Earnouts: The real value of disagreement in mergers and acquisitions. (13th March 2021)

• Record Type: Journal Article
• Authors: Battauz, Anna; Gatti, Stefano; Prencipe, Annalisa; Viarengo, Luca
• Is Part Of: European financial management. Volume 27:Number 5(2021)
• Page Start: 981
• Page End: 1024
• Publication Date: 2021-03-13
• Subjects: default -- default risk -- earnout -- litigation -- M&A -- real options; Finance -- European Union countries -- Periodicals; International finance -- Periodicals; Corporations -- European Union countries -- Finance -- Periodicals; 332.094
• DOI: 10.1111/eufm.12304
• Languages: English
• ISSNs: 1354-7798

Abstract

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.