This article was published as

C. W. Boyd 2004, “The Structural Origins of Conflicts of Interest in the Accounting Profession.” Business Ethics Quarterly, 14, 3, July, 377–398.

(A special edition of the journal devoted to Accounting Ethics)

For a PDF version of the article as published, click here.



Colin Boyd

Professor of Management, College of Commerce, University of Saskatchewan

Abstract: This paper describes the professional ethical context behind the failure of Arthur Andersen’s audit of Enron. It is argued that the evolution of extreme industrial concentration in the accounting profession, and the subsequent unrestrained diversification of the “Big Five” accounting firms were the sources of multiple conflicts of interest that were unresolved by the time of the Enron debacle. In the post-Enron era, the problems of commercial conflicts of interest and of highly concentrated power in the profession remain important issues.


Accountancy is believed by its practitioners to be a profession, not a commercial venture.

 (Magill, Previts, & Robinson 1998: 4)

The spectacular collapse of Enron in 2001 and the subsequent disintegration of their auditors, Arthur Andersen, was arguably the most significant scandal in modern US business history. The debacle has provided enough analytical fodder to engage the minds of scores of academics, and there will no doubt be many theories advanced for the reasons behind the fraud and for the failure of the audit firm to perform its role properly.

In this paper I wish to advance my own particular theory. I suggest that a substantial contribution to the Enron collapse came from the failings of Enron’s audit firm, which was itself affected by a general build-up of tensions related to conflicts of interest in large audit firms and within the accounting profession itself. These ethical tensions, like pressures between tectonic plates in geology, had built up over decades as the structure of the accounting profession evolved.

This paper will argue that there was a systemic failure to note and correct the increasing range of new conflicts of interest that were emerging from the way in which the industrial structure of the accounting profession’s delivery of services evolved in the latter part of the 20th century. These conflicts of interest placed intolerable pressures on the ethical judgments of experienced professionals employed by accounting firms that presumably otherwise espoused adherence to the highest levels of ethical integrity.

This paper has its origins in a commissioned report that I prepared for the Canadian Bar Association (CBA) about the commercial evolution of the accounting profession (Boyd 1999) 1. At that time, the CBA, in common with many other Bar Associations, was alarmed at the fact that the “Big Five” accounting firms 2 were starting to diversify into the field of provision of legal services. My report for the Canadian Bar Association was aimed directly at educating the legal profession about the stream of commercial logic that made the accounting profession evolve to the point where accounting firms began to offer legal services. The various ethical consequences of this business history were of minor interest to that audience at that time.

It is a relatively simple matter to re-describe this history from an ethical perspective. In this paper I will provide a general explanation of the recent evolution of the accounting profession, and will describe how this evolution produced a variety of ethical tensions that I propose were unresolved by the time of their ultimate expression in the Enron debacle.

In the light of recent accounting scandals such as Enron, it is of interest to note that the professional literature does not appear to provide any explicit definition of the concept of “conflict of interest” as such. For example, the report of a recent Canadian Institute of Chartered Accountants (CICA) Task Force on Conflict of Interest fails to provide any working definition of the term itself, but refers the reader to the profession’s rules of conduct for guidance (CICA 2000) 3. To illustrate the absence of any explicit definition of conflict of interest within these rules I provide an appendix to this paper that contains relevant extracts from the Code of Professional Conduct of the American Institute of Certified Public Accountants, along with some commentary about how these rules implicitly define conflicts of interest.

While the profession itself has not directly defined the concept, the academic literature has delved deeper. Gaa provides the following straightforward description: ““Conflict of interest” refers specifically to situations where one owes a duty to one party but other interests exist which may interfere with the observation of that duty.” (1994: 97) In his review of the many complexities involved in fully defining a conflict of interest in the delivery of accounting services, Gaa cites another simple definition that will aid the comprehension of the history that follows: “A person has a conflict of interest if (a) he is in a relationship with another requiring him to exercise judgment in that other’s service and (b) he has an interest tending to interfere with the proper exercise of judgment in that relationship.” (Davis 1982: 485)

The Modern Evolution of Public Accounting Firms

For much of the twentieth century the public accounting industry had a stable industrial structure. Most professional public accountants worked in public-practice accounting firms that provided tax and accounting services to businesses, other organizations, and to that small proportion of private individuals whose financial affairs were complex. The scope of most firms was local, with operations typically confined to one office servicing one town or city and its hinterland.4

Larger accounting firms operated as partnerships rather than as sole-proprietorships. Recruits to the profession entered accounting firms as articling students (“junior auditors” in the U.S.), with each firm usually admitting only that number of students as would be required by the turnover of individuals within the firm (e.g. by death or retirement) or as required for internal business growth. In countries with a federal structure, the regulation of professional accountants and the organization of their professional institutes took place at the regional (state or provincial) level. In other countries professional institutes operated at the national level.

The structure of the accounting profession was stable up until the 1960s or so. The profession enjoyed a rather insulated and protected environment – many public accounting firms had a local or regional focus, and were employed by a solid base of permanent local clients. Accountants were historically perceived by the public to be part of a solid, conservative profession with an impeccable reputation for ethical integrity.

For example, as recently as August 2001, a couple of months before the Enron revelations, a survey of attitudes within the business community undertaken for the Canadian Institute of Chartered Accountants (CICA) revealed that accountants had the highest reputation for ethical integrity compared to other professional and occupational groups. (CICA 2001: 6) The stark contrast between the profession’s historical reputation and its post-Enron reputation is remarkable. How did this dramatic change in fortunes begin to come about?

The late 1950s and 1960s saw changes in the transport and communications infrastructures of developed countries that enabled many business organizations to expand the geographical scope of their operations from a local base to a regional and then to a national level. As the accounting profession’s major clients changed their geographical scope, then so it became advantageous for ambitious accounting firms to themselves expand from a local to a regional to a national level so as to match the scope of their largest clients.

