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Partnership Versus Public Ownership of Accounting Firms: Exploring Relative Performance, Performance Measurement and Measurement Issues

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Australasian Accounting, Business and Finance Journal Volume 6 Issue 3 Article 5 Partnership Versus Public Ownership of Accounting Firms: Exploring Relative Performance, Performance Measurement and Measurement
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Australasian Accounting, Business and Finance Journal Volume 6 Issue 3 Article 5 Partnership Versus Public Ownership of Accounting Firms: Exploring Relative Performance, Performance Measurement and Measurement Issues Mark E. Pickering Swinburne University, Follow this and additional works at: Copyright 2012 Australasian Accounting Business and Finance Journal and Authors. Recommended Citation Pickering, Mark E., Partnership Versus Public Ownership of Accounting Firms: Exploring Relative Performance, Performance Measurement and Measurement Issues, Australasian Accounting, Business and Finance Journal, 6(3), 2012, Available at:http://ro.uow.edu.au/aabfj/vol6/iss3/5 Research Online is the open access institutional repository for the University of Wollongong. For further information contact the UOW Library: Partnership Versus Public Ownership of Accounting Firms: Exploring Relative Performance, Performance Measurement and Measurement Issues Abstract Despite theoretical arguments that partnerships are the most efficient ownership form for professional service firms (PSFs), PSFs are increasingly moving to other ownership structures, such as publicly listed companies (PLCs). Research on the comparative performance of PSF, PLCs and partnerships is sparse with conflicting results suggesting that some segments of PSFs are moving to a less efficient form. This study explores the performance of two Australian accounting PLCs compared to a sample of similar sized mid tier accounting firms. The accounting PLCs achieved substantially higher revenue growth rates but lower productivity than the partnership sample. Measurement issues were identified in the use of closing resource numbers and different treatment of reporting merger and acquisition revenues which may partially explain the underperformance of publicly owned PSFs in prior studies. The need for research at a more detailed level exploring the market and service focus, organisational structures, resources utilised and resource costs across different PSF ownership forms is suggested. Keywords Professional services, partnership, public ownership, accounting firms, performance, publicly quoted Cover Page Footnote This research was carried out while the author was a doctoral student at RMIT University and while teaching at Swinburne University. The author would like to acknowledge the support of David Kimber, formerly of RMIT, and Judy Oliver of Swinburne. This article is available in Australasian Accounting, Business and Finance Journal: Partnership Versus Public Ownership of Accounting Firms: Exploring Relative Performance, Performance Measurement and Measurement Issues. Abstract Mark E Pickering 1 Despite theoretical arguments that partnerships are the most efficient ownership form for professional service firms (PSFs), PSFs are increasingly moving to other ownership structures, such as publicly listed companies (PLCs). Research on the comparative performance of PSF, PLCs and partnerships is sparse with conflicting results suggesting that some segments of PSFs are moving to a less efficient form. This study explores the performance of two Australian accounting PLCs compared to a sample of similar sized mid tier accounting firms. The accounting PLCs achieved substantially higher revenue growth rates but lower productivity than the partnership sample. Measurement issues were identified in the use of closing resource numbers and different treatment of reporting merger and acquisition revenues which may partially explain the underperformance of publicly owned PSFs in prior studies. The need for research at a more detailed level exploring the market and service focus, organisational structures, resources utilised and resource costs across different PSF ownership forms is suggested. 2 Keywords: Professional services, partnership, public ownership, accounting firms, performance, publicly quoted JEL Codes: L22, L25, L84, M41. 1 Swinburne University, Australia 2 This research was carried out while the author was a doctoral student at RMIT University and while teaching at Swinburne University. The author would like to acknowledge the support of David Kimber, formerly of RMIT, and Judy Oliver of Swinburne. 