Signaling and Risk Allocation in Merger Agreements

Abstract

Acquirers and targets allocate interim risk in merger agreements through the Material Adverse Change (MAC) clause and its exclusions. While virtually all acquisitions have a MAC clause, there is broad cross-sectional variation in the numbers and types of MAC exclusions. MAC exclusions can address firm-specific or market-wide adverse changes. Fewer MAC exclusions imply broader abandonment options for acquirers. Using comprehensive hand-collected data, we find that both acquirer and target announcement returns are higher with broader firm-specific abandonment options. Broad firm-specific abandonment options serve as credible signals for higher target quality and are associated with better prior target performance. Broad abandonment options are more prevalent when information asymmetries are likely high and signaling is particularly beneficial. In contrast, acquirers tend to assume the largely exogenous, market-wide interim risk when expected deal completion periods are longer and asymmetric information is less important.