Explaining Rules-Based Characteristics in U.S. GAAP: Theories and Evidence

Despite debate on the desirability of rules-based standards, no studies provide evidence on why accounting standards take on rules-based characteristics. We identify and test five theories from prior research (litigation risk, constraining opportunism, complexity, transaction frequency, and age) that could explain why some U.S. accounting standards contain rules-based characteristics. Litigation risk and complexity are most consistently related to cross-sectional and time-series variation in rules-based characteristics. We find more limited evidence that frequent transactions, age, and desires by regulators to constrain opportunistic reporting are related to rules-based standards. We note, however, that our findings are necessarily descriptive because standards arise endogenously from market and political forces, limiting causal interpretation. Further, it is difficult to perfectly separate rules-based characteristics of the standard from both the complexity of the standard and the characteristics of the underlying transaction, including the complexity of the transaction.