65 AABFJ volume 6, no. 3, 2012 Introduction Since American Express started acquiring accounting firms in the 1990s (Shafer, Lowe & Fogarty 2002), publicly listed accounting companies have emerged as substantial organisations. Through rapid growth, accounting publicly listed companies (PLCs) have become larger than all but the big four accounting firms in Australia (King 2010) and the US (Accounting Today 2011) and include the seventh largest accounting firm in the UK (Grant 2010). More broadly, there has been a trend across a number of other professions away from the partnership form of ownership to other structures including limited liability partnerships, incorporation and PLCs (Greenwood, Deephouse & Li 2007; Greenwood & Empson 2003; Von Nordenflycht 2007). While the partnership form has been theorised to be an important attribute of the performance of professional service firms (PSFs) (Greenwood & Empson 2003), there has been limited research of the relative performance of different forms of ownership of these types of organisations (Greenwood et al. 2007; Von Nordenflyct 2007). Despite the significant size of PLCs providing accounting as their dominant service no previous studies were identified exploring the performance of these organisations. Related studies of the relative performance of different forms of ownership of large consulting firms (Greenwood et al. 2007) and advertising firms (Von Nordenflycht 2007) conclude that for some segments the movement to publicly owned companies is to a less efficient form. Measuring the relative performance of different ownership forms is problematic due to the lack of access to financial information on private partnerships with innovative researchers using proxies of profitability sourced from published industry surveys (eg. Greenwood et al. 2007; Von Nordenflyct 2007). There have been calls for further research to gain an insight as to why PSFs are moving to a less profitable ownership form (Greenwood et al. 2007). The limited research to date, information constraints, use of inconsistent proxy measures of performance and somewhat confusing prior findings suggest the need for exploratory analysis into performance measures themselves and the use of published industry survey data. This paper explores the performance of two Australian publicly owned accounting companies in comparison to a sample of ten second tier accounting partnerships using publicly available proxy measures, revenue growth and revenue per person, adapted from prior studies (eg. Greenwood et al. 2007; Von Nordenflycht 2007). Performance is taken from the perspective of the residual claims of owners rather than the professionals (agents). The measures themselves and underlying data sourced from industry survey data published in Business Review Weekly, were carefully examined to identify any data or measurement issues. Finally, for the two sample publicly owned companies the proxy measures were compared to explore whether they were reflective of the relative underlying financial performance of the companies as reported in company annual reports. While the study is exploratory it makes a number of contributions on the performance of publicly owned accounting companies in comparison to partnerships and on measurement issues of using these publicly available proxy performance measures to analyse relative performance. It is the first research to consider the performance of the newly emerged accounting PLCs. The research suggests that public ownership enables substantially faster growth than partnership by providing access to company shares as consideration for acquisitions. Rapid growth through acquisition carries risks as indicated by the failure of one of the sample companies and the high failure rate of Australian publicly owned accounting companies. The publicly owned accounting companies were less productive in terms of revenue per person than the sample partnerships. However, limited conclusions can be drawn 66 Pickering: Partnership vs Public Ownership of Accounting Firms on relative profitability across ownership forms due to measurement issues and different market focuses across samples as discussed below. The study provides insights into potential challenges of using published industry surveys and proxy measures of performance of different ownership forms of accounting and other PSFs. Different approaches to reporting revenues related to mergers and acquisitions by partnerships and PLCs and the use of year end resource (persons/ professionals) numbers rather than annual averages understate the relative productivity of fast growing PLCs when compared to slower growth partnerships. As theorised (eg. Greenwood & Empson 2003) the PLC sample focused on providing more commoditised services requiring low levels of tailoring of solutions to less sophisticated clients than the sample accounting partnerships. This suggests that lower revenue per person of the PLCs may not reflect lower productivity (hours charged per person) but lower hourly rates related to the types of services provided and customers served. This lower revenue per person noted in the study may therefore be offset by lower employee costs per person than partnership due to the lower specialisation required for less complex services. In this study, proxy measures adapted from prior studies of PSF performance were not found to be representative of the underlying performance of the PLC sub-sample per published financial information. These identified measurement issues may partially