The more things change ...

By Michael Gibbins & Karim Jamal

Have US corporate collapses had an effect on the management practices of Canadian public accounting firms?

In recent years, public accounting firms have been caught in a media firestorm fuelled by corporate fraud, disappointed investors and aggressive regulators. The collapse of Arthur Andersen has triggered questions about how well accounting firms are managed. Some former Arthur Andersen partners (Barbara Toffler in 2003 and Arthur Wyatt in 2004) have proposed that greed and mismanagement by senior partners

contributed to the firm’s demise. Much of the trouble occurred in the US, but what about Canada? Have the management practices of Canadian public accounting firms changed?

We have data about Canadian firms’ management practices, gathered just before most of the trouble became prominent, and it provides a baseline to identify what has changed since. In 1999, we surveyed 218 audit, tax and consulting partners working in 15 public accounting firms (then the Big Five, four national firms and six local firms) about their management practices. Participants were selected by their firms and responses were received from a large number of Canadian cities. (The survey was sent to 280 partners, and 218 responded, a 78% response rate.) To assess changes, we contacted some of the firms that had taken part in our 1999 study and interviewed the managing or a senior partner from several local offices in summer 2005. We went over the results of the 1999 survey with them and asked them what changes (if any) had occurred from 1999 to 2005. We also had a discussion with the partners about changes in the accounting profession. To parallel our 1999 survey, we interviewed both audit and nonaudit partners from various-sized firms.

The 1999 survey showed that partners were concerned about client service and thought of expertise as being a characteristic of individuals (not the firm). Partners’ compensation was based on short-term (annual) and largely individual performance. Respondents (especially in audit) generally thought clients were mostly interested in general professional knowledge rather than any proprietary knowledge.

In the survey, partners were asked to respond to five questions. The first asked whether they thought about their firm locally, nationally or globally. The great majority told us they thought of the firm primarily at the local office level. This was true for partners from local, national and all Big Five firms. The second question asked partners to rank four sources of expertise. Partners from all firms ranked their personal technical expertise as most important, followed by personal relationships with clients, the firm’s expertise support, and in last place, the firm’s management approach. The third question asked partners to rate, on a nine-point scale, 11 attributes of the current practices of their accounting firm. There was considerable variation in some views, but the key findings were:

• Partners perceived clients as usually wanting general professional knowledge rather than specialized knowledge.
• In all firms, partners perceived people skills with clients as the decisive factor to make partner.
• Big Five firm partners perceived their firms as formally encouraging, monitoring and rewarding individuals for sharing expertise. In local firms, expertise sharing was encouraged informally.
• Big Five partners reported their compensation was based in part on individual performance and in part on the group’s performance. National and local firm partners perceived compensation as being based more heavily on individual performance. Allpartners perceived compensation as being determined primarily based on current annual performance, with little weight on long-run practice development.

The survey’s fourth question asked participants to rate the desirability, on a nine-point scale, of 13 firm management attributes. Desirable attributes were mostly client and expertise-development related: have a formal firm-wide strategy, seek clients who need the firm’s expertise, provide whatever services clients desire and increase depth of individuals’ technical expertise. The fifth question asked participants to rank 10 items as to importance for levering partner earnings. The two highest-ranked factors were ability to sell services to clients and developing technical knowledge. Managerial factors were generally seen as being unimportant to partners’ earnings.

In summer 2005, we interviewed several managing partners and/or senior partners from a sample of the firms providing responses in 1999. To parallel the 1999 survey, we talked to audit and nonaudit partners in local, national and Big Four firms. We first went over the 1999 survey results with the partners and asked for their comments on whether any results would now be different, then asked them to describe any more general changes they saw taking place in the profession. The key themes emerging from the 2005 interviews were very similar to the 1999 survey results. Partners were concerned about client service and developing new services and thought of expertise as being a characteristic of individuals (not the firm). Compensation was based on short-term (basically annual) and largely individual performance. There was a sense that clients remained mostly interested in general professional knowledge (especially in audit) rather than proprietary knowledge. Firm management remained relatively unimportant.

Not all was unchanged, however. One change that was clear in Big Four as well as national firms: the even more central role now played by national offices, especially with respect to quality control, resulting in less local control. Consistent with this, more centrally developed training was being provided from national offices. Small (local) firms apparently have opted out of work that would require such heightened quality control, and out of registering with the Canadian Public Accountability Board (CPAB). Partners re-ported that the quality control and a perceived misguided regulatory focus on fraud detection produced a heightened sensitivity to process and documentation (tick the box). Partners disagreed somewhat about the effects of increased documentation and regulation. While some thought the increased documentation requirements and box-ticking did not create any audit value, others felt the audit profession had strayed from its roots and the new requirements were leading to a refocus on audit quality.