The means for accomplishing this change in geographical scope was the merger of partnerships based in different cities and towns. For example, KPMG Canada was formed from merging “more than 115 firms in communities across Canada.” (KPMG Canada 2003) The evolution of national firms via successions of mergers naturally increased the degree of concentration of the industry.5

It was but a simple step for the newly emerging national accounting firms to later continue to grow via transnational mergers, and to thus follow the international expansion of their clients. Global growth via international mergers was achievable for the major accounting firms because the services they offer are more or less homogeneous across national boundaries, reflecting the degree of homogeneity of accounting standards across nations. By contrast, the relative lack of homogeneity of laws across nations has obstructed the possible parallel evolution of major multi-national firms in the legal profession.

Successive waves of mergers first produced the “Big Eight” accounting firms, to be followed by the “Big Six”, and finally by the “Big Five”. The failure of the proposed merger of KPMG and Ernst and Young in 1997 prevented further consolidation down to a “Big Four”. The major structural change in public accounting in the past couple of decades has therefore been the emergence of this dominating small number of large global accounting firms.

Some statistics from 1996 demonstrate their dominance: 93% of the revenues earned by the top 18 accounting firms in the U.S. in that year went to the Big Six, while 91% of the employees were Big Six employees (data from Accounting Today (1997), after eliminating the tax preparers H&R Block and Jackson Hewitt from the figures.) The revenue of the smallest of the Big Six firms was one and a half times the combined revenue of the 7th through to the 18th largest firms.

These data show a degree of extreme concentration of power and ownership in the accounting profession that has had no parallel in any other profession.

One significant consequence is that a large proportion of the members of national or regional accounting institutes are the employees of these few giant global accounting firms. This strong concentration of interests within the membership of each accounting institute will be discussed later on in this paper. During this period of tumultuous change in the industrial structure of the profession, there was no parallel change in the basic institutional structure of the profession.

Another parallel dramatic change in the profession was the transformation of auditing from being the profession’s most conspicuous and prestigious service to its later state as a low profit activity within a constellation of other far more profitable services offered by the major accounting firms.

The sequences of successive mergers may have been one of a number of factors that reduced the loyalty of clients to their auditors in the 1970s and 1980s as audit services became to be increasingly recognized to be an undifferentiated commodity product (Magill & Previts, 1991: 123.) Clients became sophisticated purchasers, shopping around for the best deal and putting intense pressure on audit prices, and thus on profits. The traditional long-term auditor-client relationship appeared to become lost in the process. Audit prices declined steadily from the 1980s onwards (Accountancy Age 2003.)

A darker side of the increased instability of auditor-client relationships emerged when some companies began to resort to a practice known as “opinion shopping” (Magill & Previts 1991: 124.) Here, the audit client would not just approach other accounting firms to gain price quotations, but would also attempt to ascertain the degree to which each firm might interpret accounting standards so as to present the client’s financial statements in the manner that management most preferred. Accounting standards are flexible, and there are alternative standards that can conceivably be validly applied to the circumstances of any client. Given that the application of different standards can produce quite different financial pictures on any given day, some clients began to see just how far they could persuade an auditor to apply a particular desired standard.

In the price-shopping and opinion-shopping turbulence of the 1980s the audit increasingly became a commodity business which had declining margins, and which placed increased stress on the ability of audit firms to maintain a high level of professional integrity independent of these market forces. We thus see the first signs of newly evolving forms of conflicts of interest arising in the accounting profession.

The Pressures on Labor Inputs

In the face of the propensity of clients to shop for audit services, individual accounting firms found that the only competitive variable at their disposal was price. Magill & Previts note that competitive bidding by CPA firms gradually became commonplace after a removal of a ban on the practice by the American Institute of Certified Public Accountants (AICPA) in 1972, and that “bids significantly below any reasonable measure of cost or profitability (lowballing) were generating heated criticism.” (1991: 124)

If price is used as a means of attracting business, then this must either reduce the audit firm’s margins, or else put pressure on the costs of providing audit services. Given that labor is the main cost of auditing, then there are only two major ways of reducing the cost of an audit in the absence of increased automation -- either reduce the total labor-hours put into an audit, or else reduce the average cost of a labor-hour. It would be difficult to determine if large accounting firms did explicitly cut costs by cutting the total labor hours put into the average audit, because part of the period when they perhaps were doing this was indeed also the time when audits were becoming partially automated via the increased use of computers.6

However, as with any reduction in the cost of an audit labor-hour that comes from reducing the amount of expensive senior supervision of a particular audit, any reduction in overall audit labor hours would be expected to automatically lower the quality of audits. Some indirect evidence of reduced audit quality did surface in the 1970s and 1980s, when there was a general increase in the number of audit failures, a subsequent increase in litigation against the major accounting firms, and consequent sharp increases in their malpractice insurance premiums. (Griffin 1977; Wise 1994)

The other means of reducing the average labor cost per hour of an audit is to increase the proportion of low cost employees assigned to any given audit. In the case of accounting firms, the low cost employees are the articling students, or junior auditors. One major transformation in the evolution of the modern accounting profession has been a change in the approach to the use of junior employees. In the past, as was noted above, articling students were taken on primarily to meet the internal needs of the accounting firm, either as future replacements for normal labor turnover, or else to meet the needs of internal business growth.

The 1970s and 80s saw the major accounting firms beginning to employ many more articling students than they had historically needed to replace retirees and to accommodate growth. There appeared to be no adverse reactions to this phenomenon, either from the professional institutes (who stood to gain more revenues from the resultant inflation in their membership numbers) or from undergraduate business schools (who were pleased to see the demand for their accounting students increase).

One of the reasons why there was no concern for the increase in employment of articling students was the fact that there was an increasing demand for accountants in industry and commerce, outside of public practice. Large proportions of articling students in the big accounting firms ended up taking up offers of employment as accountants with the firms’ audit clients relatively early on in their careers with the accounting firms.7 It may even be that the accounting firms had to employ more articling students in the first place because of this new form of erosion of their employee numbers.

Whatever the origins of this new phenomenon, the resulting strategy proved to be very positive for the big accounting firms. The shedding of the newly excessive numbers of articling students to clients not only produced both happy clients and happy students (who had now given up on any ambition to be public practice partners), but it also seeded the business sector with friends of the big accounting firms so as to ensure a high probability of future business relationships with these “biased” clients. It was a clever strategy that had the added benefit of providing the big firms with cheap labor at the very time when price competition increased the pressure to reduce audit costs.

