Principles-Based Versus Rules-Based Standards and Earnings Management

42 Pages Posted: 27 Dec 2009  

Richard Mergenthaler Jr.

University of Iowa - Henry B. Tippie College of Business

Date Written: December 26, 2009

Abstract

Using a sample of accounting irregularities, this study investigates whether rules-based characteristics are associated with the dollar magnitude of earnings management, with the probability of being penalized by the SEC when earnings management is detected, and with the assessed penalty. To address these questions, I develop an instrument that measures the extent to which a standard contains rules-based characteristics. I find rules-based characteristics are positively associated with the dollar magnitude of earnings management. I also find a negative association between rules-based characteristics and the probability of being penalized by the SEC via enforcement actions. These results suggest the magnitude of earnings management is greater when a rules-based standard is violated and the likelihood of being penalized by the SEC is lower for detected rules-based violations.

JEL Classification: M43, G12, M41

Suggested Citation

Mergenthaler, Richard, Principles-Based Versus Rules-Based Standards and Earnings Management (December 26, 2009). Available at SSRN: https://ssrn.com/abstract=1528524 or http://dx.doi.org/10.2139/ssrn.1528524

Richard Dean Mergenthaler Jr. (Contact Author)

University of Iowa - Henry B. Tippie College of Business ( email )

108 Pappajohn Business Building
Iowa City, IA 52242-1000
United States
319-335-0848 (Phone)

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