University of Amsterdam MSc Business Economics Specialization Finance
The impact of corporate governance differences
on earnout payments in mergers and
acquisitions in the US
Master Thesis Final Version Emma Scholten Student number: 5933749 Date: March 4, 2015Abstract
This thesis investigates whether corporate governance has effect on the choice of payment method within mergers and acquisitions, where this inquiry tests for the positive relationship between corporate governance and the use of earnout payments.
With the GIM-Index as a proxy for the corporate governance of the acquirer, results show that stock payments have stronger relations to shareholder rights as earnout payments do. The presence of a female in the board increases, former employees decreases, and independent directors increases, the likelihood of the contingent
payment method. Once a transaction is paid with an earnout, increasing the shareholder rights (lower GIM) is associated with a higher level of the contingent
Content
Introduction 4
I Corporate governance, M&A, and their payment methods 7 A. The introduction of corporate governance in relation to M&A 7
B. Determinants of M&A payment methods 8
C. Earnout payment method 9
D. Corporate governance and earnout payments 13
II Methodology 14 A. Hypotheses 15 B. Model 17 C. Endogeneity 17 III Data 18 A. Sample 18
B. Sample characteristics and descriptive statistics 20
IV Interpretation and results 33
A. Frequency hypothesis 33
B. Value hypothesis 44
V Conclusions 51
Bibliography 54
Introduction
The managers of a company are deemed to handle in shareholders’ interest, but this is not always the case due to self-dealing actions by managers (Jensen & Meckling, 1976; Shleifer & Vishny, 1997). Earlier studies proved that the relation between the management and shareholders also affect the payment method used by the acquirer in M&A. First, when the management of the acquirer holds a significant stake in the company, they prefer to offer cash (Amihud, Lev, & Travlos, 1990). The payment in cash will not dilute the amount of control of the manager, which will be the case with a stock payment. On the other hand, managers could entrench themselves and be overconfident. In those situations, the managers may close deals in order to build their own empire and prefer to pay those deals with cash (Shleifer & Vishny, 1997). Because the management runs the daily business, they have an advantage over the shareholders and can abuse that privilege to close a deal in own interest instead of shareholders’ interest.
The source of disagreement comes from the separation between ownership and control, in other words the corporate governance (Shleifer & Vishny, 1997). La Porta, et al. (2000, p.4) defines corporate governance as “a set of mechanisms through which outside investors protect themselves against expropriation by the insiders”. The outside investors are the boards, people, companies, institutions and/or governments, who invest capital in return to control the corporation, or at least part of it, aiming for a better return. They are not involved into the daily business of the company, which is done by the management. Good governance is compressing the risk that managers will make self-dealing choices, and broadly increasing investor trust and confidences, as well as strong shareholder rights (McKinsey, 2002). The level of governance is important. Many factors contribute to good governance, like the relationships between the CEO and shareholder, quality, performance or efforts, etc. The biggest challenge is to quantify those parameters, especially during M&A transactions.
Looking at corporate investment, payment methods other than cash decrease the exposure to the self-entrenchment of the managers. Because offering stocks makes the managers reconsider due to it is not just a one off payment (Jensen & Meckling, 1976). Moreover, stock payments deceases the valuation risk (overpaying the target), because after the transaction the acquirer shares the risk with the current shareholders of the target (Barbopoulos & Sudarsanam, 2012). Another manner to lower the
valuation risk and disagreement between the seller and the bidder is the contingent payment method (Frankel, 2005).1 The contingent payment in M&A deals can be
defined as a prearranged payment, which states that the seller acquires additional compensation in the future, based on certain pre-specified achievable targets within a certain time frame (Reuer, Shenkar, & Ragozzino, 2004). These predetermined goals can be linked to the future performance of the managers of the target company, when the acquirer wants to maintain the targets’ management. Therefore, earnouts may reduce the moral hazard problem (Kohers & Ang, 2000; Cain, Denis, & Denis, 2011). As mentioned above, the earnout payment is a risk reducing payment method for the acquirer. There is lot of research published about the circumstances when earnout payments are used in order to solve risks. According to Datar, et al. (2001) and Kohli & Mann (2013) earnout payments are more frequently used when the acquirer is less informed or experienced with the target or within the industry the target is operating in. They find more regular earnout payments when the target is a private company, operating in service or high technology sector (high R&D expenses), because the exact value of the target is difficult to establish. In addition, Datar et al. (2001) and Frankel (2005) showed that earnouts are more frequently used when there is less merger activity, low speed of transactions and high transaction costs in the industry, because earnouts are time- and cost consuming.
As the circumstances and characteristics of the target, when a earnout payment is used, are extensively investigated, I want to investigate whether the corporate governance structures of the acquirer has effect on the frequency and level of an earnout payment in M&A deals. Since earnout payments are a risk reducing method between the acquirer and target, I hope to find results that imply that better governed firms use more frequently an earnout payment. This thesis will try to answer the following research question: Does corporate governance explain the differences in
earnout payments in mergers and acquisitions?