In her recent book about Arthur Andersen, Barbara Ley Toffler notes the existence of this general labor strategy: “…like the other big accounting firms, (it) made its money by using young, low-paid staff to do the majority of its work.” (2003: 31-32) Elsewhere, she describes the motivation of the firm’s new junior auditing recruits, and of Andersen’s explicit strategy for their use:

They all knew that their chance of making partner was slim, and that they were in for a rigorous, exhausting few years as the “grunts.” But there was that big fat brass ring at the end. Even if they did not make partner, the opportunities for an Arthur Andersen-trained accountant were many and choice. We would “tell them that they should find other employment because their future was limited,” said Spacek in an oral history, “but… help them get into good jobs because they were what I call our ‘fifth column’. When they got into the business, they remembered their alma mater, that’s all.” The point was to maintain goodwill, so that even the people who didn’t make it remembered their experience fondly and would go out of their way to steer business to the good old Firm. (Toffler 2003: 25-26, quoting from Spacek 1989: 124. Leonard Spacek was the most famous managing partner in the history of Arthur Andersen)

The ethics of this strategy of the big accounting firms encouraging former audit team members to transfer to employment within the organizations that they were continuing to audit did not appear to be a matter for widespread concern in the immediate period leading up to the Enron scandal. If these kinds of transfers were perceived to be only from within the junior ranks of accountants being shaken out from the big firms, then this practice might not have been considered to be anything other than mildly questionable.

The Enron case, however, revealed employee transfers between the auditor and the audit client on a huge scale, and at senior levels from within Arthur Andersen’s Enron audit team. A New York Times article described the closeness of the relationship, and hinted that Andersen indeed encouraged these employee transfers as a way to gain more non-audit business from Enron:

Investigators … are looking at Arthur Andersen, which so thoroughly blended its corporate DNA with its client's that a steady stream of Andersen employees came to work for Enron at the trading company's futuristic downtown tower. … One Enron vice president, who was laid off in December, said Andersen often had as many as 250 employees working inside Enron's 50-story skyscraper. ''They were involved in about everything there,'' the vice president said. … This physical proximity was accentuated by the fact that so many Enron employees had once worked at Andersen; … the company's chief accounting officer, Richard A. Causey, had started at Andersen. … ''I remember them saying that once you got to a certain level at Andersen, they would suggest you tried to get hired by a lot of clients like Enron,'' the former Enron vice president said. ''This would provide them with access to more accounting jobs.'' (Van Natta, Schwartz & Yardley 2002)

Another article in the same edition of the NY Times indicates one type of additional non-audit accounting work that Enron was giving to Arthur Andersen: “Moreover, Enron turned over to Andersen some responsibility for its internal bookkeeping, blurring a fundamental division of responsibilities that companies employ to assure the honesty and completeness of their financial figures. Further obscuring the line between an independent auditor and corporate management, many of Enron's financial executives had moved there from Andersen.” (Stevenson & Gerth 2002)

The revelation that many members of the Andersen’s Enron audit team had moved into financial management positions at Enron has provoked the consideration of placing stronger restrictions on individual accountants making such moves from audit team to audit client. As noted above, the big accounting firms had encouraged this type of transfer for many years as a part of the modern evolution of the industry. There were no prior prohibitions on such transfers, even though Congress had actually queried the ethics of this practice back in 1976 (Previts & Merino 1979: 318).

The Strategy of Horizontal Integration

Auditing was becoming remarkably unattractive to the major accounting firms: audits offered declining margins, produced difficult ethical dilemmas, cost a fortune to insure, and produced risks of time-consuming litigation which at the extreme could bankrupt a firm.8 But in the 1980s, against all intuition, the competition for audit clients began to intensify. Why did competition remain so intense?

The reason why the audit business remained desirable was because of the spin-off benefits that an audit could produce. An audit allowed an accounting firm to enter the client’s business, and to discover how the client’s various business systems operated. If the accounting firm tangentially detected aspects of the client’s systems that could be improved, then there would be an opportunity for the selling of consulting services to fix the client’s problems. These services could be priced so as give a high margin, thus off-setting the low margin audit business that enabled the firm to access the high margin business opportunity in the first place. The audit effectively became a “loss-leader” product for the accounting firms, producing at the extreme a stimulus for “low-ball” bids for audits (Magill & Previts 1991: 124)

The predominant strategic response of public accounting firms to the price/cost pressures of audit competition in the profession was thus the offering of other parallel services to audit customers: “Firms are branching out into consulting practices and other non-traditional specialties as the one-time staple of audit services is being squeezed...” (Conrod 1994)

The big accounting firms began to offer a wider range of business advisory services (eventually including even legal services, as noted above) and began to view themselves primarily as high level business advisors rather than as accounting firms focused primarily on auditing: “We will truly be a breakaway firm when our clients think of us as a professional services firm, not an accounting firm. We want them to think of us as always being able to provide them with assistance with virtually any business or industry issue they face.” (PricewaterhouseCoopers Canada 1998) “Accounting firms ... now resemble corporate cafeterias offering a staggering selection of business advisory services, many with little or nothing to do with the profession’s traditional core competencies.” (Andrew 1988: 24)

This strategic evolution of the broadening of the accounting firms’ product lines, referred to technically as horizontal integration, was one of the most critically important recent developments in the industry. Horizontal integration allowed cross-subsidization across product lines, and enabled the big firms to escape the mutually destructive battle over low price/low cost production of the audit. However, this strategy also produced a variety of ever-increasing commercial tensions within the big accounting firms that pressured their ability to provide audit services independent of their growing commercial interests.

