Detecting Earnings Management in Bank Merger Targets Using the Modified Jones Model

The purpose of this study is to examine whether merged banks are engaged in earnings management just prior to the merger. I use the Modified Jones model for the empirical tests. Other studies have used the Modified Jones model on multi-industry manufacturing samples. Two other studies (Key 1997; Cahan et al. 1997) used variations of the Modified Jones model on single industries such as Cable TV and Chemical industries, respectively. This study differs in that the exact Modified Jones model is used to examine earnings management in a single service industry, merged banks. I find that merged banks manage earnings in the pre-merger year and the year prior to the pre-merger year. The magnitude of earnings management decreases in the two years prior to the merger in comparison to year-3 to year-5 indicating that controls have an effect on earnings management, but not enough to eliminate earnings management. A split sample test indicated that merged state banks and merged national banks were managing earnings. A signed test concludes that merged banks manage earnings higher in the two years just prior to the merger compared to other years