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http://ssrn.com/abstract=2460777
 
 

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Facilitating Mergers and Acquisitions with Earnouts and Purchase Price Adjustments


Albert H. Choi


University of Virginia School of Law

September 25, 2014


Abstract:     
This paper examines how post-closing contingent payment (PCP) mechanisms (such as earnouts and purchase price adjustments) can facilitate mergers and acquisitions transactions. The paper examines two informational environments: in the first, one party (particularly, the seller) has superior information about the deal value (a private information setting) and in the second, the parties differ in their estimates on the deal value but are unable to overcome their difference (a non-convergent priors setting). By conditioning payment on verifiable information that is obtained after closing, PCPs can mitigate the problems of private information or non-convergent priors and better induce the parties to come to an agreement. Notwithstanding the benefit, PCPs operate somewhat differently in the two informational settings. In the private information setting, PCPs function as an imperfect verification, rather than a signaling, mechanism and a pooling equilibrium is possible, in which all positive-surplus deals use a PCP. In the non-convergent priors setting, PCPs can lead to too many deals being completed, even those with a negative surplus. The paper also addresses the problems of post-closing incentives to maximize (or minimize) the earnout payments. When such a moral hazard is a concern, the paper shows that (1) earnouts will be structured so as to minimize the deadweight loss with a smaller incentive component; and (2) when the valuation gap is sufficiently small, the parties will forego using an earnout altogether.

Number of Pages in PDF File: 29

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Date posted: July 1, 2014 ; Last revised: September 27, 2014

Suggested Citation

Choi, Albert H., Facilitating Mergers and Acquisitions with Earnouts and Purchase Price Adjustments (September 25, 2014). Available at SSRN: http://ssrn.com/abstract=2460777 or http://dx.doi.org/10.2139/ssrn.2460777

Contact Information

Albert H. Choi (Contact Author)
University of Virginia School of Law ( email )
580 Massie Road
Charlottesville, VA 22903
United States

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References:  26

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