The Growth of Non-Audit Business

Table 1 shows the extent to which the Big Six derived their revenues from sources other than auditing back in 1990. The author of the table comments on the decreasing reliance of the major firms on auditing: “Audit’s share of Big Six revenues declined from 62% in 1982 to just under 50% last year.” (Jacob 1991: 191)

                                                                                          Percentage of Revenues

                FIRM                                 1990 US Revenues           Auditing            Management               Tax

                                                                       (Millions)                                                  Consulting

      Arthur Andersen                       $2,282                  35%                 44%                 21%

      Ernst & Young                          $2,239                  53%                 22%                 25%

      Deloitte & Touche                     $1,921                  57%                 20%                 23%

      KMPG Peat Marwick               $1,827                  53%                 20%                 27%

      Coopers & Lybrand                  $1,400                  56%                 25%                 19%

      Price Waterhouse                      $1,200                  48%                 24%                 28%

Table 1 - Sources of US Revenue for the Big Six Accounting Firms, 1990.

(Taken from Jacob 1991)

Audit’s share of big firm revenues continued to decline to a level of 31% in 1998 from a level of 70% in 1976. (Levitt 2002a: 116) The Wall Street Journal recently reported that the audit share of the fees paid to the big accounting firms declined to a low of just 25% in 2001, but then shot back up to 38% in 2002. (Bryan-Low 2003) While this reversal of the trend does represent some stepping away from consulting by the accounting firms in the post-Enron era, the newspaper noted that audit fees had risen substantially from 2001 to 2002 (in some cases by as much as 50%), thus complicating what had previously been simple year-on-year comparisons.

Prior to 2002 the decline in the proportion of auditing revenues in the firms did not come from any decline in their levels of audit activities (these were growing in all firms), nor from audit price drops, but from the fact that the growth rates for non-audit services were far higher. For example, Ernst & Young’s global web site reported in 1999 that its worldwide audit business had grown at around 10% p.a. from 1996 to 1998, but that its management consulting revenues had grown at over 30% p.a. in that same period.

The extent of the big firms’ diversification away from the core auditing service was dramatic. Consulting and other non-audit services comprised just 30% of their business in 1976, but grew to be 75% of their business 25 years later. This shift in product mix must have inevitably meant that the power and dominance of the auditing units within each of the big firms would steadily weaken over these years, while the power of the higher growth consulting units in each firm would correspondingly strengthen.

On top of any such power shifts caused by differential growth rates, the fact that the new, high margin product lines could be used to cross-subsidize the old, low margin audit product line doubtless fueled further political friction within the firms. If the firms had a policy of sharing of total profits across all partners, no matter which unit they worked in, then the partners in the high margin areas probably resented having to share their profits with the audit partners.

Fighting between audit partners and consulting partners over internal power and about profit-sharing was the origin of the splitting away of Andersen Consulting from Arthur Andersen in 1989. The reason for the internal strife in the firm is easy to see from the data presented in Table 1, which consolidates the 1990 revenues for all of the former U.S. activities of Arthur Andersen, including Andersen Consulting.

That table shows that Andersen was by far and away the most diversified of all the Big Six at the time, with only 35% of its revenues coming from auditing, compared to an average of 54% for all the other firms. Andersen had gone the furthest down the road from its origins as an accounting firm, and suffered the political consequences of the decline in power of its audit partners as a result.

The highly successful consulting partners did not want to share their high profits with audit partners, who themselves did not want to yield power to the consultants. Unable to find a satisfactory internal resolution to the problem, the consultants split off to form their own firm, Andersen Consulting.9 The other big accounting firms did not subsequently fracture apart, however. It is likely that, having seen the mess of the break-up of Arthur Andersen, they were careful not to repeat that mistake. They somehow managed to cope with the kinds of internal stresses that had beset the most diversified firm.

It is of particular interest that Arthur Andersen itself swiftly re-grew its own consulting division following the split (Toffler 2003: 98), effectively competing with its old partners in Andersen Consulting. The commercial logic of diversification away from auditing via horizontal integration into consulting therefore seemed to have been inescapable in the accounting profession in the last decade of the 20th century.

Conflicts of Interest Between Auditing And Consulting

The emergence of possible conflicts of interest for audit firms related to the simultaneous sale of consulting services to audit clients was widely recognized by critics of the accounting profession, but this core problem remained substantially unrecognized and uncorrected by the profession itself.

Arthur Levitt, one of the profession’s leading critics, and former head of the US Securities and Exchange Commission (SEC) claims that “…conflicts of interest…inevitably occur when a company pays an accounting firm consulting fees that far outweigh the audit fee.” (Levitt, 2002a: 15) Elsewhere in his recent book he writes that “More and more, it became clear that that the auditors did not want to do anything to rock the boat with clients, potentially jeopardizing their chief source of income. Consulting contracts were turning accounting firms into extensions of management – even cheerleaders at times.” (Levitt 2002a: 116) Toffler also claims that “clients became too valuable to defy.” (2003: 82)

In the United Kingdom in particular the accounting profession came under intense public scrutiny in the early 1990s as controversy erupted over the failure of auditing to conform to social expectations. One article described the genesis of that particular ethical and political crisis in the profession in the UK:

“All the accountants’ problems have a common origin: they are no longer seen to be impartial. Too often it looks as if they are bending over backwards to help the people who write their cheques, the managers, rather than the people who pay for them, the shareholders.” …“Accountants deserve most of the stick they are getting. Like advertising agencies and investment bankers, they fell for the 1980s fad of the service conglomerate. The big eight firms became the big six as they merged and remerged, struggling to push under one roof a whole range of business services, like tax advice, management consultancy, corporate finance, and, yes, insolvency. This left them woefully dependent on non-recurring fee businesses like consulting; it also encouraged them to cut auditing fees to win other business. When auditing becomes a loss-leader it is hardly surprising that it gets done badly or misleadingly.” (Economist 1990)

The Economist article makes a key point when it notes that consulting is a non-recurring business – once one consulting contract is completed, the big accounting firm must then make a pitch for another contract from the same client, thus producing a perpetual succession of commercial pressures on the continuing audit business that provides it with access to that client in the first place.