The aim of this research is try to explain for the differences of earnout payments in the US and in order to do so I examine two hypotheses. The first hypothesis tests whether better-governed firms are more likely to use an earnout payment. Secondly, I take only the transactions that incorporate an earnout in order to test if better governance will pay a higher earnout.
In order to measure the governance of the acquirer, several governance variables are incorporated. The reference point in this thesis used, is the Governance Index (GIM-index) from Gompers, Ishii and Metrick (2003). This index measures the level of shareholder protection by counting the provisions a company incorporates. The more provisions, the higher the GIM-index, which means less shareholder protection. In addition, the composition of the board is measured and tested if it affects the use of earnouts.
I examine an extensive sample of 3054 U.S M&A transactions. Analysing the sample shows that there are diverse governance, acquirer and deal characteristics, that explain for the use of an earnout but not as I expected. Earnouts are less used compared to stock payments, in combination with very strong shareholder rights, corresponding to a low Governance Index. The results confirm the earlier finding of Amihud, et al. (1990), that stronger shareholder protection is accompanied with more stock payments. The regressions do not state significant differences with cash payments, Therefore, I conclude that earnouts are the method of payment for transactions with the acquiring company having moderate governance.
This study contributes to the literature because it examines whether the corporate governance of an acquirer is affecting the payment method within a M&A transaction focussing on earnouts, to establish a relation between contingent payments and corporate governance. The rest of this thesis is organized as follows. In the first Section I will state empirical research on determinants of contingent payments in M&A deals, where after I provide the drawbacks and the relation to corporate governance. This forms the foundation of this paper. Section II provides the methodology, where I posed several hypotheses in order to answer the research question eventually. Section III will describe the data and the different data sources that are used in this inquiry, hereafter the qualifications and results will be discussed in Section IV. The last part of this paper contains a brief summary and states the main findings.
I Corporate governance, mergers & acquisition, and their payment methods A. The introduction of corporate governance in relation to M&A
Before the eighties, corporate governance was limited. Managers were acting in the interest of the company, but not in favour of the directors (Holmstrom & Kaplan, 2001). The cash generated from fortunate corporate investments was used for bad investments intern or extern, leaving no cash to the investors (like dividend). The M&A transactions were mainly paid with cash and equity, because it did not harm the cash flows of the managers (Holmstrom & Kaplan, 2001). Managers overestimated the value of corporate investments, what Roll (1986) calls managerial hubris, and they went for empire building. Investors did not monitor the management and there were large inefficiencies (Holmstrom & Kaplan, 2001; Martynova & Renneboog, 2008).
With the introduction of several economic theories such as the asymmetric information theory and the agency theory, economists like Akerlof (1970), Ross (1973), and Jensen & Meckling (1976) provided insights that managers (agents) did not maximize the outcomes of the investors (principals), but had the freedom and possibility to act in personal interest. As a result, corporate governance, the relation between the shareholder and manager, started to take form (Holmstrom & Kaplan, 2001). The control shifted from the managers to the shareholders, where the shareholders closely monitored the management. The capital structure changed by increasing the amount of debt and therefore decreasing the free cash flow due to the obligations to creditors (e.g. repayments and interest expenses) and paying corporate takeovers with debt (LBO’s).
The internal corporate governance mechanism, the relation between the shareholders and management, was controlled by M&A (Holmstrom & Kaplan, 2001). Nowadays, good corporate governance is to take the outside investors in protection and minimize the chance of self-dealing by the insiders (McKinsey, 2002). This is aligned with low information asymmetry and low agency costs, which are, as below explained, the two main determinants of the M&A financing method. The rest of this study is focussing on this relation between corporate governance and M&A transactions and the level of corporate governance.
B. Determinants of M&A payment methods
M&A is about creating value, but with quite a risk. The exact amount of risk is difficult to estimate because of all the assumptions made, boards can talk through one’s hat, external factors and other interested parties that may influence the valuation. Moreover, it is impossible to determine the degree of bargaining power of a specific party (Baker, Pan, & Wurgler, 2012). Before the closing, the risk for the acquirer concerns the valuation, the chance of overpayment, insufficient due diligence or improper target (market) identification (Roll, 1986; Datar, Frankel, & Wolfson, 2001; Barbopoulos & Wilson, 2013). Post deal, the greatest concern is the cultural fit, whether there is an effective integration of the two companies, in other words, the corporate governance (Deloitte, 2013). The governance between companies (bidder and seller) and within a company (shareholders and management) matters for the decision of the payment method (Martin, 1996; Faccio & Masulis, 2005).
