Principles-Based Versus Rules-Based Accounting Standards: The Influence of Standard Precision and Audit Committee Strength on Financial Reporting Decisions

Abstract:     
Recent accounting scandals have resulted in regulatory initiatives designed to strengthen audit committee oversight of corporate financial reporting and have led to a concern that U.S. GAAP has become too rules-based. We examine issues related to these initiatives using two experiments. CFOs in our experiments exhibit more agreement and are less likely to report aggressively under a less precise (more principles-based) standard than under a more precise (more rules-based) standard. Our results also indicate that CFOs applying a more precise standard are less likely to report aggressively in the presence of a strong audit committee than a weak audit committee. We find no effect of audit committee strength when the standard is less precise. Finally, we find support for a three-path mediating model examining mechanisms driving the effect of standard precision on aggressive reporting decisions. These results should be of interest to U.S. policy makers as they continue to contemplate a shift to more principles-based accounting standards (e.g., IFRS).

Number of Pages in PDF File: 39

Keywords: standard precision, rules-based standards, principles-based standards, audit committee, corporate governance, International Financial Reporting Standards (IFRS)

JEL Classification: M41, M43, M44, M49, G38

Accepted Paper Series