Rule- vs. Principle-Based Accounting Standard and Earnings Characteristics : An Analysis Using ASC 606

51 Pages Posted: 13 Feb 2020

See all articles by Kyungran Lee

Kyungran Lee

The University of Hong Kong - School of Business

ShinWoo Lee

Columbia University - Columbia Business School

Date Written: February 6, 2020

Abstract

We examine the effect of the adoption of the new revenue recognition standard (ASC 606) on earnings characteristics and how it, in turn, affects the stock and the debt market. The new rule standardizes, simplifies, and harmonizes previous revenue recognition practices among companies, which is a transition from a rule-based accounting standard to a principle-based accounting standard. We find that the new rule decreases earnings predictability and it is associated with the increased discretion in preparing earnings numbers. In addition, the use of earnings-based covenants decreases in debt contracting. However, we do not find evidence that the new standard is associated with an increase in earnings management behavior. In terms of the stock market response, the earnings response coefficient (ERC) does not change after the new rule overall. However, it has increased for firms with high institutional holdings after the adoption and decreased for firms with low institutional holdings. Our analysis supports the idea that this is due to different investors interpreting the new disclosure associated with ASC 606 differently.

Keywords: ASC 606, principle-based accounting standard, rule-based accounting standard, earnings characteristics, debt covenant, institutional investors

JEL Classification: G18, M41, M48

Suggested Citation

Lee, Kyungran and Lee, Shin Woo, Rule- vs. Principle-Based Accounting Standard and Earnings Characteristics : An Analysis Using ASC 606 (February 6, 2020). Available at SSRN: https://ssrn.com/abstract=3534039 or http://dx.doi.org/10.2139/ssrn.3534039

Kyungran Lee (Contact Author)

The University of Hong Kong - School of Business ( email )

Meng Wah Complex
Pokfulam Road
Hong Kong
China

Shin Woo Lee

Columbia University - Columbia Business School ( email )

3022 Broadway
New York, NY 10027
United States

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