There are several determinants for the choice of payment method in M&A. The first is asymmetric information, also known as the lemon problem introduced by Akerlof (1970). When the asymmetric information gap between the acquirer and bidder is enhancing, the overvaluation risk for the bidder is more severe. In order to downsize the valuation risk the acquirer faces, payments other than cash shift some risks to the target. For example, if the acquirer overpays for the stock of the target, the risk is shared with the current shareholders of the target, because the value of the stock depends on the profitability of the transaction. If the transaction is overpaid, the value of the stock will not adapt to the price the bidder paid, where the risk is divided between the target shareholders and the acquirer (Hansen, 1987).
Secondly, the agency problem, the conflict of interest between two parties where one party is demanded to serve in the other party’s interest. In the context of corporate finance, the agency problem refers to the relation between managers and shareholders, where managers should maximize shareholders’ wealth (Masulis, Wang, & Xie, 2007). Managers have the advantage over shareholders, because they run the business on a daily basis. It is proven that managers love to ‘build an empire’. This can be achieved in two different ways. By making value destroying deals in order to increase the scope of control or finance M&A transactions with sources that does not maximize the value for shareholders but does not dilute the ownership of the manager. High control by the management of the bidding company lowers the
frequency of equity payment and prefers a cash investment (Stulz, 1988; Amihud, Lev, & Travlos, 1990; Faccio & Masulis, 2005).
Moreover, the characteristics of the acquirer play a determining role choosing the payment method. This concerns the liquidity position of a company (internal cash) and the possibilities for external funding (issuing debt or equity). The pecking order theory starts with internal funds, followed by debt and if no other options are left, the issue of equity (Myers & Majluf, 1984). The external funding depends on the regulation of the country where the acquirer operates in (Faccio & Masulis, 2005).2 Companies with high cash reserves or with self-dealing managers are more inclined to finance the deal with internal cash or equity. Outside investors may think the company is overvalued, when an equity issue is announced, which results in a value drop (Martynova & Renneboog, 2009).
Finally, the level of market competition and deal flow matters. Fishman (1989) showed that cash payments are frequently used when there is a high bidding competition. Cash payments have more chance of success and signal a higher value for the target.3
C. Earnout payment method
Overall, literature about payment methods in M&A transactions is neglecting the contingent payment method. The earnout payment is a partial substitute for a stock or cash consideration. Barbopoulos & Sudarsanam (2012, p.679) define earnout payments as “a contingent form of payment used to finance an acquisition and involves a two stage payment structure – an initial upfront (or first stage) payment to target shareholders and a second stage payment conditional upon the target, under the bidder’s ownership post-acquisition, achieving certain agreed performance goals”. The two payments can be divided as follows: the first payment at closing indicates the jointly agreed part of the deal value, and the contingent payment displays the disagreement gap (bid-ask spread) between the two parties (Kohers & Ang, 2000; Frankel, 2005).
The reference point of an earnout payment lays always somewhere in the near future (i.e. between 2 and 5 years) and is attached to some threshold in the future, like
2 The policy of the central bank and laws are decisive. Since the central banks have sharpened their policy,
because of the financial crisis, it is more difficult to access debt.
3 A cash bid gives a positive signal, because issuing equity ensures that investors think the company is overvalued
EBITDA, earnings or revenue. These contingent payments are paid in cash or equity. The contingent payment diminishes the bidder’s risky upfront (financial) position and it fades out the over-optimistic picture of the potential performance of the seller. The risk the acquirer faces is partially shifted to the target (Reuer, Shenkar, & Ragozzino, 2004; Ragozzino & Reuer, 2009).
There are two types of earnout payments. The first, and at the same time the most frequently used, is the cash established earnout. The arrangement is based on a predetermined goal and the bidder pays an amount of cash to the seller if the threshold is reached. The second type is the equity earnout, paid with shares. The acquirer issues shares if the target exceeds the agreed amount, based upon EBITDA, revenues or earnings (not an index like S&P500) (Prince Waterhouse Coopers, 2010).
Earnout payments are complex and heterogeneous in every case. First of all, they vary in size and form of the payment, next to the threshold that must be passed in order to receive the contingent payment. The performance measure, on which the earnout is based, differs among the deals, as well as the time interval. Overall, contingent payments are used to mitigate risks the acquirer faces during M&A negotiations with different structures for every deal (Kohers & Ang, 2000; Reuer, Shenkar, & Ragozzino, 2004; Ragozzino & Reuer, 2009; Cain, Denis, & Denis, 2011).
This section will first briefly discuss the determinants of earnout payments used in M&A deals, where after the drawbacks are set forth.
C1. Determinants of earnout payments
The theories and the explanations for using earnout payments are discussed below.
