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The Use of Escrow Contracts in Acquisition Agreements

Author

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  • Bhagat, Sanjai

    (University of CO)

  • Klasa, Sandy

    (University of AZ)

  • Litov, Lubomir P.

    (University of AZ)

Abstract

Many private stand-alone firm and subsidiary acquisition deals make use of escrow contracts, whereby a fraction of the total sale proceeds is placed in an escrow account. These contracts give the bidder the opportunity to lay claim on these funds subsequent to the acquisition if the seller fails to meet specific terms of the acquisition agreement or it is found that negative information about the target was hidden from the bidder. We hypothesize that escrow contracts are an efficient contracting mechanism that helps buyers and sellers to manage acquisition-related transaction risk and mitigate information asymmetry problems. Supporting our hypothesis, we show using hand-collected data that the likelihood an escrow contract is used in a private stand-alone firm or subsidiary acquisition is higher when buyer and seller transaction risk or information asymmetry about the value of the target is larger. Further, we document that escrow contracts enable sellers to obtain a higher sale price and that the use of these contracts positively impacts the extent to which a private firm or subsidiary acquisition results in value creation for the bidder.

Suggested Citation

  • Bhagat, Sanjai & Klasa, Sandy & Litov, Lubomir P., 2014. "The Use of Escrow Contracts in Acquisition Agreements," Working Papers 13-19, University of Pennsylvania, Wharton School, Weiss Center.
    • Handle: RePEc:ecl:upafin:13-19
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    File URL: http://fic.wharton.upenn.edu/fic/papers/13/13-19.pdf
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