Auditor monitoring and verification in financial contracts: evidence from earnouts and SFAS 141(R)

47 Pages Posted: 31 Aug 2011 Last revised: 23 Sep 2018

See all articles by Kristian D. Allee

Kristian D. Allee

University of Arkansas - Department of Accounting

Daniel Wangerin

Wisconsin School of Business

Date Written: September 13, 2018

Abstract

We study how monitoring and verification of accounting-based performance benchmarks influences the design and efficiency of earnout contracts. Earnouts are commonly used to resolve agency conflicts arising in mergers and acquisitions, but these contracts create measurement and other agency problems when contingent payments are tied to future accounting-based performance. Exploiting changes in auditor monitoring of earnouts that arose as a consequence of SFAS 141(R), we find that acquisition contracts are more likely to incorporate accounting-based earnouts and that contingent payments tied to accounting-based performance benchmarks make up a larger portion of the consideration when acquiring firms have high-quality auditors. We also find that market reactions to announcements of earnout deals are more positive after SFAS 141(R) for acquisitions most susceptible to disputes over accounting-based performance metrics and these results are more pronounced for acquiring firms with high-quality auditors. By exploiting the features of this unique setting, we illuminate the role of monitoring and verification of accounting information in financial contracts.

Keywords: acquisitions; earnouts; financial contracting; earnings guidance; auditors

JEL Classification: G34, M41, M42

Suggested Citation

Allee, Kristian D. and Wangerin, Daniel D., Auditor monitoring and verification in financial contracts: evidence from earnouts and SFAS 141(R) (September 13, 2018). Review of Accounting Studies, Forthcoming, Available at SSRN: https://ssrn.com/abstract=1920256 or http://dx.doi.org/10.2139/ssrn.1920256

Kristian D. Allee (Contact Author)

University of Arkansas - Department of Accounting ( email )

University of Arkansas
Business Building 458
Fayetteville, AR 72701
United States
479-575-5227 (Phone)

Daniel D. Wangerin

Wisconsin School of Business ( email )

975 University Avenue
4104 Grainger Hall
Madison, WI 53706
United States

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