Convergence of audit and credit rating practices: Going concern ratings


Amid heightened concerns for systemic risk in the global audit and credit rating markets, this article takes a departure from the silo approach of the current debate on audit and credit rating by exploring the potential benefits of convergence of audit and credit rating practices, such as going concern (GC) rating (or audit rating) with notching relationship to issuer credit rating, an alternative practice platform for auditors and credit rating agencies (CRA) to form strategic alliances, and use of innovative insurance solutions to mitigate catastrophic litigation risks in order to facilitate the capital formation for such audit–credit rating alliances. If successfully implemented, the convergence would lead to potentially seven global audit–credit rating alliances (the Big 7) in the financial reporting industry, instead of an audit market dominated by the Big 4 and a credit rating market by the Big 3. Given the exploratory, conjectural nature of this article and non-existence of research literature on the convergence subject, issues and ideas discussed in this article, such as the auditor independence issue for assigning GC ratings and CRAs assigning GC ratings through internal audit practices, will inevitably require further conceptual exploration and fundamental research. The intent of this article is to spur further debate and research on the convergence of the two practices.

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  1. 1.

    Going concern rating or audit rating is defined as to convey audit opinions statistically on an ordinal rating scale. For consistency, the terminology ‘going concern rating’ is used in this article.

  2. 2.

    Revenue estimates of the top 10 global accounting networks and top 10 global accounting associations according to the 2009 industry ranking by International Accounting Bulletin.

  3. 3.

    Estimate of total revenues of the Big Three, Moody's, S&P and Fitch Ratings and other second-tier rating agencies in 2009.

  4. 4.

    Grant Thornton (2010).

  5. 5.

    RSM McGladrey is the fifth largest accounting firms in the United States ranked by revenue in 2008, according to Public Accounting Report.

  6. 6.

    RSM International is the sixth largest global accounting networks ranked by revenue in 2009, according to International Accounting Bulletin.

  7. 7.

    McGladrey & Pullen is a CPA firm licensed to conduct public audit practice, which is ring-fenced from the rest of RSM McGladrey.

  8. 8.

    EXEL was launched as a captive in 1986 by a group of Fortune 500 companies in response to shortage of D&O insurance capacity. The company in time was renamed XL Insurance to provide insurance to third-party market outside its traditional captive market. In 1991, XL raised approximately $630 million capital via an IPO on NYSE, with 24.7 million shares at a listing price of 25.50. Today XL Group is one of the largest global insurance groups with shareholders’ equity of $10.9 billion.

  9. 9.

    L. Cunningham (2007).

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    US Government Accountability Office (2008).

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    SEC (2009).

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    US Government Accountability Office (2010).

  13. 13.

    US Government Accountability Office (2008).

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    Integrity Research (2010).

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    London Economics, in association with Professor Ralf Ewert, Goethe University, Frankfurt am Main, Germany (2006).

  17. 17.

    US Treasury Department (2008, p. VII: 25).

  18. 18.

    Cornerstone Research (2010a).

  19. 19.

    Estimates of equity capital of the Big 3 and that of second-tier rating agencies in 2009.

  20. 20.

    Australia is the first country in the world to allow public investment and ownership in law firm. In May 2007, Melbourne-based Slater & Gordon was listed on the Australian Stock Exchange (ASX). Upon completion of its IPO, Slater immediately launched a rapid succession of 13 acquisitions from May 2007 to October 2010. Slater now has more than 700 staff located in over 35 offices in one of the largest and widest networks of law offices in Australia.

  21. 21.

    CPA firms are subject to the Uniform Accountancy Act (UAA) jointly maintained by AICPA and state CPA governing boards, which is represented by the National Association of State Board of Accountancy (NASBA). The ownership and structure are further defined in Sections 7 and 8 of the UAA. Although CPA firms may include non-licensed owners, at least a simple majority, that is 51 per cent, of the ownership, in terms of financial interests and vote rights, must belong to the registered holder under Section 8 of the UAA. The AICPA supports non-CPA ownership of CPA firms as long as: 1. Licensed CPAs must hold a simple majority of the firm ownership 2. A licensed CPA must be the managing partner of the firm 3. The partner in charge of attest services must be a licensed CPA 4. All non-CPA owners must be actively engaged in working for the firm, or an affiliated entity. Passive ownership is not allowed As of December 2010, 44 states mandate 51 per cent CPA ownership while the remaining states, including New York, have no current provision allowing non-CPA ownership.