In the case of Enron, it was widely noted that Arthur Andersen provided consulting services to Enron alongside its audit service: “In recent years, concerns have mounted about whether auditors are truly independent of their clients. Accounting firms have come to rely more on consulting work rather than on traditional audits for their revenues, raising questions about their ability to stand up to clients if improper bookkeeping is suspected. … In Enron's case, consulting work accounted for slightly more than half of the $52 million that Andersen received in fees in 2000.” (Abelson & Glater 2002)

For Enron, the press suspected a conflict of interest within Arthur Andersen because the revenue split between consulting and audit revenues was 1 to 1. In the later case of the collapse of WorldCom (where Andersen was again the auditor) the revenue split between Andersen’s consulting and audit revenues from WorldCom was 3 to 1, suggesting an even greater likelihood of a conflict of interest influencing Andersen’s audit independence.

The splits between audit and consulting revenues from the same client that are typically quoted in the press do not in fact reveal the full scale of the conflicts of interest that might actually have existed in these cases. The business journalists (and critics such as Arthur Levitt) have overlooked the fact that the profit margin from consulting can be as much as 3 times the margin from auditing (Economist 1988: 89). Such a differential in margins would imply that Andersen’s annual consulting profit from WorldCom was about 9 times higher than their annual WorldCom auditing profit.

In a context where the power of audit partners had declined because of diversification into consulting, it is not surprising that there was intense pressure on the audit team to not rock the boat. The consulting profits were simply too high to be able to consider sacrificing them for the sake of adhering to a professional principle in auditing that no one in the outside world might ever hear about.

Recalling her time as an ethics consultant at Arthur Andersen, Barbara Ley Toffler describes the actual process of selling non-audit services to audit clients: “Typically, the auditor -- the keeper of the sacrosanct relationship -- would set up the meeting with the client, and then would call as many consultants as he could to come and strut their stuff.” (2003: 56) This description clearly implies that auditing and consulting were heavily intertwined in that firm.

Arthur Levitt suggests that the commercial pressures on audit partners were reinforced by the compensation systems in the big firms: “Some firms even paid their auditors on how many non-audit services they sold to their clients.” (2002a: 116). Toffler notes that not only were the auditors in Arthur Andersen compensated on the basis of the total fees they brought in (including consulting), but that they were actually “punished if they were involved in any restatement” (2003: 246), and that “any restatement of earnings…would torpedo their chance to earn new (partnership) units.” (2003: 136)

Elsewhere in her book Toffler refers to an internal document in Arthur Andersen which noted that “audit partners were often assessed on how satisfied their client was.” (2003: 163) In his recent paper about Enron, Coffee also asserts that “abundant evidence does exist for the thesis that [consulting] incentive fees can bias audit decision-making." (2002: 22) All these claims imply that the accounting firms’ compensation systems discouraged auditors from following the profession’s code of conduct on independence and conflicts of interest.

The Big Five and the AICPA had consistently claimed that auditor independence was particularly unaffected by consulting. They argued that since there was no empirical evidence of conflicts of interest between auditing and consulting, then such conflicts could not be presumed to exist. Levitt refers to this as the “no smoking gun” argument (2002a:129). A number of research studies had sought to produce empirical evidence of a conflict of interest between audit and consulting work provided for the same client, but these had generally been inconclusive. Craswell, Stokes, & Laughton (2002) provide a list of such studies.

Enron has provided the ‘smoking gun” evidence, indicating that the profession had reached the stage where commercial interests simply overwhelmed allegiance to professional integrity.10 The outcome has been catastrophic for the profession. This begs the question as to why, when the problem of conflicts of interest had been known about for so long, had so little been done to protect the sanctity of the profession’s core activity?

The Power and Influence of the Big Five

The Big Five have without doubt had an enormous direct influence on the accounting institutes via representation of their employees both on the directing boards of the institutes, and as elected officials. However, there are other less obvious ways in which the Big Five almost certainly influenced the institutes.

Earlier in this paper I suggested that the evolution of a few giant accounting firms had a parallel pattern of influence within the membership of accounting institutes. The most obvious form of influence on institute affairs relates to pure scale. As the Big Five became so large and dominant within the accounting profession, then the sheer number of accountants that they employed who were also members of accounting institutes gave the Big Five an effective dominant voice within each institute.

The exercise of membership power within accounting institutes may not have been any kind of overt strategy by the Big Five at all – they might have exercised their influence in exceptionally subtle ways within the institutes without any kind of explicit oversight of the process. But there is some evidence from the legal profession of the Big Five flexing their muscles within the American Bar Association via the collective vote of the many lawyers that they employ: “... by hiring ever more lawyers, the Big Five put themselves in a position to claim with ever greater force that they represent the interests of a substantial proportion of the bar. This phenomenon was demonstrated in the evident angst of the Tax Section of the American Bar Association, in which lawyer-employees of accounting firms are heavily represented, in deciding on its position on the IRS reform act.” (New York State Bar Association 1999)

As the numbers of accountants employed by the big accounting firms increased over time, then so too did the number of their former employees who had left to become industry accountants (Previts & Merino, 1998: 400). The Big Five’s influence within the accounting institutes may then not just have been confined to those institute members who were their then-current employees, but may also have come from those institute members who had been their former employees – the “fifth column” referred to by Spacek (1989: 124).

The dilution of the membership of the public accounting institutes by ever-increasing numbers of industry accountants may also conceivably have allowed a greater influence by the Big Five in institutional affairs by default. The interests of these non-public practice accountants were likely very fragmented compared to the unity of interests of the Big Five, and they certainly had a relative lack of concern for the issues facing public practitioners.

Unfortunately, the growing influence within accounting institutes of the big accounting firms’ employees likely occurred in parallel with the diminishing role of auditing inside their own firms, and alongside these firms’ ever-increasing interest in expanding their non-audit businesses. The unspoken agenda of the dominant membership group within the accounting institutes may thus have been to facilitate the growth of the non-audit activities of their firms, possibly to the detriment of each accounting institute’s position on defending auditing from the ethical pressures spawned by these commercial developments.

The growing conflicts of interest between auditing and consulting within the Big Five’s business activities would thus have been mirrored in subtle ways within the accounting institutes themselves, most obviously manifest by their reluctance to support initiatives designed to eliminate these conflicts of interest. There are a fair number of examples of such reluctance, but I shall only deal with two of these.