explain prior findings of the underperformance of large publicly owned consulting companies compared to large consulting partnerships (Greenwood et al. 2007). For future research on the relative performance of different ownership forms of accounting and other PSFs this study suggests the need for care in the use of revenue based proxy measures of performance, the need to control for service/client focus across samples and for detailed case studies and researcher surveys to provide a greater understanding of the underlying performance of these entities. Literature Review This section examines the literature on partnership as an optimal form of managing professionals, the trend of accounting firms and other large PSFs to other ownership structures, prior studies of the ownership structure and performance relationship and measures used in prior studies. Partnerships as an Optimal Form for Managing Professionals Professional service firms, such as accounting, law, engineering and consulting firms have traditionally been structured as professional partnerships (Greenwood, Hinings & Brown 1990). In these organisations, partners act in multiple roles as owners, managers and key professionals which is different to large corporations where ownership, management and operational employment is separated (Greenwood et al. 1990). Partnerships also involve unlimited liability where partners are liable for the actions of other firm partners (Empson and Chapman 2006). The predominance of this form of ownership is due to legal constraints and professional body requirements (Empson & Chapman 2006: Von Nordenflycht 2007) and due to partnership being theorised to be the optimal structure to manage professionals and balance the conflicting needs of shareholders, professionals and clients (Empson & Chapman 2006; Greenwood & Empson 2003). Partnership has been theorised to balance the potential agency issues (Fama & Jensen 1983) and conflict between firm owners and key professionals over ownership of knowledge assets and client relationships by combining both roles and enabling key professional participation in decision making (Empson & Chapman 2006; Hart & Moore 1990). The 67 AABFJ volume 6, no. 3, 2012 difficulty in applying formal controls due to the complex and non-routine nature of professional activities is addressed in partnerships by the sharing of profits and the use of peer control and self-monitoring processes encouraged by unlimited liability (Empson & Chapman 2006; Greenwood & Empson 2003). The up-or-out approach to promotion is often used in professional partnerships (Galanter & Palay 1991; Gilson & Mnookin 1989; Morris & Empson 1998). The small percentage of juniors making partner and the high rewards of partnership (compensation, involvement in decision making and status (Greenwood & Empson 2003)) represents the tournament system of motivation (Becker and Huselid 1992; Lambert, Larcher & Wielgelt 1993) which has been associated with greater work effort and productivity (eg. Galanter & Palay 1991; Gilson & Mnookin 1989). Internal ownership, unlimited liability and the up-or-out promotion policy of partnerships provide reassurance to clients even with asymmetric knowledge (Empson & Chapman 2006). Personal liability and their ownership of the firm aligns partners interests with those of clients in terms of ensuring quality standards and not placing external shareholder needs above clients (Shafer et al. 2002). The tournament system provides a safeguard on the professionalism of individual partners for both partners and clients (Covaleski et al. 1998; Galanter & Palay 1991; Gilson & Mnookin 1985). The above attributes of partnerships have been theorised to result in partnerships having lower internal agency costs than the external agency costs of PLCs that separate ownership from management and the organisation s professionals, remove personal partner liability and detract from the motivational power of the quest to achieve partner status (Greenwood & Empson 2003). Moves to Other Forms of Ownership Despite the theorised benefits of partnerships in managing professional service firms, there has been a trend in large professional service firms moving from traditionally being structured as professional partnerships to other forms of ownership, such as unlimited partnerships, private corporations and PLCs (Greenwood & Empson 2003; Greenwood et al. 2007; Von Nordenflycht 2007). Even traditional professions such as accounting and law have seen some change to public ownership. Accounting firms had traditionally been constrained to partnership and sole trader forms by legislation and the regulations of accounting professional associations (Von Nordenflycht 2007). During the late 1980s and 1990s, due to large legal settlements, accounting firms and professionals lobbied to use ownership structures which limited accounting firm liability and the personal liability of firm partners (Accountancy Age 1986; Bruce 1995). During the 1990s and early 2000s legislative and regulatory changes were introduced in many countries enabling incorporation of accounting firms and the