Principles-Based Versus Rules-Based Standards and Earnings Management
Richard Mergenthaler Jr.
University of Iowa - Henry B. Tippie College of Business
December 26, 2009
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.
Number of Pages in PDF File: 42
JEL Classification: M43, G12, M41
Date posted: December 27, 2009