Enforcement Quality and the Use of Earnouts in M&A Transactions: International Evidence

45 Pages Posted: 17 Apr 2018  

Luca Viarengo

Catholic University of the Sacred Heart of Milan - Department of Economics and Business Administration

Stefano Gatti

Bocconi University - Department of Finance

Annalisa Prencipe

Bocconi University - Department of Accounting

Multiple version iconThere are 2 versions of this paper

Date Written: March/April 2018

Abstract

Earnouts are contractual agreements in merger and acquisition (M&A) deals that link part of the acquisition price to the future performance of the target company. These contracts seem to be a panacea for adverse selection and valuation risk issues in M&As. However, earnouts are not very popular. A likely reason for their limited diffusion is that earnouts have their origin in disagreement and in disagreement they may end: given the complexity of the verification of their outcome and the risk of moral hazard by the bidder, litigation at the time of their payout is far from uncommon. Absent effective legal protection for earnout holders, the potential benefits of these contracts could turn out to be empty promises, thus limiting incentives to include them in acquisition deals. Using an international sample of 37,228 deals completed between 2000 and 2015, we show that the inclusion of these contracts in M&As is significantly related to a country's enforcement quality. Furthermore, we show that a similar relation holds for the proportion of earnout payments with respect to total consideration. Our results hold after controlling for other determinants of earnout suggested by prior literature and for other institutional factors that could affect the use of earnouts.

Keywords: earnouts, enforcement quality, international M&As, investor protection, litigation risk

Suggested Citation

Viarengo, Luca and Gatti, Stefano and Prencipe, Annalisa, Enforcement Quality and the Use of Earnouts in M&A Transactions: International Evidence (March/April 2018). Journal of Business Finance & Accounting, Vol. 45, Issue 3-4, pp. 437-481, 2018. Available at SSRN: https://ssrn.com/abstract=3163917 or http://dx.doi.org/10.1111/jbfa.12314

Luca Viarengo (Contact Author)

Catholic University of the Sacred Heart of Milan - Department of Economics and Business Administration ( email )

20123 Milano
Italy

Stefano Gatti

Bocconi University - Department of Finance ( email )

Via Roentgen 1
Milano, MI 20136
Italy

Annalisa Prencipe

Bocconi University - Department of Accounting ( email )

Via Roentgen 1
Milan, 20136
Italy

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