How Do Representations and Warranties Matter? Risk Allocation in Acquisition Agreements

50 Pages Posted: 10 Apr 2019 Last revised: 10 Feb 2021

See all articles by Omri Even-Tov

Omri Even-Tov

Haas School of Business - UC Berkeley

James Ryans

London Business School

Steven Davidoff Solomon

University of California, Berkeley - School of Law; University of California, Berkeley - Berkeley Center for Law, Business and the Economy; European Corporate Governance Institute (ECGI)

Date Written: February 10, 2020

Abstract

In merger agreements, the seller makes contractual representations and warranties (“reps”) about the state of the target, e.g., attesting to the accuracy of the target’s financial statements. We obtain a proprietary sample of claims for breaches of the reps in acquisition agreements related to 1,690 acquisitions comprising $470 billion in enterprise value. We analyze this claims data to study how and when reps matter. Financial statement misstatements are the most common type of breach. Parties appear to negotiate reps consistent with the risk allocation necessary in an agreement, utilizing reps to reduce information asymmetry and create value depending upon the industry, firm volatility, and governing law. Our findings also show that more experienced acquirers such as private equity appear to utilize reps more efficiently to create value. These results highlight the importance of reps in risk allocation, reducing information asymmetry and creating value, but they also highlight the role of investor skill in creating value from reps.

Keywords: mergers and acquisitions, representations and warranties, material misstatements, indemnification, insurance, private equity, valuation uncertainty, adverse selection, moral hazard

JEL Classification: D82, G22, G24, G34, K12, K22, K41, L14, M41

Suggested Citation

Even-Tov, Omri and Ryans, James and Davidoff Solomon, Steven, How Do Representations and Warranties Matter? Risk Allocation in Acquisition Agreements (February 10, 2020). Available at SSRN: https://ssrn.com/abstract=3361184 or http://dx.doi.org/10.2139/ssrn.3361184

Omri Even-Tov

Haas School of Business - UC Berkeley ( email )

Haas School of Business
Berkeley, CA 94720
United States
3104302236 (Phone)

James Ryans (Contact Author)

London Business School ( email )

Sussex Place
Regent's Park
London, NW1 4SA
United Kingdom

HOME PAGE: http://www.london.edu

Steven Davidoff Solomon

University of California, Berkeley - School of Law ( email )

215 Boalt Hall
Berkeley, CA 94720-7200
United States

University of California, Berkeley - Berkeley Center for Law, Business and the Economy ( email )

Berkeley, CA 94720-7200

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

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