In the United Kingdom back in 1992 the Auditing Practices Board (APB) produced a discussion paper proposing several initiatives as a means of preventing any reoccurrence of the 1989/90 accounting scandals in the UK. Two of the APB proposals were:

1.      The compulsory periodic rotation of auditors through individual audit clients to prevent a close relationship from developing. One suggested plan was that an auditor, once appointed, must be retained by the client for 5 years, and then must be compulsorily replaced by another auditor who would then remain in place for another 5 years.

2.      That any firm auditing a client should not simultaneously provide any non-audit services for that client. (Auditing Practices Board 1992)

The profession successfully lobbied against these initiatives in the UK.

A more recent example came in 2000, when Arthur Levitt’s legislative proposals were similarly thwarted by the profession: “When I was chairman of the Securities and Exchange Commission, we put into place a number of reforms to improve audits and minimize conflicts of interest. But we were largely unsuccessful in persuading accounting firms to separate their auditing businesses from their consulting businesses and in convincing the auditing profession to do a better job of policing itself.” (Levitt 2002b)

Levitt’s failure was attributable to intense political lobbying: “The profession has succeeded in fighting off tougher regulation over the decades, but it reached its apex in political power only in the last few years, a reflection of the industry's mushrooming campaign contributions and increased lobbying. … At the height of the fight between the industry and Mr. Levitt in the second half of 2000, all the Big Five accounting firms sharply increased their political donations and spending on lobbying. Andersen doubled its lobbying budget, to $1.6 million. …The investment paid off.” (Labaton 2002a)

We therefore see that the Big Five had not just become powerful within the accounting institutes themselves, but that their power and influence had extended deep into the external political sphere as well.11

To all intents and purposes, by the end of the 20th century the Big Five had overwhelmed the accounting profession to such an extent that the profession no longer appeared to have any voice independent of the interests of the Big Five (Kliegman 1999).12 And unfortunately for the whole profession, when the commercial interests of these big firms conflicted with the protection of the integrity of the core activity of the profession, then the profession’s interests were apparently sacrificed.

The fear that this scenario would evolve was voiced a decade ago in a prescient article by Barefield, when he pondered the implications of diversification by the big accounting firms: “What will happen as the firms grow to be managed by non-audit people (as they will, because the people from the more profitable product lines will be promoted)? Is there reason to question whether our status as a regulated profession is at risk as this diversification unfolds? Some believe so.” (Barefield 1991)

Will the Sarbanes-Oxley Act Work?

The Enron scandal directly prompted the passing of the Sarbanes-Oxley Act in the United States in 2002, in the face of strong lobbying by the accounting profession. Those sections of that Act that deal with the issues that I have raised in this paper will be discussed below.

With regard to audit team members joining the audit client, section 206 of the Sarbanes-Oxley Act directs that “The CEO, Controller, CFO, Chief Accounting Officer or person in an equivalent position cannot have been employed by the company's audit firm during the 1-year period preceding the audit.” (U.S. House of Representatives 2002; 31)

This measure will to some extent prevent conflicts of interest arising from the transfers of employees at the highest levels, although it does not bar the transfer of audit team members into intermediate or transitory positions within audit clients. The fact that the ban is just for one-year seems to be insufficient – the financial rewards may be such that an employee subject to the transfer ban may be willing to step out of the ring for one year. A one-year ban is also far too short a time for the audit team’s work practices to have changed sufficiently so as to render a former audit team member’s knowledge of these practices obsolete.

Section 203 of the Sarbanes-Oxley Act directs that “the lead audit or coordinating partner and the reviewing partner must rotate off of the audit every 5 years.” (U.S. House of Representatives 2002: 30) This compulsory rotation of the audit leaders falls far short of the full rotation of the audit firm itself that was originally proposed in the United Kingdom, as noted above.

However, Section 207 of the Sarbanes-Oxley Act does direct the Comptroller General of the United States to conduct a study and review of the potential effects of requiring the mandatory rotation of registered public accounting firms within 1 year of the enactment of the Act. (U.S. House of Representatives 2002: 31) This study may, of course, be the subject of intensive lobbying by the accounting profession, and so it remains to be seen if this deferred study will result in any change in the status quo.

From the perspective of this paper, the most relevant element of the Sarbanes-Oxley Act is Section 201, which limits the range of services an auditor can offer to a client alongside the audit. The prohibited services include:

… (1) bookkeeping or other services related to the accounting records or financial statements of the audit client; (2) financial information systems design and implementation; (3) appraisal or valuation services, fairness opinions, or contribution-in-kind reports; (4) actuarial services; (5) internal audit outsourcing services; (6) management functions or human resources; (7) broker or dealer, investment adviser, or investment banking services; (8) legal services and expert services unrelated to the audit; (9) any other service that the [Public Company Accounting Oversight] Board determines, by regulation, is impermissible. (U.S. House of Representatives 2002: 28)

The prohibited activities in the list seem to be drawn up as if the conflicts of interest with auditing are perceived to mostly take the form of operational or production conflicts of interest for the auditor. A number of the conflicts of interest that I have presented in this paper originate within the marketing and sales activities of the big accounting firms, encouraged by internal reward systems and cultural norms.13 Accordingly, the Sarbanes-Oxley Act may have missed the mark here by not considering those audit conflicts of interest that are marketing-related.

With the proviso that item (9) above allows the Oversight Board to add anything to the list, it is of interest to note that this list does not explicitly ban the offering of consulting services alongside audit services. The Act does however place a minor limitation on the offering of such services, in that they must all be pre-approved by the client’s audit committee, and then openly reported. The degree to which client audit committees will be effective as a moral screen to eliminate consulting conflicts of interest remains to be seen.

The Future Evolution of the Profession

Both prior to and following the rapid demise of Arthur Andersen, three of the four remaining big accounting firms distanced themselves from their original consulting divisions to varying degrees. However, given that there is no outright legal prohibition on them offering many consulting services to audit clients, it is conceivable that if the profession experiences a few years of negligible levels of controversy in the immediate future, then some firms may be tempted to start to use the audit as a lever to expand consulting again.

