Religion and Mergers and Acquisitions Contracting: The Case of Earnout Agreements
69 Pages Posted: 30 Jun 2016 Last revised: 30 Nov 2016
Date Written: November 29, 2016
As currently practiced, earnout agreements in mergers and acquisitions lead to significant agency problems and also violate Islamic law. First, using regression and difference-in-difference techniques, we show that target managers significantly increase earnings by cutting discretionary expenses during earnout periods. Also, comparing matched samples, acquisitions with earnout clauses are followed by significantly lower long-term abnormal returns. Second, earnout agreements involve high uncertainty, ignorance, and possibly harmful consequences, all of which are prohibited in Islamic law. We propose alternatives to earnout agreements as currently structured that address both the agency and Islamic law issues.
Keywords: Mergers and Acquisitions, Earnout agreements, Sharia compliant finance, Earnings management, Agency cost
JEL Classification: G14, G15, G34, N25, N35
Suggested Citation: Suggested Citation