C1.1. Asymmetric Information
Before a deal can be closed, it is necessary for the bidder to have extensive knowledge about the target company. It is difficult for the acquirer to determine the present value, the growth rate and the terminal value of the target company. The buyer is the less informed party, resulting in the valuation risk, which may lead to an overpayment for the target, because the target leaves out important information. Or the asymmetric information leads to enormous transaction costs during the bargaining process and comprehensive due diligence (Roll, 1986; Ragozzino & Reuer, 2009; Baker, Pan, & Wurgler, 2012).
Concerning this problem, contingent payments reduce this adverse selection risk in two ways. First, the earnout contract is serving like a risk-hedging mechanism because the bidder only pays the earnout when the prearranged targets are realised. Secondly, earnouts work as an informative signalling mechanism. Targets only accept earnout offers when they are convinced about achieving the objectives; therefore they remove the overpayment risk by signal their true value (Frankel, 2005; Ragozzino & Reuer, 2009; Kohli & Mann, 2013).
Datar et al. (2001), Frankel (2005), and Ragozzino & Reuer (2009) find evidence that earnouts are more frequently used in transactions with privately held companies, start-ups, high growth and volatile companies in high growth and volatile markets, because the information asymmetry between the acquirer and the target is more severe. Those companies have large amounts of intangible assets, do not have their stocks listed (so no relation to an index), which makes the value determination of a company more difficult. In addition, earnout payments are more common when the target and acquirer are operating in different industries or countries and when the target is functioning in a high-tech industry or in a service related sector. This is because the acquirer has a lack in experience and less accurate information (Kohers & Ang, 2000; Reuer, Shenkar, & Ragozzino, 2004; Kohli & Mann, 2013).
C1.2. Agency problem
This theory focuses on the idea of management pursuing to maximize their own utility, conflicting with shareholders’ value. Actually, it can be seen as a “separation of ownership and control”. The management needs to run the company optimally and maximize the value for the shareholders. Managers can act in their own interest and may take excessive risk, because the managers will not feel the costs of risk-taking, because the shareholder will bear the brunt (Jensen & Meckling, 1976).
The pecking-order model, promoted by Myers & Majluf (1984), states that asymmetric information increases the cost of financing. The priority for financing, looking from a shareholder perspective, is to start with internal funds, then debt and at last equity. Internal funding requires low costs, where debt incorporates higher
interest costs and external equity hurts the amount of shares, and indirectly, the payoff (return) of investment (external ownership).4
Jung, et al. (1996) states that managers prefer equity financing before debt. This is because debt requires interest payments, whereby the free cash flow decreases. Issuing equity leaves the cash flow unimpaired and the managers have the possibility to invest those cash flows in other projects. Companies with poor investment opportunities are better off by using debt financing, because it prevents managers from investing in more poor projects. Companies with valuable opportunities for investments are the companies who need to issue equity. This is preferable because it maintains the financial flexibility and maximizes the investment return (Martin, 1996) As managers like to ‘build an empire’, it is necessary to make sure that managers will act in the shareholders’ interest (Jensen & Meckling, 1976). For the shareholders it is necessary to find out whether they are involved in a value creating or destroying transaction. The information presented to the shareholders can be turned in favour of the management, or managers will leave some information out.5 In order to minimize the problem, the principal (shareholder) of the acquirer can offer an earnout payment. This lowers the financial exposure at the beginning, better monitors the management, and lowers the chance that the transaction was for ‘empire building’ purposes because the transaction is not a one-off transaction (Frankel, 2005; Martynova & Renneboog, 2009).
C1.3. Moral Hazard
To determine the valuation of a company where the value depends on human capital ensures more uncertainties and valuation risks. It is unknown whether the managers of the target company have the intention to stay or leave after the deal is closed. It is possible that the manager has a pivotal role within the company, but what exactly is his contribution to the value of the company? By offering an earnout, the acquirer tries to retain the manager(s) of the selling company. An earnout payment can reduce or even eliminate the human capital problem. Since the valuation of the target company depends on the performance of the management, a contingent payment linked to the effort of the manager of the target company can be a solution. The
4 When managers issue new external equity, investors will interpret that that the firm is overvalued and that
managers want to take advantages of this overvaluation. In reaction to this, the price of the company may drop and the price to pay for equity is even higher.
earnout payment is associated with goals the manager needs to achieve, and gives the managers of the target company an incentive to stay and to put effort in the company in order to acquire a higher contingent payment (Kohers & Ang, 2000). The earnout payment is of greater value compared to a normal cash payment, which is the incentive for the manager to stay with the company and makes sure he will perform in the interest of the company. Kohers & Ang (2000) and Cain, et al. (2011) contributes that earnout payments are more frequently used in circumstances when the valuation risk becomes more severe because the value of human capital is an assumption.
