Abstract
ABSTRACT We examine audit firms’ responses to increased legal liability. Using audit-effort data in China, we find audit firms increase audit effort when they are forced to switch from limited liability corporations (LLCs) to limited liability partnerships (LLPs). Audit fees also increase after the switch from LLCs to LLPs. Furthermore, we show the increase in audit effort is greater for clients that are in financial distress and for clients that report higher discretionary accruals. Overall, our study suggests audit firms respond to increased legal liability by increasing their audit effort, and the increase in audit effort is more pronounced for risky clients.
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