The Economics of Deal Risk: Allocating Risk Through MAC Clauses in Business Combination Agreements

Abstract

In any large corporate acquisition, there is a delay between the time the parties enter into a merger agreement (the signing) and the time the merger is effected and the purchase price paid (the closing). During this period, the business of one of the parties may deteriorate. When this happens to a target company in a cash deal, or to either party in a stock-for-stock deal, the counterparty may no longer want to consummate the transaction. The primary contractual protection parties have in such situations is the merger agreement's "material adverse change" (MAC) clause. Such clauses are heavily negotiated and extremely complex, and when parties dispute whether one of them has been MAC'd between signing and closing, the fate of the transaction (and thus often billions of dollars in value) depends on the proper interpretation of the MAC clause. This article reports the results of an empirical study of MAC clauses in over 350 business combination agreements filed in the SEC's EDGAR database between July 1, 2007, and June 30, 2008, argues that prior theories of the allocation of risk in MAC clauses are inconsistent with the empirical data, and then explains why the complex allocations of risk typically made in public company merger agreements are in fact efficient.