Abstract
AbstractEarnouts address merger valuation risk by deferring payment of a large part of deal consideration and making it contingent on targets’ future performance. We find acquirers of unlisted targets using earnouts gain more (less) than those making full up‐front payments in cash (stock). Larger and older acquirers benefit more from earnout‐based deals, as do foreign acquirers and acquirers advised by top‐tier or boutique advisors. We address identification through the propensity score matching method and a quasi‐natural experiment. Acquirers realize the highest returns from earnouts when the deferred payment is around 30% of deal value. Deferred payments are larger after the SFAS 141(R) reform.
Highlights
We do not intend to analyze the relative merits of earnouts versus contractual solutions offered by other means. 6Although prior studies investigate the earnout effects on acquirers’ gains by including listed target mergers and acquisitions (M&As), we offer the first analysis in which only M&As of unlisted targets are included, and we study whether including listed target M&As can distort the analysis of earnout valuation effects. 7Recent evidence, challenges the traditional view that stock‐swap listed target acquisitions are associated with a negative pricing effect on acquirer value
The average acquirer in our sample enjoys a 1.72 percentage point cumulative abnormal return (CAR) over the 5‐day event window. This is consistent with prior studies analyzing the valuation effects of unlisted target M&As, including private (CAR = 1.61 percentage points) and subsidiary (CAR = 1.93 percentage points) target M&As on acquirer returns (Barbopoulos et al, 2020; Chang, 1998; Faccio et al, 2006; Fuller et al, 2002)
We further find that acquirers in earnout and nonearnout M&As enjoy similar CARs, some interesting heterogeneity is observed, which is pertinent to the contingent properties in the corresponding nonearnout payment
Summary
Earnout is a contractual payment mechanism in mergers and acquisitions (M&As) where a relatively large part (often around a third) of the deal consideration is deferred and payable to the target's shareholders at multiple stages following the M&A announcement, contingent upon some observable measure(s) of the target firm's future performance within prespecified periods (Barbopoulos, Danbolt, & Alexakis, 2018; Cain et al, 2011). EarnoutsJ Financ Res. 2021;1–33.| wileyonlinelibrary.com/journal/jfir 2|JOURNAL OF FINANCIAL RESEARCH are very popular among M&As of unlisted (i.e., private and subsidiary) target firms, those operating in the high‐technology, healthcare, and other innovation‐ and patent‐rich sectors, where valuation risk is generally high because of moral hazard and adverse selection (Kohers & Ang, 2000). Prior studies show that earnouts are associated with higher acquirer gains, and higher takeover premia, relative to counterpart M&As that are settled in single up‐front payments at closing (Barbopoulos & Adra, 2016; Kohers & Ang, 2000). Prior studies show that earnouts are associated with higher acquirer gains, and higher takeover premia, relative to counterpart M&As that are settled in single up‐front payments at closing (Barbopoulos & Adra, 2016; Kohers & Ang, 2000). This is because earnout alleviates merger valuation risk by reducing adverse selection and moral hazard issues.
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