Why Do M&A Bidders Adopt Performance Commitment Clauses? A Tunneling Perspective

Abstract

Although the literature shows that earnout, a contingent payment contract in acquisitions, has long-run positive market reactions in developed countries, the opposite effect emerges one year after the deal announcement for performance commitment clause, a counterpart in China. The premium paid by bidding firms is transferred from minority shareholders to the controlling shareholders, who have stakes in target firms and liquidate bidding firms' stocks as front runners within one year. The short-term stock outperformance rewards target sellers with career promotion. Our study shows evidence that controlling shareholders adopt performance commitment clauses for tunneling purposes at the cost of minority shareholders.

Keywords: performance commitment, resource tunneling, overpayment

JEL Classification: G34, G38, G14