The Use of Escrow Contracts in Acquisition Agreements
University of Colorado at Boulder - Department of Finance
University of Arizona - Department of Finance
Lubomir P. Litov
University of Arizona - Department of Finance; University of Pennsylvania - Wharton Financial Institutions Center
July 28, 2013
Many private firm and subsidiary acquisition deals make use of escrow contracts, whereby a fraction of the total sale proceeds are 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 bidders and targets 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 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 the seller 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.
Number of Pages in PDF File: 49
Keywords: mergers and acquisitions, escrow contracts, financial contracting
JEL Classification: G34working papers series
Date posted: May 29, 2013 ; Last revised: July 28, 2013
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