Earnouts in M&A: how information asymmetry affects the choice of payment method

Examining a large sample of M&A deals which involves bidder and target companies from selected country in the 2002-2022 period, this study provides specific deal, target and bidder characteristics that affect the type of consideration agreed. In particular great emphasis is put on the role of earnout contracts which represent an effective tool for mitigating adverse selection problems and bridging valuation gap in M&A deals. As expected, this work yields empirical support for the view that the usage of contingent payment mechanism increases in transactions characterized by a high level of information asymmetry. The results show that earnout tends to involve smaller acquiring firms and privately held or subsidiary targets which operate in high-technologies or service-related industries. In addition, contingent payment provisions are more likely to be included in M&A between acquiring and selling companies located in different countries. Supplemental analysis indicates that the same proxies of adverse selection, selected for studying the use of earnout, can be also exploited to define transactions where the stock issuance is more or less likely.