Management Judgment and Discretion in Principles-Based Standards: Can Corporate Governance Mechanisms Ensure Effective Implementation?

• In Event: Taxes, firm profitability and public debt
  In Dialogue Session: Taxes, Firm Profitability and Public Debt

Abstract

This study examines whether corporate governance mechanisms can constrain managements’ exercise of judgment and discretion and ensure the effective implementation of principles-based standards. We identify firm-specific characteristics, incentives for opportunistic decisions by management, and corporate governance attributes associated with the recognition of asset retirement obligations upon adoption of SFAS No. 143 in 2003. Univariate and regression results reveal particular firm-specific factors associated with ARO recognition, evidence of management’s motivations concerning adoption decisions, and the presence of strong corporate governance and monitoring during the implementation process. However, noncompliance identified by the FASB led to the issuance of FIN 47 in 2005 and the subsequent recognition of additional AROs. The adoption of FIN 47 is also examined to distinguish between firms that complied with SFAS No. 143 and groups of noncompliant firms. The results indicate consistent elements of corporate governance and monitoring among the sample firms but reveal evidence of opportunistic decision-making among particular noncompliant firms. Overall, the findings reveal that corporate governance was not sufficiently effective in constraining managements’ use of judgment and discretion, necessitating two attempts to properly implement a single principles-based standard. This study extends emerging literature on the application of principles-based standards in the U.S. and should be of interest to the SEC, FASB, preparers, auditors and investors since principles-based standards will remain integral to the U.S. financial reporting environment.

Authors

• Matthew Bjornsen, University of Nebraska-Lincoln

• James M Fornaro, SUNY-Old Westbury