To split or not to split, that is the question

When Ernst & Young announced it planned to separate its audit and advisory business in September 2022, it sent murmurings throughout the accounting industry.

The mysteriously named ‘Project Everest’ was in response to a series of high-profile corporate collapses – Carillion and BHS among them – that prompted the UK government to question the quality of their audits.

The Financial Reporting Council had asked the Big Four firms – PwC, EY, Deloitte and KPMG – to separate auditing as a standalone business in the UK by June 2024.

In April 2023, Project Everest was called off – the firm had already spent over $600 million and a year working to separate its businesses.

At the time, the firm said it was stopping work on the project because the heads of EY’s US arm, the biggest of its global network, had decided not to move forward with the plan.

A split would undoubtedly have had an impact on staff, clients, and future growth of the firm – but given the cash already spent in preparation, was a halt the right decision?

Measuring the impact

The conflict of interest between audit and consultancy have more than once resulted in some of the largest firms in the world backing into a corner.

In addition to Carillion, in the US, you had the Enron scandal in 2001 which led to their bankruptcy and Arthur Anderson’s who were fifth in terms of size after the Big Four at the time.

The reasons behind this split are simple: EY can grow both parts of it’s business without having to worry about breaching compliance.

It allows both parts of the business to operate under their own names when they work with clients or potential customers who may not know about them yet.

When EY announced plans back in September 2022, chief executive Carmine Di Sibio said that a global split could bring in an extra $10 billion a year for the consulting arm in advisory fees from big technology companies as the firm is barred from selling advice to audit clients.

There would also have been benefits for staff. Under the plan, EY would have been able to list its consulting business on the stock market, with speculation it could raise billions by selling off near 15% in the new firm.

The remainder of the shares could have been handed to its consulting partners, and audit partners were told to receive cash payouts of somewhere around the $2 million mark.

The reasons behind this split are simple: EY can grow both parts of it’s business without having to worry about breaching compliance.

It allows both parts of the business to operate under their own names when they work with clients or potential customers who may not know about them yet.

Untangling can be messy

Following the collapse of Arthur Andersen, EY shed its advisory arm to Capgemini – so it is no stranger to going through messy overhauls. However, when voting on whether to go ahead with the split, discussions among member organisations unearthed several of challenges.

Key areas of discussion included compensation agreements between EY and the ‘NewCo’ (the consulting business) and how to divide the Tax division.

The logistics of divvying up assets and legal liabilities and shoring up pension payments added to the challenge of separating the $45 billion operation across 75 different jurisdictions.

There is also a risk that demand for some services could slow down, leading to one ‘arm’ of the businesses struggling. PwC, for instance, plans to cut up to 600 jobs from its consultancy arm and a small number from the tax department.

What are the others doing?

KPMG have said they would consider splitting, while PwC has said it has no plans to break apart its business.  It has however said it will look at diversifying its revenue streams by taking on more consultancy and advisory work.

Deloitte has reiterated it will not be splitting its business arms as they do not want to fragment its offering.

Even beyond the Big Four there are signs others could consider a shake up. The UK accounting regulator criticised BDO, another significant player in the industry, for unacceptable shortcomings in its audit work.

In response, BDO invested an extra £8mn in its central audit quality team and recruited a further 300 people to its audit division. BDO’s headcount also jumped to 7,500 from 7,000 a year earlier.

However, this growth in audit has not been without its challenges. BDO’s partner pay dropped due to higher spending on new hires and quality improvements.

 And while governments do not seem to be in any rush to see audit reform – the UK chancellor omitting it from his priority list in his autumn statement – pressure from clients is starting to build.

Firms are increasingly competing with one another for clients – meaning that they need to find new ways of differentiating themselves from each other. A split could be just was is needed to stand out.