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Abstract
The valuation adjustment mechanism (VAM) is a contingent-payment contractual arrangement used in the Chinese mergers and acquisitions (M&As) market. The ‘two-direction payment’ design of Chinese VAMs can reduce deal uncertainty and generate value, especially for poorly performing companies that can use VAM contracts to boost short-term performance. I find in this empirical investigation that acquirers applying VAM terms have significantly higher market returns after addressing endogeneity. I also document that poorly performing bidders sign larger VAM contracts, pay higher bid premiums and achieve higher operating performance, and which types of firms are more likely to adopt a VAM in transactions.
Highlights
Takeovers of privately held firms represent the vast majority of transactions worldwide (Chang 1998; Draper & Paudyal 2006), and acquirers earn significant positive returns when acquiring a privately held company, especially when the method of payment is stock (Fuller et al 2002)
The valuation adjustment mechanism (VAM) is a contingent-payment contractual arrangement used in the Chinese mergers and acquisitions (M&As) market
This study empirically analyses the relationship between VAM contracts and acquisitions in China
Summary
Takeovers of privately held firms represent the vast majority of transactions worldwide (Chang 1998; Draper & Paudyal 2006), and acquirers earn significant positive returns when acquiring a privately held company, especially when the method of payment is stock (Fuller et al 2002). While the Chinese VAM is not part of a payment currency in an acquisition transaction, it serves as an additional contract term to align the interests of acquirers and targets, and the full payment made upon the announcement of the deal and the later payback mechanism – if the target cannot deliver the promised profits – can effectively solve the “moral hazard” issue of high first-stage payment problems associated with earnout payments Both the VAM and earnouts are used to reduce information asymmetries, especially for private target acquisitions, for which detailed information on targets is not publicly available on the market.
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