Auditing Here, Consulting Over There
For Disney (DIS ), splitting audit from consulting was damage control as much as anything. Over the years, the company known among nine-year-olds for Mickey Mouse and Space Mountain has angered shareholders with over-the-top executive pay packages and other corporate-governance snafus. But this year, shareholders are red-hot over a different matter. Last fall, a group of Walt Disney Co. stock owners submitted a shareholder resolution demanding that the company stop giving lucrative consulting contracts to its auditor, PricewaterhouseCoopers. With Enron Corp. still splashing regularly across the front pages, investors worried that the auditor was making five times as much consulting to the Magic Kingdom as it was from the audit. Could they skeptically review its books?
That was one black eye Disney figured it could avoid easily enough. Well before its February annual meeting, the company decided to voluntarily separate auditing from consulting. "We didn't need someone to tell us that our shareholders would expect this of us," says Disney Chief Financial Officer Thomas O. Staggs.
Disney may have been the first major company to split consulting and auditing. But many more have followed in what is emerging as a sweeping and preemptive move on the part of businesses to rethink their relationships with auditors well ahead of any government action. Even as the Enron hearings continue on Capitol Hill and the Securities & Exchange Commission debates the pros and cons of splitting auditing and consulting, similar shareholder resolutions are pending at 22 other companies. And at least eight other companies that were facing such resolutions have taken the offensive and moved to limit auditor business.
Many other companies aren't waiting for investors to ask questions. In the past few weeks, a host of blue-chip companies, including Bristol-Myers Squibb Co. and Apple Computer Inc., have announced new limits on their auditors, according to the Investor Responsibility Research Center. "I don't know of an audit committee that doesn't have discussing this on the agenda," says Len Schutzman, former treasurer of PepsiCo Inc. and a member of a number of board audit committees.
The stakes for Big Five consulting arms and independent consulting firms are huge, as corporations rush to reshuffle the deck. Much of the business at stake is info-tech consulting, but there are other major lines of business affected as well. On the table is everything from strategic management consulting to mergers-and-acquisition work and even outsourcing. Big Five firms control about 20% of the total consulting market, almost $23 billion of annual revenue.
Of the Big Five, three will be most directly affected: Arthur Andersen, Deloitte & Touche, and PricewaterhouseCoopers. That's because those firms have yet to split off their technology consulting practices, although Deloitte and PWC are moving in that direction. KPMG and Ernst & Young, which sold their high-tech consulting arms in the past two years, will not be hit nearly as hard.
All in all, SG Cowen Securities Corp. analyst Moshe Katri estimates there is $4 billion to $5 billion worth of annual consulting being done by "conflicted" auditors, a massive pot of gold for the firms that can wrest it away. "I've never seen anything like this before," says Terry Ozan, CEO of the Americas for independent consulting giant Cap Gemini Ernst & Young, and a 30-year veteran of the industry. Ozan figures thousands of companies are in the market for new consultants. "When you ask `When do you want to do this?' they're looking at their watch, not their calendar."
Not everyone thinks the rush to split is smart. Securities & Exchange Commission Chairman Harvey L. Pitt frets that a forced split between auditing and consulting will make audits worse, not better. Without the lure of consulting work, "it's hard to see the best and the brightest minds going into [the accounting] field," Pitt warns. Although he endorses barring auditors from performing internal audits for clients, he'd prefer that the SEC and board audit committees decide case-by-case on other consulting jobs. Even companies looking to bid out some consulting have so far fought to retain their auditors as tax advisers. They argue that those services are improved by the auditor's deep knowledge of the company's numbers.
But tax advice is only one segment of the nonaudit work Big Five firms do, and the market isn't waiting for regulators to act before they divvy up the rest. Clients worth $200 million in consulting revenue have already dropped Andersen, according to trade journal Consultants News, based in Peterborough, N.H. For PWC, Disney's decision to break off consulting from auditing alone is a huge hit: In 2001, PWC earned $43 million selling services other than auditing to the entertainment giant. On the audit itself, it earned $8.7 million.
The independence issues that companies like Disney are grappling with are relatively new. A decade ago, most large businesses wouldn't have relied on their auditors for much nonaudit work. In the 1980s, companies were more likely to look to firms like McKinsey & Co. and Boston Consulting Group Inc. for strategic or management advice. But as the 1990s took hold, consultants that had once specialized in just identifying problems, including those at the then-modest practices of the Big Five firms, increasingly took an active role in trying to solve them. A fervor for IT consulting took hold, and auditors found they had an advantage relative to the competition. Chief financial officers--with whom the auditors already had a trusted relationship--often controlled the IT budgets. Soon, the Big Five's consulting businesses were growing 35% a year with IT and a range of other services flourishing.
Now the tables have turned. Instead of the Big Five boasting of having a myriad of services to offer, other consultants are selling customers on their independence. In January, tech-services giant EDS (EDS ) decided to go after the Big Five's biggest consulting clients, hit list of more than 50 choice companies that were using their auditors for IT consulting. Where only 30% to 40% of these prospects would have considered EDS in the past, now 70% to 80% are entertaining its bids, says John W. McCain, president of the E Solutions unit of EDS. "The door's open now," says McCain, who has boosted his pipeline of pending deals 15% to 20%.
Despite the hard sell from independents, many companies are choosing instead to switch one Big Five name for another. On Feb. 22, when bankrupt retailer Kmart Corp. (KM ) took its financial advisory business away from auditor PWC, it gave it to Ernst & Young. "It's trading Park Place for Boardwalk," says Mac J. Slingerlend, president of CIBER Inc., a boutique consulting firm based in Greenwood Village, Colo., that often competes with the Big Five. "They're sorting it out among themselves."
Even so, taking work away from one consultant and giving it to another can have big trade-offs. Companies get the benefit of looking clean, but they're often giving up firms they were happy with. And severing ties can be quite messy. "You just can't drop your consultant in the middle of a project," says Kmart Audit Committee Chairman Thomas T. Stallkamp.
Still, changing auditors, executives agree, would be even more disruptive. That's why most companies making the split are keeping their auditor and moving their consulting. Avon Products' board, for instance, recently decided to restrict its auditor to audit and tax work. CFO Robert J. Corti says it shouldn't be hard to find suitable consulting alternatives. "There are a lot of other good firms out there specializing in everything you can think of," says Corti. And their phones are ringing off the hook.
By Nanette Byrnes in New York, with Mike McNamee in Washington, Ronald Grover in Los Angeles, Joann Muller in Detroit, and Andrew Park in Dallas