40 Pages Posted: 14 Feb 2010
Date Written: February 14, 2010
According to agency theory, including performance-based consideration (earnout clauses) in the merger contract should align parent and retained target management incentives, leading to better merger performance. Yet, earnouts are frequently not paid out because retained target management fail to reach the performance milestones specified in the contingent provision. So, why does incentive alignment fail? The decision-making literature offers a possible explanation for the inconsistency. Prospect theory suggests that the performance contingent consideration in an earnout clause may be framed as a potential loss or gain, leading retained target management to display risk-seeking or risk-averse behavior. Risk-seeking or risk-averse behavior may positively or negatively impact merger outcomes, depending on the merger characteristics. In this paper, I examine whether specific merger characteristics, including parent’s customer strategy and characteristics of the target’s technology, impact if the M&A deal value is framed in terms of total consideration (earnout is perceived as a potential loss) or guaranteed consideration (earnout is perceived as a potential gain).
Keywords: M&A, Prospect Theory, Contract Capability
Suggested Citation: Suggested Citation
Weber, Libby, The Right Frame of Mind for M&A: The Impact of Merger Characteristics on M&A Deal Frames (February 14, 2010). Available at SSRN: https://ssrn.com/abstract=1552975 or http://dx.doi.org/10.2139/ssrn.1552975