The utter commercial logic of consulting being an automatic companion to auditing was, as noted above, illustrated by the re-growth of a new consulting division within Arthur Andersen following the splitting off of Andersen Consulting. In the light of that commercial logic I remain skeptical about the effectiveness of any rule other than a complete prohibition on the offering of consulting services to audit clients as the means of preventing commercial pressures from affecting audit independence and integrity.

It appears almost inevitable, given the profession’s apparent inability to police itself, and given that audit firms will still be allowed to offer some consulting services in the future, that some further scandal will eventually occur, prompting an externally dictated prohibition on the simultaneous provision of consulting and audit services to the same client.

One problem in reforming the profession is the degree of inertia inherent in the cultures of the big firms. Toffler’s book reveals that the conflict of interest arising from the offering of consulting services to audit clients had produced a profoundly corrupted internal culture within Arthur Andersen. In a recent plenary speech to the American Accounting Association, Arthur Wyatt, a former Andersen partner himself, suggests that this cultural flaw was not exclusive to his own firm: “…greed became a force to contend with in the accounting firms. In essence, the cultures of the firms had gradually changed from a central emphasis on delivering professional services in a professional manner to an emphasis on growing revenues and profitability. This gradual change resulted in firm culture being drastically altered over the forty years leading to the end of the century.” (Wyatt 2003: 5)

The inertia of accounting firm organizational culture causes Wyatt to also be skeptical about the effectiveness of the Sarbanes-Oxley Act in preventing future scandals: “…the underlying causes of the decline in accounting professionalism remain in place. …the internal culture of the firms needs a substantial amount of attention if the reputation of the firms is to be restored. No piece of legislation is likely to solve the behavioral changes that have evolved within the firms over the past thirty years.” (Wyatt 2003: 7) Strong leadership of each big accounting firm would be required to effect a reversal of such behavioral changes, and yet it seems unlikely that any such reformers could muster sufficient support within the current cultures of the big firms to be able to get into leadership positions in the first place.

The extreme concentration of the industry and the continuing dominance of the accounting institutes by the interests of the remaining “Big Four” are important concerns that also remain to be resolved. One issue is that of consumer choice. The accounting institutes were conspicuously silent about the negative consequences of increased concentration in the industry in 1997 when the last round of big firm mergers created the Big Five. At that time leading finance directors in the UK were vehement in their denunciation of the mergers and the resulting oligopoly, complaining about the “dramatic narrowing of choice with regard to the statutory audit.” (Daily Telegraph 1997) The range of choice of auditor is now even narrower, given the passing of Arthur Andersen.

Wyatt raises the prospect of a further scandal producing the demise of one of the remaining Big Four. He suggests that this would provoke the break-up of the remaining three firms by legislative or regulatory intervention. (2003: 7) He hints that the four largest firms should anticipate such a prospect, and that they should think about whether their firms are effectively unmanageable from an ethics perspective: “Maybe some consideration should be given to whether a split-up of a big firm would enhance the firm’s quality control [over professional behavior] and permit more effective delivery of quality service.” (Wyatt 2003: 7)

Coffee also hints at the break-up of the large firms, or at least at the logic of a less concentrated industry producing a market stimulus for ethical behavior. He considers that concentration in the accounting profession has produced an implicit collusion between the largest firms, and that this has suppressed the possibility that one of the firms may stress its greater reputation for integrity as a competitive strategy. (Coffee 2002: 20) He notes that: “…in a less concentrated market where several dozen firms competed it would be predictable that some dissident firm would seek to market itself as distinctive for its integrity. (Coffee 2002: 21)

As with a prohibition on the offering of consulting services, and the reform of accounting firm cultures, it is difficult to conceive of how any reduction of the degree of concentration in the accounting profession could ever be initiated from within the profession itself. All of the evidence suggests that the modern evolution of the accounting profession has been down a one-way street, and that a voluntary reversal of this evolution back towards an era of greater professional integrity would be extremely hard to effect. The future evolution of the profession would appear to lie in the hands of external regulators and legislators, implying that the fundament of any profession, self-regulation, is forever lost to the accounting profession.



1           The report that I produced for the Canadian Bar Association was itself based on prior research on the strategic evolution of the accounting profession that I had undertaken on behalf of the Certified General Accountants Association of Canada in 1994.

2           The Big Five at that time were: Arthur Andersen; Deloitte Touche Tohmatsu; Ernst and Young; KPMG; and PricewaterhouseCoopers. This paper will refer to the “Big Five” group of accounting firms as they existed prior to the Enron debacle, i.e., as if Arthur Andersen had not yet met its demise.

3           The CICA Task Force on Conflict of Interest interpreted its terms of reference narrowly, being concerned only with conflicts of interest related to the delivery of accounting services other than auditing: “There is a need to deal with the subject of conflicts as they may affect auditor independence and objectivity. Given the many dimensions of that issue, the subjects of auditor independence and objectivity are not dealt with in this report.” (CICA 2000: 3)

4           There are a number of exceptions to this section’s generic description of the evolution of the business structure of the profession. For instance, in Canada there were examples of national accounting firms dating back as far as the 1920s. Similarly in the U.S., some firms grew geographically at one stage by opening their own branch offices in new cities rather than via mergers with existing partnerships. And there were several early examples of firms operating with branches in more than one country.

5           “Concentration” in an industry is a concept in Industrial Economics that describes the proportion of that industry’s total annual turnover that passes through the hands of a small number of industry members. Not only did the accounting industry become highly concentrated compared to other industries, but also the distribution of the size of firms within the profession became highly skewed.

6           Audit automation via computerization was implemented from around 1986 through to the early 1990s, as indicated by the topics of articles in practitioner journals (e.g. Temkin 1986; Fischer & McAllister 1993.)

7           The long-term effect has been to increasingly dilute the accounting institutions with members who originally trained to be auditors but then who no longer engage in public practice: “By the mid 1980s, professional accountants, including CPAs entering positions in corporate practice, began to outnumber CPAs in public practice by greater margins. Yet public practice remained the preferred, if not common, entry-level experience forum; for CPAs, public practice, and the experience it represented, was a “rite of passage.”” (Previts & Merino 1998: 400) This membership dilution has been such that the Canadian Institute of Chartered Accountants has admitted that fewer than 25% of its members were involved in auditing and taxation work in 1996 (CICA 1996: 36.)

