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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.

Abstract

We empirically examine earnout contracts, which provide for contingent payments in acquisition agreements. Our analysis reveals considerable heterogeneity in the potential size of the earnout, the performance measure on which the contingent payment is based, the period over which performance is measured, the form of payment for the earnout, and the overall sensitivity of earnout payment to target performance. Our tests of the determinants of contract terms yield support for the view that earnouts are structured to minimize the costs of valuation uncertainty and moral hazard in acquisition negotiations.

Suggested Citation

  • Cain, Matthew D. & Denis, David J. & Denis, Diane K., 2011. "Earnouts: A study of financial contracting in acquisition agreements," Journal of Accounting and Economics, Elsevier, vol. 51(1), pages 151-170.
  • Handle: RePEc:eee:jaecon:v:51:y:2011:i:1:p:151-170
    DOI: 10.1016/j.jacceco.2010.05.001
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    Cited by:

    1. repec:eee:finlet:v:22:y:2017:i:c:p:233-243 is not listed on IDEAS
    2. K.S. Reddy & En Xie & Yuanyuan Huang, 2016. "Contractual buyout - a legitimate growth model in the enterprise development: foundations and implications," International Journal of Management and Enterprise Development, Inderscience Enterprises Ltd, vol. 15(1), pages 1-23.
    3. Mittal, Amit & Garg, Ajay Kumar, 2017. "Private information implications for acquirers and targets in horizontal mergers," MPRA Paper 85355, University Library of Munich, Germany.
    4. repec:agh:journl:v:18:y:2017:i:1:p:103-116 is not listed on IDEAS
    5. Mittal, Amit & Garg, Ajay Kumar, 2017. "Why do acquirers prefer M&A? Evidence from Banks in India," MPRA Paper 85354, University Library of Munich, Germany.
    6. Macias, Antonio J. & Moeller, Thomas, 2016. "Target signaling with material adverse change clauses in merger agreements," Journal of Empirical Finance, Elsevier, vol. 39(PA), pages 69-92.
    7. Barbopoulos, Leonidas G. & Adra, Samer, 2016. "The earnout structure matters: Takeover premia and acquirer gains in earnout financed M&As," International Review of Financial Analysis, Elsevier, vol. 45(C), pages 283-294.
    8. Elnahas, Ahmed M. & Kabir Hassan, M. & Ismail, Ghada M., 2017. "Religion and mergers and acquisitions contracting: The case of earnout agreements," Journal of Corporate Finance, Elsevier, vol. 42(C), pages 221-246.
    9. Reddy, Kotapati Srinivasa, 2015. "Market for Corporate Control and Contractual Buyout (CoBO): A New “Collective Ownership-and-Administrative” Strategy," MPRA Paper 63937, University Library of Munich, Germany, revised 2015.
    10. Nils Patschureck & Friedrich Sommer & Arnt Wöhrmann, 2015. "Contract design as a risk management tool in corporate acquisitions: theoretical foundations and empirical evidence," Journal of Management Control: Zeitschrift für Planung und Unternehmenssteuerung, Springer, vol. 26(4), pages 279-316, October.
    11. Kohli, Reena & Mann, Bikram Jit Singh, 2013. "Analyzing the likelihood and the impact of earnout offers on acquiring company wealth gains in India," Emerging Markets Review, Elsevier, vol. 16(C), pages 203-222.
    12. Barbopoulos, Leonidas & Sudarsanam, Sudi, 2012. "Determinants of earnout as acquisition payment currency and bidder’s value gains," Journal of Banking & Finance, Elsevier, vol. 36(3), pages 678-694.
    13. Barbopoulos, Leonidas G. & Molyneux, Phil & Wilson, John O.S., 2016. "Earnout financing in the financial services industry," International Review of Financial Analysis, Elsevier, vol. 47(C), pages 119-132.
    14. Hong Zhu & Qi Zhu, 2016. "Mergers and acquisitions by Chinese firms: A review and comparison with other mergers and acquisitions research in the leading journals," Asia Pacific Journal of Management, Springer, vol. 33(4), pages 1107-1149, December.

    More about this item

    Keywords

    Earnouts; Acquisitions; Contingent payments; Moral hazard; Valuation uncertainty; SFAS 141(R);

    JEL classification:

    • G34 - Financial Economics - - Corporate Finance and Governance - - - Mergers; Acquisitions; Restructuring; Corporate Governance
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting

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