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Economic Determinants and Information Environment Effects of Earnouts: New Insights from SFAS 141(R)
Author(s) -
CADMAN BRIAN,
CARRIZOSA RICHARD,
FAUREL LUCILE
Publication year - 2014
Publication title -
journal of accounting research
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 6.767
H-Index - 141
eISSN - 1475-679X
pISSN - 0021-8456
DOI - 10.1111/1475-679x.12036
Subject(s) - goodwill , adverse selection , valuation (finance) , business , moral hazard , value (mathematics) , fair value , actuarial science , information asymmetry , mergers and acquisitions , market value , payment , value of information , agency cost , enterprise value , agency (philosophy) , microeconomics , accounting , economics , incentive , finance , corporate governance , philosophy , mathematical economics , epistemology , machine learning , computer science , shareholder
Contingent considerations (earnouts) in acquisition agreements provide sellers with future payments conditional on meeting certain conditions. Prior research provides evidence that acquiring firms use earnouts to minimize agency costs associated with acquisitions. Using earnout fair value information, recently mandated by SFAS 141(R), we provide new insights into the economic determinants to include earnout provisions in acquisition agreements, including motivations to resolve moral hazard and adverse selection problems, bridge valuation gaps, and retain target firm managers. We document variations in initial earnout fair value estimates and earnout fair value adjustments that correspond with these underlying motivations. We also provide evidence that target managers stay longer with the firm after the acquisition when earnouts are included primarily to retain target managers. Finally, we demonstrate that earnout fair value adjustments required by SFAS 141(R) provide valuable information to market participants and are negatively associated with the likelihood of contemporaneous and future goodwill impairments.