C2. Drawbacks of earnout payments
Earnout payments also have a few drawbacks. An earnout is used to minimize risks and to provide an answer to the disagreement between the two parties.6 Earnout transactions are time- and money consuming (Frankel, 2005). The structure of the contingent payment needs extra attention in order to prevent unexpected surprises. The key factors to consider are the amount, which metric is used and who determines the value of the metric, the time span, dispute resolution and at last who can make decisions.
Next to solving agency problems, contingent payments can also generate those problems. Frankel (2005) calls this problem, the ‘adverse incentive problem’. The contingent payments are related to a prearranged goal under the post-transaction acquirer regime, in order to retain the management of the target. This may cause difficulties. Firstly, the target can sabotage the short-term outcomes in order to receive the earnout payment, which has a negative effect on the long-term result, such as lowering the R&D expenditures or abolishing the maintenance activities. Secondly, the acquirer holds control over the target company (and management) after the deal, so the probability of the earnout payment is in hands of the acquirer. He can manipulate financials away from the threshold to avoid paying the earnout (Datar, Frankel, & Wolfson, 2001; Lukas, Reuer, & Welling, 2012).
D. Corporate governance and earnout payments.
Corporate governance refers to the relation between management and board, the level of shareholder protection, and at the same time what rights the management is able to
perform. The governance depends on a lot of factors and is difficult to value. Results showed that good governance is associated with strong shareholder rights, because there is less space for the management to play their own game in their own interest (La Porta, et al., 2000).
Good governed companies are monitoring their management, increasing their firm value, the expanding circulation of corporate value among the stakeholders, and run effectively the business (Hart, 1995). They leave less space for the management to have a double agenda, or e play games. Those circumstances are favourable for using the earnout as a payment method in M&A transaction. Therefore this thesis is investigating whether corporate governance predict for the use of payment methods in M&A transactions.
II Methodology
The choice of payment method brings risks and has conflicting effects; therefore the financing method is a crucial trade-off. The bidder has to deal with financing constraints, like the definite cash and liquid assets, which may lead to more frequent stock payments in large deals.7 Moreover, the managers of the acquirer may fear for their corporate control, meaning more preference for cash payments because the management of the bidder wants to maintain the control and do not dilute their shareholding. Martin (1996) and Amihud, et al. (1990) find that M&A transactions have less probability of stock financing when the management holds a larger stake of ownership8.
This study is an extension of the literature published about the consideration to finance the transaction with cash or stocks, where in those inquiries the earnout payment was disregarded. I will especially focus on that type of payment method. The mission of this thesis is to clarify whether governance determines earnout payments in M&A deals. This part explains the methodology, including the hypotheses and the economic models this research is using.
7 This is confirmed in this sample with lower means for transaction values.
8 Faccio & Masulis (2005), who explored European transactions, find that the incentive to choose the cash
payment is especially strong when the major shareholder of the bidder company has a voting power between 20% and 60%.
A. Hypotheses
The main hypothesis of this study is whether the corporate governance of the acquirer affects the use of earnout payments. Since there is not an overall formula that is applicable to measure corporate governance, this study will use the Governance Index as one of the key explanatory variables, which is encountered from the IRRC database that holds over 2000 corporations (Gompers, Ishii, & Metrick, 2003). The index serves as a proxy to measure the level of shareholder rights. Every provision the company sets, which limits the rights of the shareholders, yields a point for the G-index. Based on this index and previous written literature regarding the relationship between corporate control and stock and cash payment methods in M&A deals, like Stulz (1988), Amihud, et al. (1990), Martin (1996), and Faccio & Masulis (2005), the following hypotheses are formulated.
Hypothesis 1: the frequency hypothesis
Hypothesis 1: Better governance causes more frequent use of earnout payments. In other words, low G-index will account for more earnouts as payment method.
With the G-index as reference point, I investigate whether the level of corporate governance of the acquirer can explain for the payment method in M&A. Good governance means less defensive provisions and refers to higher shareholder rights, indicating a low G-index. If there is a decline in shareholder rights, there may be an increase in the agency costs, because at times when managers have more rights, they may use them in their own interests (Myers & Majluf, 1984). Self-dealing and overconfidence by the management, will be less noticed due to limited monitoring. Therefore, at companies where the management has stronger rights, cash payments are more frequently used. I assume that better-governed companies (stronger shareholder rights) are using more frequent an earnout because they monitor their management, signal for quality and the management is more dedicated to a firm. Earnouts are more frequently used with higher shareholder rights. This is the first hypothesis that will be tested:
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Hypothesis 2: the value hypothesis
Hypothesis 2: In the set of earnouts: better governance accounts for higher fraction of the earnout payment in relation to the total transaction value.
For my second hypothesis, a subset of the sample is used.9 Here I try to examine if governance provisions can explain the level of an earnout payment. Once an earnout is offered, whether the governance influence the level of the earnout. After de deal is closed, the acquirer company will (try to) implement their governance to the target.10 Implementing good governance is meaningful and may be value creating, as McKinsey (2002) mentioned. Better-governed firms will value the governance higher compared to companies that do not have good governance. I assume that better-governed firms pay higher part of the transaction in an second payment.
