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Addressing Informational Challenges with Earnouts in Mergers and Acquisitions

20 Pages Posted: 13 Sep 2016 Last revised: 26 Sep 2016

Albert H. Choi

University of Virginia School of Law

Date Written: September 25, 2016

Abstract

This essay examines the role played by earnouts in mergers and acquisitions transactions. When one party is better informed of the true value of the deal than the other, the parties face the well-known “lemons” problem, which could prevent them from consummating the transaction even when both are aware that the deal will produce a positive (but uncertain) surplus. By harnessing post-closing, verifiable information, earnouts allow the transacting parties to overcome this informational challenge. The essay also analyzes (1) how the adoption and the size of an earnout will vary depending on the various characteristics of the transaction and (2) the earnout design issues when the parties face the problems of ex post moral hazard, such as engaging in inefficient behavior to either maximize or minimize the earnout payment.

Keywords: Earnouts, Mergers and Acquisitions, Information Asymmetry, Post-Closing Verification

Suggested Citation

Choi, Albert H., Addressing Informational Challenges with Earnouts in Mergers and Acquisitions (September 25, 2016). Research Handbook on Mergers and Acquisitions, Forthcoming; Virginia Law and Economics Research Paper No. 2016-17. Available at SSRN: https://ssrn.com/abstract=2838029 or http://dx.doi.org/10.2139/ssrn.2838029

Albert H. Choi (Contact Author)

University of Virginia School of Law ( email )

580 Massie Road
Charlottesville, VA 22903
United States

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