An interesting article was posted on SSRN last month titled Rules-Based Accounting Standards and Litigation by Dain Donelson, John McInnis, and Richard Mergenthaler. The article discusses the association between rules-based standards and litigation and whether rules serve more to convict or to defend firms. In the conclusion, the authors write:

Overall, we find support for the view that rules-based standards reduce incidence of litigation and lower settlement amounts. In a sample of restatements, we find firms that violate rules-based standards are less likely to be sued, consistent with the Complexity view. We find no relation between dismissal decisions and rules-based characteristics. After controlling for selection effects, we find that rules-based violations settle for smaller amounts. However, in a conditional analysis of only sued firms, we find suits involving rules-based standards settle for higher amounts, consistent with the roadmap view. Finally, consistent with the safe harbor view, we find that non-restatement cases involve allegations of principles-based standards, and these cases are dismissed at higher rates and have lower settlements.

Our primary analysis, involving restatements, suggests a shift to less rules-based accounting standards will increase litigation risk. Eliminating complex rules may lead to fewer restatements attributable to pure errors. As these restatements do not typically lead to lawsuits, this decrease in innocent restatements would not affect litigation risk. However, with less complex standards, restatements that do occur will expose firms to higher litigation risk because managers will be less able to credibly claim the restatement was an “innocent error.”