This sample will cover only the transactions that used the contingent payment method. The dependent variable is the fraction of the earnout payment over the total transaction value. Thus, the dependent variable will be the ratio of the earnout payment related to the total deal value. The companies are allocated according to the extent of their governance, ordered from well governed (low G-index) to poor governed (high G-index).
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9 227 transactions that incorporate an earnout payment.
10 In order to ensure that the acquirer can execute control of the target, only bids of at least 50% of the targets’
B. Model
The first hypothesis has a binary dependent variable. With running different logistic regressions, the explanatory variables are estimated to what extent they explain the payment method used in the transactions.11 The logistic regression will run six times for different dependent dummy variables, representing the different payment methods. These dummy variables are in line with the article of Martin (1996), except I have four different methods by incorporating earnouts. EARNSTOCK takes value 1 when consideration is an earnout and 0 when the payment is in stocks. EARNMIX takes value 1 if it is an earnout payment and 0 for mixed payments. EARNCASH takes value 1 if the payment method is contingent and 0 when it is a cash deal. STOCKMIX takes value 1 if consideration is a stock payment and 0 for mixed. STOCKCASH takes value 1 for stock and 0 for cash, and finally MIXCASH takes value 1 if the transaction has a mixed payment and 0 if it is in cash. To complete the logistic regressions, a multinomial regression is done. A multinomial regression changes a logistic regression into a multiple outcome regression. The multinomial regression has dependent variable PAYMENT. This is constructed by giving transactions paid with
CASH value 1, transactions with MIXED considerations value 2, STOCK transactions
3 and deals paid with EARNOUT value 4.
For my second hypothesis, the earnout payment over the deal value,
rearndeal, is regressed on the variables collected from different datasets in order to
explain the frequency and level of an earnout payment. This incorporates only 227 transactions with an earnout payment. Due to the continuous dependent variable, it is not possible to test with a logistic model; as of here I used the Ordinary Least Squares method. After the OLS regressions, two extreme portfolios are created. Topearndeal represents the upper 25% of the earnout values, which equates values of $ 75 million or more. Downearndeal accounts for the lowest 25% of the sample, representing values of $ 8 million or less. To complete the research, logistic regressions are done on both of the portfolios.
C. Endogeneity
As in the corporate finance it is inescapable of having endogeneity issues. One form of endogeneity is omitted variable bias. This refers to variables that should be part of
11 This research is also possible with the probit model. The logit and probit regression have different coefficients,
the model but are omitted, because without taking them into account, they are correlated with the error term. This study is exposed to the endogeneity problem due to the difficult measurement of governance variables, such as the quality of the managers or CEO and other firm variables. Therefore I assume that the error term is not correlated with other explainable variables.
Another endogeneity problem within corporate finance is reversed causality, where there is indistinctness of which is the cause and effect. This research needs extra attention because of the G-index I use. It is false to state that a high G-Index causes companies to make poor acquisitions.
To diminish the endogeneity problem, this research incorporates control variables that are used in the closely related literature. Unfortunately, there will be always an endogenous factor, but by running multiple, different regressions this research tries to find consistent outcomes.
III Data
This section explains the restrictions of the sample and provides a clarification of used variables and their summary statistics.
A. Sample
The data is collected from different databases. Thomson Financials’ Securities Data Company (SDC) covers the M&A deals with an announcement date for the time period from the 1st of January 2000 to the 31st of December 2012. The transactions
contain only domestic mergers and acquisitions, leaving all foreign deals out of the sample. The domestic sample consists of 18.660 U.S. deals and in order to reduce the sample I exclude the financial sector (finance, insurance and real estate) and government related firms.12 The percentage of the shares purchased with the transaction is set at 50% and higher (>50%) in order to make sure acquirers have majority control and transaction types as share buybacks and exchange offers are ignored. All transactions are closed and completed and the market value of the
12 Based on (Barbopoulos & Sudardsanam, 2012). The exclusion is based on SIC codes. The companies registered
with codes with 6000 – 6999 (financial sector) and 9111 – 9999 (government related firms) are not part of this sample. (Barbopoulos & Sudarsanam, Determinants of earnout as acquisition payment currency and bidder's value gains, 2012)
acquirer needs to exceed at least $ 1 million ($ 1.000.000). The sample is related to the IRRC database, as Gompers et al. (2003), which lists around 2000 corporations with extended data on corporate governance of those companies, retrieved from annual and quarterly reports (10-K and 10-Q) and other public sources. The acquirer must be listed in the IRRC database, matched by TICKER codes and CUSIP numbers, and if not removed from the sample. All companies with dual class shares are deleted from the sample.
