Is Modified Jones Model Effective in Detecting Earnings Management? Evidence from A Developing Economy

Md. Aminul Islam, Ruhani Ali, Zamri Ahmad

Abstract


This study analyzes the effectiveness of Modified Jones Model in detecting earnings management among the initial public offerings that are listed between 1985 – 2005 in the Dhaka Stock Exchange (DSE). Prior research documented that the Modified Jones model is effective in detecting earning management in mostly developed economies. However recently an empirical research of Korean stock exchange revealed that the Modified Jones model was not effective in detecting earnings management in the context of Korea. Our findings are similar to the Korean experience. Results of our study confirmed that Modified Jones model is not effective in detecting earnings management in the context of Bangladesh. We employed the modified Jones model to detect earning management in context of Bangladesh capital market and found out that it was not found very effective as the explanatory power of the model was only about 9 percent. This study then attempted to extend the modified Jones model and found it to be very successful. The inclusion of few factors such as revenue, depreciation expenses, retirement benefit expenses, asset disposal gains/losses with the modified model was very effective in detecting earning management in the context of Bangladesh. The explanatory power of the model was increased to about 84 percent. Therefore it is concluded that the modified Jones model is not effective in gauging the extent of earnings management practiced by the IPO firms in the Bangladesh capital market.


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International Journal of Economics and Finance  ISSN  1916-971X (Print) ISSN  1916-9728 (Online)

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