The real effects of earnout contracts in M&As

Abstract

Earnouts address merger valuation risk by deferring payment of a large part of deal consideration and making it contingent on targets’ future performance. We find acquirers of unlisted targets using earnouts gain more (less) than those making full up-front payments in cash (stock). Larger and older acquirers benefit more from earnout-based deals, as do foreign acquirers and acquirers advised by top-tier or boutique advisors. We address identification through the propensity score matching method and a quasi-natural experiment. Acquirers realize the highest returns from earnouts when the deferred payment is around 30% of deal value. Deferred payments are larger after the SFAS 141(R) reform.