After reducing the SDC dataset, the required data from COMPUSTAT and Risk Metrics about the acquirer firm and its board structure, are retrieved. Combining those datasets and delete transactions with missing data gives a more comprehensive size of 3054 transactions. Those 3054 transactions are referred to the complete dataset used in this inquiry and based on the synopsis of every deal, divided into four different payment considerations, namely cash, mixed, stock and earnout payments. The frequency of every payment method within this sample is displayed in Table I.
The dataset consists of 227 deals incorporating an earnout, where the value of the earnout is reported. Moreover, according to the synopsis of the listed deals, 73 transactions are also closed with contingent payments. They include an earnout payment based upon an unrevealed amount in future based payments, but the value of the actual payment is not known. Nonetheless, I take those 73 transactions as an earnout transaction in the first regression, because the value of the earnout is disregarded. Those transactions are not valid in the second part of this research, because the earnout payment is not known.
Table I
Frequency distribution payments
This table reports the total number of transactions and the distribution (in numbers and percentages) of the payment methods used in this sample
Earnout Stock Mixed Cash Total
Frequency 300 188 557 2009 3054
B. Sample characteristics and descriptive statistics
The sample consists of 3054 transactions completed between 2000 and 2012. The acquirer company is listed in the Investor Responsibility Research Center (IRRC) dataset, which is based on the S&P 1500.13 The size of those firms is quite different. Based on a comparison of assets, the smallest company is called Savient Pharmaceuticals, Inc.14 with an asset value of $ 2,8 million and the biggest company is General Electric with a total asset value of $ 781,8 billion. The biggest transaction incorporated in this sample was the deal closed in 2006, when AT&T bought BellSouth for $ 72,7 billion with a mix of cash, common stocks and liabilities. The largest deal that includes an earnout payment occurred in 2004 when Boston Scientific bought Advanced Bionics Corporation for a total deal value of $ 1,89 billion, with $1,15 billion in earnout (over 60% in contingent payments). The press release on the website of Boston Scientifi confirms the amount of cash payment, namely $ 740 million. The threshold of the earnout was linked to the net sales with a time horizon of 6 years (Boston Scientific , 2004).
B1. Dependent variables
The dependent variables are explained and shown graphically below.
B1.1. Payment considerations
As mentioned before the dataset is strongly reduced to 3054 U.S. transactions within a time period between 2000 and 2012. Figure 1 shows the annual distribution of the M&A transactions in the sample with the payment considerations. From this figure,
13 The S&P1500 is a combination of all stocks listed in S&P500 (large-cap), S&P400 (mid-cap) and S&P600
(small-cap) together, which covers about 90% of the U.S. stocks market.
14 Proir 2003 the company was called Bio-Technology General Corporation.
0 50 100 150 200 250 300 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 Cash Mixed Stock Earnout
the end of the sixth merger wave in 2008 is apparent, as is the percentage increase in earnout payments since 2000 (Martynova & Renneboog, 2008; J.P. Morgan, 2011).
Comparing the rates of the earnout payments, this sample shows a higher fraction in comparison to others. In the dataset of Kohers & Ang (2000), 5,6% of the transactions used an earnout, this was 4,1% for Datar, et al. (2001) and 3,9% for Cain, et al. (2011). The higher rate in my sample is explainable by the more recent sample period this research used (the sample of Cain, et al. (2011) covers 1994 till 2003) and the increasing use of earnouts since 2000.
To clarify the more precise distribution between the payment considerations, Table II presents the percentages per year for every payment method. The last two years of the fifth merger wave (2000 and 2001), where the equity consideration was the dominant one, is clearly seen. Thereafter, the stock payments decrease sharply. Moreover, the increase in earnout and cash payments is evident, which is in line with the publications of J.P. Morgan (2011) and Martynova and Renneboog (2008).
B1.2. Relative earnout value
For the second hypothesis the earnout value is divided by the total value of the transaction.
