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Earnouts: A Study of Financial Contracting in Acquisition Agreements

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  • Cain, Matthew D.
  • Denis, David J.
  • Denis, Diane K.
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    Abstract

    We empirically examine earnout contracts, which provide for contingent payments in acquisition agreements. Our analysis reveals considerable heterogeneity in the terms of earnout contracts, i.e. the potential size of the earnout, the performance measure on which the contingent payment is based, the period over which performance is measured, the frequency with which performance is measured, and the form of payment for the earnout. Consistent with the costly contracting hypothesis, we find that the terms of earnout contracts are associated with measures of target valuation uncertainty, target growth opportunities, and the degree of post-acquisition integration between target and acquirer. We conclude that earnouts are structured to minimize the costs of adverse selection and moral hazard in acquisition negotiations.

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    Bibliographic Info

    Paper provided by Purdue University, Department of Economics in its series Purdue University Economics Working Papers with number 1196.

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    Length: 52 pages
    Date of creation: Sep 2006
    Date of revision:
    Handle: RePEc:pur:prukra:1196

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    14. Datar, Srikant & Frankel, Richard & Wolfson, Mark, 2001. "Earnouts: The Effects of Adverse Selection and Agency Costs on Acquisition Techniques," Journal of Law, Economics and Organization, Oxford University Press, vol. 17(1), pages 201-38, April.
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