The Earnout Structure Matters: Takeover Premia and Acquirer Gains in Earnout Financed M&As

Abstract

In this article, based on both parametric and non-parametric methods, we provide a robust solution to the long-standing issue on how earnouts in corporate takeovers are structured and how their structure influences the takeover premia and the abnormal returns earned by acquirers. First, we quantify the effect of the terms of earnout contract (relative size and length) on the takeover premia. Second, we demonstrate how adverse selection considerations lead the merging firms to set the initial payment in an earnout financed deal at a level that is lower than, or equal to, the full deal payment in a comparable non-earnout financed deal. Lastly, we show that while acquirers in non-earnout financed deals experience negative abnormal returns from an increase in the takeover premia, this effect is neutralised in earnout financed deals.

Keywords: Earnout financing; Information asymmetry; Takeover premia; Abnormal returns; Propensity Score Matching; Rosenbaum-bounds

JEL Classification: G34