Fair Value of Earnouts: Valuation Uncertainty or Cookie Jar Reserve?

58 Pages Posted: 13 Jul 2021 Last revised: 28 Feb 2023

See all articles by Andrew Ferguson

Andrew Ferguson

Department of Accounting, UTS

Cecilia Wei Hu

Deakin University

Peter Lam

University of Technology, Sydney - Discipline of Accounting; Financial Research Network (FIRN)

Date Written: July 12, 2021

Abstract

This study explores the unintended consequences of fair valuing earnouts as required by IFRS 3 (2008). Using a sample of acquisitions completed by Australian firms after IFRS 3 (2008) took effect, we find that a significant portion of acquirers overstate initial earnout liabilities, with subsequent reversals recorded as operating income. Cross-sectional analysis suggests that firms under investment- and performance-related pressure tend to overstate earnout liabilities, while high-quality auditors and debt-financed deals curtail managers’ reporting discretion. In addition, an overstatement of earnout liabilities inflates goodwill, which we find is less value relevant. Further, a difference-in-difference analysis shows that IFRS 3 (2008) leads to a significant increase in both the frequency and magnitude of earnout use in public acquirers’ transactions. Overall, we highlight an accounting side benefit of using earnouts for acquirers.

Keywords: acquisitions, earnouts, contingent consideration, fair value accounting, financial liability, IFRS 3

JEL Classification: G34, M41

Suggested Citation

Ferguson, Andrew and Hu, Wei and Lam, Peter, Fair Value of Earnouts: Valuation Uncertainty or Cookie Jar Reserve? (July 12, 2021). Available at SSRN: https://ssrn.com/abstract=3884775 or http://dx.doi.org/10.2139/ssrn.3884775

Andrew Ferguson (Contact Author)

Department of Accounting, UTS ( email )

PO Box 123 Broadway
Sydney, NSW 2007
Australia
61 2 9514 3565 (Phone)

Wei Hu

Deakin University

221 Burwood Hwy, Burwood
Victoria, Victoria 3125
Australia

Peter Lam

University of Technology, Sydney - Discipline of Accounting ( email )

P.O. Box 123 Broadway
Sydney, NSW 2007
Australia
02 9514 3926 (Phone)
02 9514 3669 (Fax)

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

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