Economic Determinants and Information Environment Effects of Earnouts: New Insights from SFAS 141(R)

45 Pages Posted: 6 Apr 2012 Last revised: 9 Nov 2013

See all articles by Brian D. Cadman

Brian D. Cadman

University of Utah - David Eccles School of Business

Richard Carrizosa

University of Texas at El Paso - Department of Accounting & Information Systems

Lucile Faurel

Arizona State University

Multiple version iconThere are 2 versions of this paper

Date Written: November 7, 2013

Abstract

Contingent considerations (“earnouts”) in acquisition agreements provide sellers with future payments conditional on meeting certain conditions. Prior research provides evidence that acquiring firms use earnouts to minimize agency costs associated with acquisitions. Using earnout fair value information recently mandated by SFAS 141(R), we provide new insights into the economic determinants to include earnout provisions in acquisition agreements including motivations to resolve moral hazard and adverse selection problems, bridge valuation gaps, and retain target firm managers. We document variations in initial earnout fair value estimates and earnout fair value adjustments that correspond with these underlying motivations. We also provide evidence that target managers stay longer with the firm after the acquisition when earnouts are included primarily to retain target managers. Finally, we demonstrate that earnout fair value adjustments required by SFAS 141(R) provide valuable information to market participants and are negatively associated with the likelihood of contemporaneous and future goodwill impairments.

Keywords: Contingent considerations, earnouts, acquisitions, fair value, moral hazard, adverse selection, information content, contracting

JEL Classification: G34, G41, M41

Suggested Citation

Cadman, Brian D. and Carrizosa, Richard and Faurel, Lucile, Economic Determinants and Information Environment Effects of Earnouts: New Insights from SFAS 141(R) (November 7, 2013). Available at SSRN: https://ssrn.com/abstract=2035536 or http://dx.doi.org/10.2139/ssrn.2035536

Brian D. Cadman

University of Utah - David Eccles School of Business ( email )

1645 Campus Center Drive
Salt Lake City, UT 84112
United States
801-585-9517 (Phone)

HOME PAGE: http://www.business.utah.edu/bio/briancadman

Richard Carrizosa

University of Texas at El Paso - Department of Accounting & Information Systems ( email )

University Library - Acquisitions Department
500 West University Avenue
El Paso, TX 79968
United States

Lucile Faurel (Contact Author)

Arizona State University ( email )

W.P. Carey School of Business
School of Accountancy, B267H
Tempe, AZ 85287
United States
(480) 965-6216 (Phone)

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