registration of firms as Limited Liability Partnerships in the United States (Hamilton 1995) and the United Kingdom (Linsell 2001). The late 1990s saw a trend towards the public ownership of accounting firms in the US through the acquisition of thousands of firms by companies such as American Express, H&R Block and CBIZ Inc. (Shafer et al. 2002; Wootton, Wolk & Normand 2003). American Express subsequently exited the accounting business in 2005 selling the business to H&R Block subsidiary RSM McGladery (H&R Block 2005). In Australia in 1998, publicly owned WHK Group (then named Investor Group) acquired its first accounting firm going on to acquire another 150 accounting and financial planning firms over the next twelve years (Pickering 2010). Four other publicly owned companies with major accounting focus were listed in Australia between 2000 and 2003 with all except WHK Group collapsing by 2005 (Drury 2007; Fraser 2005). Survivor WHK Group was recently joined on the Australian 68 Pickering: Partnership vs Public Ownership of Accounting Firms Securities Exchange in December 2010 by CountPlus Limited (Hatch 2011). In the UK early in the 2000s four publicly owned accounting firms were listed and grew rapidly by acquisition (Hanney 2005A; Hinks 2008) with one of these, Numerica PLC, collapsing in 2005 (Hanney 2005B) and a second, Vantis PLC, going into administration in mid-2010 (Armistead 2010). RSM Tenon and insolvency firm Begbies Traynor remain listed in the UK as of early While the number of accounting PLCs remains low globally they now represent some of the largest accounting firms outside of the Big 4 in Australia, the US and the UK. In Australia, WHK Group Limited is the 5 th largest accounting firm with revenues in 2010 of Aus$348 million (King 2010), RSM and the related McGladery and Pullen are combined the 5 th largest firm in the US with revenues of US$1,379 million (Accounting Today 2011) and RSM Tenon PLC is the 7 th largest firm in the UK with revenues of UK 225 million (Grant 2010). In Australia, the first legal services PLCs (Integrated Legal Holdings and Slater and Gordon Limited) have emerged while in the UK the Legal Services Act has recently been passed allowing the ownership of law firms by non-lawyers (Faulconbridge & Muzio 2009). Factors that may result in the move towards incorporation of PSFs include the growth in the size and complexity of firms resulting in collegiate decision making becoming more difficult and requiring the addition of further controls, the expansion in types of services offered resulting in professionals with different values joining the organization and creating difficulty obtaining agreement and the growing need for capital to fund increasing technology costs (Greenwood & Empson 2003). Environmental factors such as increasing risk of litigation (Van Lent 1999), reduced incentives for professionals to aspire to partnership due to opportunities for greater rewards outside of partnership and a preference for a balanced lifestyle reducing the relative benefits of partnership (Greenwood & Empson 2003). This is supported by ownership structure related benefits expected by partners of accounting partnerships selling their firms to PLCs. These include: gaining access to capital to enable growth by acquisition and investment in information technology systems; addressing partnership succession issues with firms struggling to find new partners willing and able to pay up to $500,000 to buy in; and the ability to pay out retiring partners (Pickering 2010). Overcoming limitations with consensus decision making in partnerships, particularly as firms grew larger, and difficulties in introducing more corporate governance structures into partnerships were also cited as reasons for selling. Removing partners liability did not emerge as a major reason for selling into a public company (Pickering 2010). Relative Performance of Different Forms of Ownership of PSFs While PSFs have been moving to alternative forms of ownership the question as to whether the form of ownership affects the performance of professional service firms has been neglected (Greenwood et al. 2007; Von Nordenflycht 2007). Greenwood et al. (2007) in the study of large consulting firms find that private companies and partnerships outperform PLCs but found no difference in the performance of partnerships and private corporations. Durand and Vargas (2003) suggest that the relative performance of different ownership forms will change with the size and complexity of organisations. Organisational complexity, as defined by the number of offices, was not found to impact the relationship between ownership form and performance in large consulting firms (Greenwood et al. 2007). However, performance was found to be negatively correlated to the number of professionals in the firm suggesting increasing costs of coordination with size (Greenwood et al. 2007) consistent with Nanda s (2004) study of the performance of US legal firms. Moving to public ownership was not found to lower performance of large advertising ag
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