  22. 22.

    On 29 June 1999, H&R Block purchased the non-audit practices of McGladrey & Pullen LLP, the seventh largest CPA firm in the United States, for $240 million plus assumption of pension liabilities of approximately $50 million. The acquisition was completed with regulatory approval in August 1999. Under the term of the agreement, HRB created a new subsidiary called RSM McGladrey to market the non-audit services of McGladrey & Pullen. RSM McGladrey was ranked by Public Accounting Report in 2008 as the fifth largest accounting firm in the United States with $1467 million in fee income, of which 44% are derived from audit-related practices. RSM International was ranked by International Accounting Bulletin in 2009 as the sixth largest global accounting network with $3875 million in fee income, of which 48 per cent are derived from audit-related practices.

  23. 23.

    Deepening insolvency is based on a controversial theory that refers to the artificial prolongation of a corporation's life beyond insolvency, resulting in a worsening of the financial situation, usually in the form of increased debt, which damages the corporation. Under this doctrine, a bankrupt company or its representative may recover damages caused by an expanding list of third parties, including officers and directors, accountants, financial advisors and other professionals, and even lending institutions, that have either mismanaged or controlled the debtor or misrepresented the debtor's financial condition such that the company's existence is artificially extended to the detriment of creditors.

  24. 24.

    Valuation is one of the nine prohibited non-audit services listed in Sarbanes-Oxley Act, Title II, Section 201, and the SEC final rule regarding auditor independence.

  25. 25.

    See further discussion on notching relationship in the ‘Zone of Insolvency’ section.

  26. 26.

    Moody's KMV (2003), 18 December.

  27. 27.

    Carroll School of Management, Boston College (2008).

  28. 28.

    Referenced in Haskins’ book, Geert Hofstede analyzed the impact of the four cultural dimensions in his book ‘Culture and Organization – Software of the Mind’: power distance, collectivism versus individualism, femininity versus masculinity, and uncertainty avoidance on business behaviors, and the importance of understanding these cultural differences when reading financial reports from different countries and regions. A fifth dimension was added later: long-term versus short-term orientation.

  29. 29.

    Internal audit services are currently offered by the advisory units of auditors to non-audit clients and by specialized internal audit firms such as Protiviti, a wholly owned subsidiary of Robert Half International.

  30. 30.

    The Big 4 and the Big 3 are assumed in this article not to pursue alliances with each other due to potential monopoly issue of such alliances. Therefore, the Big 7 in this article refers to the Big 4 auditors and the potential alliances between the Big 3 CRAs and the second-tier auditors.

  31. 31.

    Given that GC rating is not designed for regulatory financial reporting but for meeting the informational needs of investors, the hypothetical GC rating model presented in this article is premised on the assumption that auditor independence issues for assigning GC rating are resolved and auditors are permitted to expand their role to provide more relevant information to investors.

  32. 32.

    Effective governance measures, legal or operational separation between credit rating and GC rating practices are assumed to exist before CRAs are permitted to assign GC ratings through internal audit services. For more discussion please see the Rating Going Concern Risk section.

  33. 33.


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Correspondence to Simon Hu.

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1spent the last 15 years in the global credit rating industry, most recently with Fitch Ratings as a senior director and before that managing director and general manager for A.M. Best Asia-Pacific. He holds a bachelor degree in electrical engineering from Rutgers University and an MBA degree from Golden Gate University. Mr Hu is currently on academic sabbatical for his research on alternative credit worthiness standards.

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Hu, S. Convergence of audit and credit rating practices: Going concern ratings. Int J Discl Gov 8, 323–338 (2011).

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  • convergence
  • audit rating
  • going concern rating
  • credit rating
  • insolvency