Abstract
In this study, we examine whether and how an increase in auditor litigation risk affects client innovation. Exploiting multiple exogenous shocks that both increase and decrease legal liability for audit failures as a means of identification, we provide evidence that increased auditor legal liability has a detrimental effect on innovation as measured by patent-based metrics. The findings highlight a potential negative externality of increased auditor legal liability and provide insights into how regulation could potentially distort managerial incentives and firm investments.
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