm level.
Figure 5 plots audit fees (median ratios of audit fees to total assets) and nonaudit fees (median ratios of non-audit fees to total assets) for Big N firms from 1973
through 2022, calculated at the firm level. The figure shows that non-audit fees
tended to increase while audit fees tended to decrease through the 1990s, consistent
with a negative relation. When we assess this more directly by calculating correlations, we find a correlation of −0.45 over 1973–1988, consistent with these activities
being complementary. There is also a negative relation for non-Big N firms over this
period, although it is more modest (−0.31), perhaps because of the smaller amount
of non-audit services offered by non-Big N firms (per above). We also find that,
for Big N firms, the correlation reverses after the 1980s—the correlation is + 0.07
over 1989–2012 and + 0.45 for 1989–2022. The likely reason is an overall decline in
non-audit fees for the Big N over this period, driven, at least in part, by increasing
C. Ferguson et al.
concerns about auditor independence (due to the substantial growth of non-audit
fees, particularly for the Big N) and industry pressure to limit non-audit fees.73
6 Conclusions
We use longitudinal data from Australia to provide evidence on the causes and consequences of audit market concentration. Our data begins before the market becomes concentrated and so allows us to explore the forces that led to the emergence of the Big N.
We explore three forces that could drive audit market concentration, recognizing that each likely plays some role and are likely related. We first examine random
growth, under which the growth of public companies, especially very large companies, meant that some audit firms grew as their clients became larger. Second, that
growth of the market allowed certain audit firms to make sunk cost investments—
in brands, human capital, industry expertise, technology, and the ability to offer
non-audit services—to better service large clients, differentiate their offerings, and
increase market share. Third, that the market became concentrated due to mergers.
We first show that the size distribution of Australian public companies becomes
increasingly skewed over time. (The capital market became more concentrated.) Roughly
coincident with this, the audit market, largely fragmented in the 1960s, became concentrated over the 1970s and 1980s and the Big N emerged, with mean audit firm size
increasing through the late 2000s. Median firm size increased over the 1960s and 1970s
but fell in the 1980s, suggesting the scale necessary to audit public companies (minimum efficient scale) stabilized. Because the market continued to expand, this suggests
factors other than simple growth/scale economies are necessary to explain concentration.
Our evidence suggests there was a deliberate (endogenous) investment in sunk costs
by firms that emerged to form the Big N as company size became increasingly skewed.
This includes investments in the capability to provide non-audit services, audit technology (leverage), industry expertise, and advertising. This suggests that increased audit
market concentration can generate positive externalities from a competitive arms race
in endogenous sunk cost investments. This has implications for policy in regard to
recent technological developments such as big data, data science, and artificial intelligence. It is likely (and supported by what we find) that these developments will give
rise to a number of opportunities and thus an arms race of investment in sunk costs by
accounting service firms with resulting benefits to clients. Because these investments
are very risky (there can be only a few winners), it is important that incentives of an ex
ante long-run return on investment to the accounting firms (and their clients and society) is not removed by concerns over concentration and regulatory intervention.
73
While there is no regulation in Australia that caps non-audit services provided by an auditor, there
was increasing industry pressure from the early 2000s, supported by regulation. For example, in 2013
legislation was introduced requiring auditors to publish a transparency report, which usually included the
ratio of non-audit fees to audit fees. Carson (2019) reports that the market for non-audit services declined
from 2012 to 2018. As another example, ANZ, one of Australia’s largest companies, capped non-audit
fees at 5% of total audit and non-audit fees (ANZ 2019).
Why did the Big Four get so large? Evidence from Australia
We find little evidence the audit market became less competitive over time. This
evidence, while only suggestive, is hard to reconcile with the idea that increased concentration reduced competition. We find that the rate of client switching, a measure
of competitiveness, increased over time and is highest in the most recent subperiod
(1989–2022), after the Big N emerged. We also find that audit firms remained pricetakers in response to the downward pressure on audit fees during recessions. The fact
that audit fees tend to decline more in recessions, including in 2008–2009 after the
audit market was concentrated (and did so to a greater extent for Big N firms), is hard to
reconcile with the notion that greater concentration made the market less competitive.
The nature of our evidence—we report long-term trends and examine whether these
trends are consistent with different explanations for audit market concentration—makes
it difficult to formally test alternatives or establish causality. Nevertheless, our longitudinal evidence is new to the literature and complements existing evidence on the Big
N, which is largely cross-sectional (DeFond and Zhang 2014). Further, we provide a
battery of tests that provide largely consistent evidence, along with anecdotal evidence,
that buttresses our conclusions. Considered as a whole, a cogent picture emerges that
audit market concentration is the natural result of economic forces related to increased
capital market concentration, as opposed to being due to large audit firms seeking market power to increase audit fees, lower quality, or both. We find no evidence that the
audit market became less competitive over time, in spite of a striking increase in concentration and the emergence of the Big N.
