Corporate Monitoring and Misreporting: The Role of Rules-based and Principles-based Accounting Standards
62 Pages Posted: 27 Feb 2018 Last revised: 30 Aug 2022
Date Written: August 30, 2022
Abstract
Prior research provides some evidence that strict corporate monitoring constrains financial misreporting. We examine whether the efficacy of various corporate monitoring mechanisms hinges on the nature of accounting standards―rules-based standards (RBS) versus principles-based standards (PBS)―in place. We generally document that the negative association between the likelihood of misstatements and tough monitoring by audit committees, boards, external auditors, and the SEC is more pronounced under RBS than under PBS. This evidence collectively suggests that most corporate gatekeepers fulfill their monitoring obligations primarily through ensuring better compliance with detailed standards when the applicable standards are more specific and leave less room for discretion. In contrast, our results imply that corporate monitors may fail to effectively constrain managerial opportunism when the standards are less specific and provide wider scope for managers to exercise discretion. Relevant to the public policy discourse, our results lend support to the narrative that there is a sound institutional fit between the current corporate monitoring structure and rules-oriented accounting standards, while casting doubt on whether current corporate monitoring mechanisms would continue to function effectively in the event that the U.S. financial reporting regime moves to a more principles-based framework.
Keywords: Accounting Standards, Restatements, Corporate Governance
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