Earnouts: The real value of disagreement in mergers and acquisitions |
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Authors: | Anna Battauz Stefano Gatti Annalisa Prencipe Luca Viarengo |
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Institution: | 1. Department of Finance, IGIER and Baffi-Carefin, Bocconi University, Milan, Italy;2. Department of Finance and Baffi-Carefin, Bocconi University, Milan, Italy;3. Department of Accounting, Bocconi University, Milan, Italy;4. Department of Economics and Business Management, Università Cattolica del Sacro Cuore, Milan, Italy |
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Abstract: | Earnout agreements link part of the payment for an acquired company to its future performance. Despite their option-like features, they cannot be valued using vanilla option-pricing methods. Two peculiar sources of risk affect these contracts: Bidder default before the earnout expiration (default risk) and potential litigation associated with earnouts (litigation risk). We developed an option-pricing model that encompasses these sources of risk, showing that counterparty and litigation risk can have a remarkable impact on earnout values. Our model's relevance is further enhanced by recent accounting standards that require contingent payments to be valued at fair value. |
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Keywords: | default default risk earnout litigation M&A real options |
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