0.0025
0.0020
0.0015
0.0010
0.0000
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
2022
0.0005
Non-Audit Fees/Total Assets
Audit Fees/Total Assets
Fig. 5 Big N Audit Fees/Total Assets and Non-Audit Fees/Total Assets. Figure reports annual median
ratio of non-audit fees/total assets and audit fees/total assets for Australian companies that were audited
by Big N firms, 1973–2022
C. Ferguson et al.
Appendix 1 Please see Table 12.
Table 12 Variable definitions and data sources
Variable
Definition
Big N
We define the Big N as the Big Nine in Australia in 1982. A
detailed history of Coopers & Lybrand in Australia refers to
the “Big Nine” in Australia in 1982 (Falkus 1993). We take
these nine firms (including their antecedents) as the Big N in
Australia from 1962 through 1982; see Appendix 2 Table 13,
which provides more details. By 1982, these nine firms had
an aggregate share of just over 70% and dominated the market
(see Fig. 1). These firms then merge into the Big Eight and
ultimately the Big Four
TABLE 1 and 2. Descriptive Statistics
Audit Firm Size
Computed each year for each firm as the sum of audit fees of
all companies audited by that firm. Audit fees are measured
in constant 2022 Australian dollars. Nominal audit fees
are adjusted to constant 2022 dollars using the Australian
Consumer Price Index produced by the Australian Bureau of
Statistics
Big-N Share
Annual Big-N share of total audit market measured using audit
fees computed as the annual sum of audit fees of companies
audited by Big-N firms divided by the annual sum of audit
fees of all companies in the sample
Herfindahl Index
The annual Herfindahl–Hirschman Index computed each year as
the mean of the sum of squared market shares based on audit
fees of all firms
Skew
Skewness of the yearly distribution of company total assets
in year t computed as Skew = [(PERC75t − ­PERC50t) − ­(
PERC50t − ­PERC25t)]/IQR where ­PERC75t ­(PERC50t)
is the 75th (50th) percentile of the distribution of total
assets in year t and IQR is the interquartile range defined as
­IQRt = PERC75 − PERC25
Table 3. Time-Series Determinants of audit market concentration, 1973 to 1988,
MedianAuditFirm_Sizet
Median audit firm size in year t where firm size is the sum of
audit fees across all clients in the sample
NAF/AllFees
Annual sum of non-audit fees of all companies in the sample
divided by annual aggregate sum of audit and non-audit fees
of all companies in the sample
TABLE 4. Sources of Growth
Overall growth
Average annual percentage growth in the size of Big N audit
firms across the designated periods. The growth for each audit
firm was computed as audit firm size in year t divided by size
in year size t-1, where is size is measured as the sum of audit
fees of all companies audited by each firm
Growth from existing clients
Average annual percentage growth in size of Big N audit firms
due to growth in audit fees from existing clients
Growth through mergers and acquisitions
Average annual percentage growth in size of Big N audit firms
due to mergers and acquisitions
Switch gains
Average annual percentage growth in size of Big N audit firms
due to new clients that switch from a different audit firm
Switch losses
Average annual percentage decline in the size of Big N audit
firms due to loss of clients that switch to a different audit firm
Why did the Big Four get so large? Evidence from Australia
Table 12 (continued)
Variable
Definition
TABLE 6. Staff-to-Partner Ratios
Average Partner
Annual average number of partners in Big N or non-Big N audit
firms
Average Staff
Annual average number of staff in Big N or non-Big N audit
firms
TABLES 7, 8. Switching Analysis and Regressions
Switch
An ordered yearly variable that takes the value of 0 for no switch
in year t, a value of 1 if company switches to a Big N auditor,
and a value of 2 if a company switches to a non-Big N auditor
Size
The size of the client company measured as log total assets in
year t-1
Growth
Growth is the percentage growth in total assets of the client
company over the three years ending year t
%ChgNAF
The percentage change in non-audit fees after the switch measured from end of t-1 to t + 2
%ChgAF
The percentage change in audit fees after the switch measured
from end of t-1 to t + 2
IndustrySpec
A dummy coded as 1 if the auditor that the client switched to is
an industry specialist (details provided in text)
Post84
Post84 is a dummy variable that takes the value of 0 for the years
before 1984 (1973 to 1983) and the value 1 for the years after
1984 (1985 to 1988)
Data Sources
