EARNINGS MANAGEMENT BY MERGER TARGETS: DISCRETION OVER THE LOAN LOSS PROVISION IN COMMERCIAL BANKS

This paper investigates the relationship between commercial banks accrual choices and the likelihood of their takeover. I study a sample of 2,414 commercial bank holding companies (banks) over the period of 1987 through 1998. The sample consists of 14,574 bank-years. I perform two complimentary tests to determine if the targets in bank mergers are managing their loan loss provision downward in the period prior to the merger. In the first test, I select a sample of 641 bank-years for banks in the year before they are the targets in a merger. I test for the mean difference in the loan loss provision between these target-banks and the rest of the sample after controlling for the economic determinants of the loan loss provision. I find that both public and private intrastate targets as well as private interstate targets all demonstrate a negative unexpected loan loss provision during a time-period where there is a high probability of takeover. I do not find an earnings management difference between public and private targets. In the second test, I select a sample of 116 target banks that continue to be reported as a subsidiary to their new parent. I test for a negative (positive) unexpected loan loss provision prior to (after) the merger. There is some evidence that these targets do have a negative provision prior to the merger, but they do not exhibit the expected reversing behavior.