8           The seventh largest US accounting firm Laventhol & Horwath went bankrupt in November 1990. At that time the firm had 115 legal actions against it related to sloppy audit work, seeking to recover a total of $362 million. See Wooton & Tonge (1993).

9           See The Economist (1991) for an overview of this notorious battle for power between Andersen’s accounting and consulting partners. More extensive descriptions can be found in Toffler (2003: ch. 4), and in Stevens (1991: ch. 3).

10          There is insufficient space for me to fully describe another possible form of evolution of the Big Five accounting firms that appeared to further prejudice the audit. According to KPMG’s 1997-98 Annual Report in the United Kingdom, that firm had moved from a product-based form of organizational design, in which the audit division was nominally separate from the consulting division on the firm’s organization chart, to a market-oriented form of organizational structure, in which all services to particular market sectors were grouped together in industry-specific divisions. Such a structure would be notably more efficient, but likely at the cost of yet more pressures on audit independence had the structure become to be widely adopted by the Big Five.

11          For a brief history of the 1993 origins of the profession’s modern lobbying power see Labaton (2002b).

12          The strategic planning exercises conducted by both the Canadian Institute of Chartered Accountants and the American Institute of Certified Public Accountants in the mid-to-late 90s reveal that these organizations had come to define themselves in terms of the diverse breadth of activities undertaken by the Big Five rather than according to a core body of professional accounting knowledge. (See AICPA 1998; and CICA 1996.) The AICPA web page summary of that Institute’s Vision Project is of particular interest because the visions described therein do not contain any word related to “accounting” or “accountant.”

13          There have been other dramatic examples of evolving conflicts of interest in the profession that do not directly relate to the arguments presented in this paper, except insofar as they may too have been the products of warped internal cultures. For example, Arthur Levitt describes the 1998 investigation of the stock holdings of partners in PricewaterhouseCoopers. The investigation revealed 8,000 violations of stock ownership rules, involving half of the firm’s US partners: “The heads of major PwC divisions and top managers in charge of enforcing conflict-of-interest rules owned stock in audit clients. Even PwC chief executive James Schiro owned forbidden stock.” (Levitt 2002a: 125)



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Extracts from the AICPA Code of Conduct

There is no explicit definition of conflict of interest in the American Institute of Certified Public Accountants’ Code of Professional Conduct (AICPA 2003). The Code (as amended Jan. 14, 1992) contains the following component principles (code quotations are shown in italics):

Article I: Responsibilities. In carrying out their responsibilities as professionals, members should exercise sensitive professional and moral judgments in all their activities.

Article II: The Public Interest. Members should accept the obligation to act in a way that will serve the public interest, honor the public trust, and demonstrate commitment to professionalism.

Article III: Integrity. To maintain and broaden public confidence, members should perform all professional responsibilities with the highest sense of integrity.

Article IV: Objectivity and Independence. A member should maintain objectivity and be free of conflicts of interest in discharging professional responsibilities. A member in public practice should be independent in fact and appearance when providing auditing and other attestation services.

Article V: Due Care. A member should observe the profession's technical and ethical standards, strive continually to improve competence and the quality of services, and discharge professional responsibility to the best of the member's ability.

Article VI: Scope and Nature of Services. A member in public practice should observe the Principles of the Code of Professional Conduct in determining the scope and nature of services to be provided.

The Code indicates that an accountant has a primary duty to uphold the public interest. Article II.01 states that: A distinguishing mark of a profession is acceptance of its responsibility to the public. The accounting profession's public consists of clients, credit grantors, governments, employers, investors, the business and financial community, and others who rely on the objectivity and integrity of certified public accountants to maintain the orderly functioning of commerce. This reliance imposes a public interest responsibility on certified public accountants. The public interest is defined as the collective well-being of the community of people and institutions the profession serves.

Article II.02 further states that: In discharging their professional responsibilities, members may encounter conflicting pressures from among each of those groups. In resolving those conflicts, members should act with integrity, guided by the precept that when members fulfill their responsibility to the public, clients' and employers' interests are best served.

This section of the AICPA Code implies that a “conflict of interest” for an auditor could be defined as any interest that tempts that auditor to provide a report that would differ from that which would have been provided if the auditor had been beholden to the public interest alone.

The following extracts from the Code provide further clarification about the nature of other interests that may clash with this public interest responsibility.

Article IV.01 states that: Objectivity is … a distinguishing feature of the profession. The principle of objectivity imposes the obligation to be impartial, intellectually honest, and free of conflicts of interest. Independence precludes relationships that may appear to impair a member's objectivity in rendering attestation services.

Article IV.03 goes on to say that: For a member in public practice, the maintenance of objectivity and independence requires a continuing assessment of client relationships and public responsibility. Such a member who provides auditing and other attestation services should be independent in fact and appearance.

Article V.01 reaffirms the profession’s primary responsibility: Due care …imposes the obligation to perform professional services to the best of a member's ability with concern for the best interest of those for whom the services are performed and consistent with the profession's responsibility to the public. With regard to the audit, this professional service is performed on behalf of the shareholders, and not on behalf of management.

Article VI.01 states that: Objectivity and independence require that members be free from conflicts of interest in discharging professional responsibilities. Article VI.03 specifically addresses the issue of consulting services provided to audit clients, but it does not bar their sale: (Members should…) determine, in their individual judgments, whether the scope and nature of other services provided to an audit client would create a conflict of interest in the performance of the audit function for that client.

The accounting professionals in Arthur Andersen who performed the audit of Enron operated additionally under the Rules of Professional Conduct of the Texas State Board of Public Accountancy (Texas State Board, 2003). Rule §501.73(c) is particularly stringent, stating that: Certain professional engagements, such as audits, reviews, and other services, require independence. Independence impairments … cannot be eliminated by disclosure and consent.