In 2005, partners still thought of personal technical expertise, rather than firm-supported expertise, as key. Personal expertise is important not least because partners are not tenured: those who are deemed not to be performing to (mostly financial) expectations can be let go in a very short time. Even with the more centralized quality control and anticipation of audits by CPAB, partners continued to think of firm management as being relatively unimpor-tant. In the Big Four firms there was a shift toward placing more weight on personal technical knowledge and less on client relationships, whereas in national and local firms there continued to be an emphasis on client relationships.

Partners claimed to be more careful in client selection, emphasizing clients who had successful business operations and could afford to pay professional fees driven up by quality control. Local firms felt squeezed and unable to pass increased costs on to clients. Audit partners tended to think of audit as a specialty, and Big Four audit partners reported audit as being much more profitable and respected in the firm. Nonaudit partners (even in Big Four firms) thought of audit as a commodity. In national and local firms, assurance services (e.g., audit, review) were generally seen as commodities, with more profitable opportunities available in selling other services to clients.

Big Four firms reported more central control, more teamwork and more emphasis on technical knowledge as determinants of success in the 2005 environment. Local firms reported more individual orientation, less teamwork and a continuing reliance on client relationships as key to success. But, unchanged from 1999, all partners saw developing new services as being important to the success of their firms. Also unchanged were partner compensation practices. In 2005, partner compensation was still largely based on short-term and individual results (with some greater weight being placed on group results in Big Four firms). Staff retention was also viewed as being more important in 2005, partly because of the great demands of meeting clients’ SOX and similar Canadian regulatory requirements.

All interview participants reported operating in a very competitive business environment. Partners told us that some firms were using telemarketers and human resource firms to approach other firms’ professional staff and sometimes clients. While partner compensation had increased substantially since 1999, the increase came at a price: partners had to meet more demanding (financial) expectations to succeed in the firm. There was also a sense of vulnerability. One mistake could wipe out a lifetime’s work, and there was not much faith in the rationality and fairness of the regulated system in which audit partners work.

All participants also reported operating in a more highly regulated environment. Participants who were CPAB registrants were polite and careful in describing their relationship with CPAB, though the general view was that CPAB audits were less useful than the internal quality control audits done by the firms themselves. There was some concern that older partners might prefer to retire rather than keep up with the standards overload emanating from CPAB and the Accounting Standards Board and in response to the general decline in autonomy and professionalism in auditing. Local firms were driven further away from the audit market by the increased standards and by CPAB’s fee and registration requirements.

There was a sense among all interviewees that clients were becoming more demanding. For Big Four firm partners, a key change was in dealing with audit committees. While stronger relationships with audit committees were generally seen as good for the auditors, it was more complicated to maintain relationships with both the top management and the audit committee. Audit committees were seen to demand justifications for new accounting and audit standards and to be skeptical about whether increased audit fees were creating value for them. Some audit partners claimed they found it difficult to explain many of the new accounting and auditing standards when challenged by clients. They saw audit quality as intangible, even opaque, and not really valued by clients.

Audit partners were seen not only to have less autonomy but also to work in a higher pressure environment than in 1999. There were also concerns about audit committees being more likely to steer work, especially tax services, away from the audit firm.

There was some fear that audit services (and audit-related services such as internal control certification) were increasingly a commodity rather than a professional service. Partners generally did not see auditing as requiring proprietary services or innovation. Though auditing was more profitable than it had been, proprietary services (and their higher margins) were generally thought to occur elsewhere. The increased pressure was not limited to audit — for example, in local firms, pressure was felt from clients who demanded very fast response times to complex (usually tax) questions.

Finally, many interview participants raised demographics as an issue. As the profession ages, and many audit partners retire early (turned off by standards overload and decreased autonomy, and their leaving facilitated by substantial personal wealth and other opportunities), partner succession was seen as a problem.

To return to the question: have management practices of Canadian public accounting firms changed after all this? Our answer is largely no. While there has been some tightening of internal procedures and more attention paid to independence rules, these are mainly imposed by outside forces and do not appear to have produced dramatic internal changes. Life is more complicated, but there is still a focus on short-term performance and the firms’ management practices are still not seen as very significant in partners’ day-to-day lives. The financial targets may have become more demanding, the competitive environment is intense and regulations are more intrusive, all of which, we believe, are pushing public accounting toward being more of a business and less of a profession, and auditing to being less rewarding professionally even though more profitable. The underlying management of public accounting is not much different, nor more appreciated, in spite of the changing world and increased pressures.

Michael Gibbins, PhD, FCA, is Winspear Distinguished Professor of Professional Accounting at the University of Alberta. He can be reached at michael.gibbins@ualberta.ca. Karim Jamal, PhD, CA, is a professor and Chartered Accountants’ Distinguished Chair at the University of Alberta. He can be reached at karim.jamal@ualberta.ca

Technical editor: Michel Magnan, PhD, FCA, Lawrence Bloomberg chair in accountancy, John Molson School of Business, Concordia University, and associate Raymond Chabot Grant Thornton