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Understanding MACs: Moral Hazard in Acquisitions


Ronald J. Gilson


Stanford Law School; Columbia Law School; European Corporate Governance Institute (ECGI)

Alan Schwartz


Yale Law School

February 2004

Columbia Law and Economics Working Paper No. 245; Stanford Law and Economics Olin Working Paper No. 278; Yale Law & Economics Research Paper No. 292

Abstract:     
The standard contract that governs friendly mergers contains a material adverse change clause (a "MAC") and a material adverse effect clause (a "MAE"); these clauses permit a buyer costlessly to cancel the deal if such a change or effect occurs. In recent years, the application of the traditional standard-like MAC and MAE term has been restricted by a detailed set of exceptions that curtails the buyer's ability to exit. The term today engenders substantial litigation and occupies center stage in the negotiation of merger agreements. This paper asks what functions the MAC and MAE term serve, what function the exceptions serve and why the exceptions have arisen only recently. It answers that the term encourages the target to make otherwise noncontractable synergy investments that would reduce the likelihood of low value realizations, because the term permits the buyer to exit in the event the proposed corporate combination comes to have a low value. The exceptions to the MAC and MAE term impose exogenous risk on the buyer; the parties cannot affect this risk and the buyer is a relatively superior risk bearer. The exceptions have arisen recently because the changing nature of modern deals make the materialization of exogenous risk a more serious danger than it had been. The modern MAC and MAE term thus responds to the threat of moral hazard by both parties in the sometimes lengthy interim between executing a merger agreement and closing it. The paper's empirical part examines actual merger contracts and reports preliminary results that are consistent with the analysis.

Number of Pages in PDF File: 49

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Date posted: March 11, 2004  

Suggested Citation

Gilson, Ronald J. and Schwartz, Alan, Understanding MACs: Moral Hazard in Acquisitions (February 2004). Columbia Law and Economics Working Paper No. 245; Stanford Law and Economics Olin Working Paper No. 278; Yale Law & Economics Research Paper No. 292. Available at SSRN: http://ssrn.com/abstract=515105 or http://dx.doi.org/10.2139/ssrn.515105

Contact Information

Ronald J. Gilson
Stanford Law School ( email )
559 Nathan Abbott Way
Stanford, CA 94305-8610
United States
650-723-0614 (Phone)
650-725-0253 (Fax)
Columbia Law School ( email )
435 West 116th Street
New York, NY 10025
United States
212-854-1655 (Phone)
212-854-7946 (Fax)
European Corporate Governance Institute (ECGI)
c/o ECARES ULB CP 114
B-1050 Brussels
Belgium
Alan Schwartz (Contact Author)
Yale Law School ( email )
P.O. Box 208215
New Haven, CT 06520-8215
United States
203-432-4030 (Phone)
203-432-8260 (Fax)
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