Litigation is a major problem for the auditing profession. It threatens not only the wealth that partners hold inside their
audit firms but also their outside wealth. Auditors have lobbied for legal protection of their personal assets, arguing that
their inside wealth is sufficient to ensure high quality audits. Accordingly, some countries now permit audit firms to
choose organizational forms that confer limited liability. In contrast, other countries impose unlimited liability which
exposes partners’ personal assets to the risk of litigation. These cross-country differences have arisen in the absence of any
systematic evidence on the implications of allowing audit partners to have limited liability. The purpose of this study is to
address the following research questions: (1) Is audit quality impaired after audit partners obtain limited liability? (2) Do
clients perceive that they suffer adverse consequences when partners are protected by limited liability? (3) Do auditors
become more tolerant of client litigation risk after they switch to limited liability? We provide evidence using data from
the United Kingdom (UK), which first permitted audit firms to become limited liability partnerships (LLPs) in 2001.
We begin by comparing the audit firms that switch to the LLP organizational form versus those that retain unlimited
liability. For two reasons, we predict that larger audit firms are more likely to become LLPs. First, the negligent actions of
just one bad partner threaten the entire partnership and this risk is magnified for the larger audit firms that have more
partners signing off on audit engagements. Second, the larger audit partnerships are the potential targets of deep pockets
lawsuits (Dye, 1993) and so they have stronger incentives to obtain limited liability. Consistent with these arguments, we
find that larger partnerships are more likely to obtain limited liability. As expected, we also find a positive relation
between client litigation risk and an audit firm’s propensity to become an LLP