We obtain audit firm, audit fee, and non-audit fee data from (a) the AGSM database, which contains data for around
half of publicly listed Australian companies from 1950 to 1985; (b) the Craswell (1999) database of audit fees for
listed companies from 1980 to 1999; (c) annual report data on fees paid to auditors of Australian public companies
from 2000 through 2012; and (d) data on auditor names from Jobson’s yearbook for the period from 1959 until
1979. We lose observations for which annual reports (obtained from microfiche in the University of Melbourne
library) are not available. We obtain the company financial variables such as total assets in the period from 1962
to 1985 from the AGSM database. From 1980 to 1985, we obtain these variables from the Craswell database if not
available from AGSM. After 1985 we obtain these variables from the Craswell database and then Morningstar. We
obtain staff and partner numbers from the Australian bi-monthly publication CHARTAC​(self-described as “The
Independent Digest of the Latest Accounting News”)
This appendix provides definitions of variables used throughout the paper. Data sources are indicated at
the bottom of this table
Deloitte, Haskins &
Sells
Yarwood Vane
(1891); Duesbury’s
(1870)
none
Allard, Way, & Hardie 1933
(Cooper Brothers,
(Sydney)
UK)
1913
Coopers & Lybrand
none
1976 (YV becomes
national firm)
1976
1948 (three of five
associated state
firms link to Cooper
Brothers & Co. UK)
1998: Merges with PW
1980 (Deloitte, Haskins Now Deloitte
& Sells)2
1989: Becomes part
of Deloitte, Ross,
Tohmatsu International
1993: Duesbury’s
merges into Deloitte
(but see Ernst entry
below)
1973 (Coopers &
Lybrand)
Merges with Ernst &
Whinney to form
E&Y in 1989
1973 (Arthur Young)
1975
1957 (Arthur Young
International formed,
linking 36 associated
firms outside US,
including Nixon)
Edwin V. Nixon &
Partners
Arthur Young
1959 or 1961 (depend- Absorbed into E&Y in
ing on source)
2002
1961 (Australian part- 1961
ners become partners
of U.S. firm)
Exclusive use of inter- Transition to Big Four
national ­name1
1939 (Andersen, US)
Fuller, King, Treloar
& Davis
(early 1900s)
National firm established
More formal links
First link to firms in
UK and/or US
Arthur Andersen
Australian predecessor firm(s)
Table 13 Evolution of the Big Nine in Australia: Links to International Accounting Firms (as of 1982) and Transition to the Big Four
Appendix 2
C. Ferguson et al.
Hungerford’s
FJ Smith, Smith Johnson & Co., Cook,
Tomlins & Mirams
Flack & Flack (1904)
Spry Walker & Co
KMG
Peat Marwick Mitchell & Co
Price Waterhouse
Touche Ross & Co
1896 (Price Waterhouse & Co., UK)
1968
1974 (Touche Ross
& Co.)
1948 (Thompson,
McLintock & Co.);
1959 (Touche Niven
Bailey & Smart)
Firm merged into
KPMG but many
partners did not
1998: Merges with
Coopers & Lybrand
Circa 1969
Uniquely, Flack &
Flack always trades
as a national firm
1946 (F&F joins
international firm,
Price Waterhouse)
Merges with KMG
to form KPMG
Peat Marwick in
1990 (KPMG name
adopted in 1995)
1963
1978
1949 (Peat Marwick
Mitchell & Co.)
Merges with KMG to
form KPMG Peat
Marwick in 1990
1996, 1998
1989: Merges with
1984 (Ernst &
Arthur Young to form
Whinney). Binder
E&Y
Hamlyn merges into
firm, also in 1984.
One source also
includes Duesbury’s
as merging in here
as well
Exclusive use of inter- Transition to Big Four
national ­name1
none
1966 (Fell & Starkey
formed by merger,
creating national
firm)
none
1912 (David Fell &
Co. links to Whinney, Murray & Co.,
London; Ernst &
Ernst, US)
none
National firm established
More formal links
First link to firms in
UK and/or US
2. Prior to this time, reports signed on Yarwood Vane, Deloitte, or Haskins & Sells letterhead depending on the source of the work (local, United Kingdom, or United
States, respectively)
1. After this point use of local names discontinued. Prior to this time, local and international names used depending on original source of work (for example, Cooper
Brothers & Co. name used for work sourced by U.K. firm while composite names such as Cooper Brothers & Co., Way & Hardie used for work sourced by local firm, in
this case Sydney firm)
David Fell & Co.
(Melbourne);
Starkey & Starkey
(Sydney)
1880s
Australian predecessor firm(s)
Ernst & Whinney
Table 13 (continued)
Why did the Big Four get so large? Evidence from Australia
C. Ferguson et al.
Funding Open Access funding enabled and organized by CAUL and its Member Institutions.
Data availability Data are available from the public sources cited in the text.
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