Relative earnout value = 𝑟𝑒𝑎𝑟𝑛𝑑𝑒𝑎𝑙 = !"#$%&' !"#$%!"#$ !"#$%
The graph below shows the earnout related to the transaction value. More than half of the transactions capture an earnout rate between 1% and 25% of the total
Year 2000 332 10,87% 16 4,82% 82 24,70% 75 22,59% 159 47,89% 2001 234 7,66% 19 8,12% 38 16,24% 58 24,79% 119 50,85% 2002 273 8,94% 25 9,16% 18 6,59% 76 27,84% 154 56,41% 2003 269 8,81% 23 8,55% 14 5,20% 52 19,33% 180 66,91% 2004 286 9,36% 30 10,49% 9 3,15% 57 19,93% 190 66,43% 2005 280 9,17% 32 11,43% 5 1,79% 61 21,79% 182 65,00% 2006 272 8,91% 20 7,35% 5 1,84% 35 12,87% 212 77,94% 2007 266 8,71% 33 12,41% 2 0,75% 43 16,17% 188 70,68% 2008 193 6,32% 17 8,81% 2 1,04% 27 13,99% 147 76,17% 2009 146 4,78% 17 11,64% 5 3,42% 19 13,01% 105 71,92% 2010 185 6,06% 16 8,65% 5 2,70% 19 10,27% 145 78,38% 2011 165 5,40% 26 15,76% 3 1,82% 16 9,70% 120 72,73% 2012 153 5,01% 26 16,99% 0 0,00% 19 12,42% 108 70,59%
Earnout Stock Mixed Cash
Table II
Distribution payments
This table reports the total number of transactions and the distribution (in numbers and percentages) of the payment methods used in this sample
transaction. This is in line with the sample characteristics of Cain, et al. (2011), where it lies between 1% and 28%. Moreover, as my sample consists of outliers, the sample of Cain, et al. (2011) do so too.
B2. Independent variables
The following variables are added to the regression model, because they are closely related, and according to earlier literature they can explain part of the dependent variable. First the proxies for governance, which are the explainable variables are explained, where after the control variables are discussed.
B2.1. Governance Variables Governance Index
The Governance index (hereafter G-index or GIM) is the key independent variable, since this study tries to find a significant relationship between the level of corporate governance and payment considerations within M&A transactions. The GIM is calculated through counting the rules every acquiring company incorporates. In total there are 28 provisions, but the maximum is a count of 24 because there are four state law rules, which overlap the firm-level rules. Table III represents a summary of the occurrence of every provision.15
15 The list of provisions is described in Appendix 1.
0 10 20 30 40 F re q ue ncy 0 .2 .4 .6 .8 1
Relative earnout value
Graph I. Graphical presentation of the percentage of the earnout value to the total deal value with the
Through counting these points, the companies may have strong rights for their shareholders (low number of points) or strong rights for the management of the company (high number of points). Gompers, et al. (2003) refer in their paper to ‘dictator portfolios’ and ‘democracy portfolios’. ‘Dictator’ contains firms with the weakest shareholder rights (G ≥ 14) and ‘democracy’ includes companies with strong rights for shareholders (G ≤ 5). They developed this index in order to try whether different levels of shareholder rights can explain the differences in firm value, profits, sales growth and capital expenditures. They find lower firm value, lower profits, lower sales growth, higher capital expenditures and higher acquisition activity for firms with weak shareholder rights (dictator firms). The distribution of the GIM is provided in Table IV.
Provision number percentage
Antigreenmail / Antigreenmail Law 498 16,31%
Blank Check 2886 94,50%
Business Combination Law 2818 92,27%
Bylaws 565 18,50% Cash-out Law 85 2,78% Charter 51 1,67% Classified Board 1768 57,89% Compensation Plans 2401 78,62% Contracts 348 11,39% Cumulative Voting 307 10,05%
Directors' Duties / Directors' Duties Law 289 9,46%
Fair Price / Fair Price Law 1268 41,52%
Golden Parachutes 2180 71,38% Indemnification 616 20,17% Liability 1121 36,71% Pension Parachutes 31 1,02% Poison Pill 1915 62,70% Secret Ballot 378 12,38% Severance 169 5,53% Silver Parachutes 63 2,06% Special Meeting 1700 55,66%
Supermajority / Control Share Acquisition Law 980 32,09%
Unequal voting 42 1,38%
Written Consent 1424 46,63%
Table III
Governance Provisions
This table reports the number and percentage of each of the provisions occuring in this sample. The data is retrieved from Riskmetrics and is based on the IRRC database. Appendix 1 shows detailed information for
The more the management of the acquirer has corporate control, the more likely the payment is in cash (Amihud, Lev, & Travlos, 1990). The payment in cash will not dilute the amount of control of the manager, which will be the case with a stock payment. To specify the impact of the GIM-index better, I refer to the Dictator and Democracy portfolios, as Gompers, et al. (2003) did. DIC represents the Dictator Portfolio where the management has the power (G ≥ 14) and DEM refers to the Democracy Portfolio (G ≤ 5). Next to the extreme DIC and DEM portfolios, I created two less extreme dummies, in order to try to regress them, later on, at the different payment methods. Those are dicgim (12 ≤ G ≥ 13) for the semi-dictator portfolio and
demgim (6 ≤ G ≥ 7), the semi-democracy portfolio. In relation to earnouts, I expect
better shareholder protection with the contingent payments.
Looking at the upper part of the table, the mean and median of GIM in relation to the stock payments is lower compared to other payment methods.This table shows, in line with Amihud, et al. (1990), higher shareholder rights (low G-index) related to more stock payments. There is a positive relation between the G-index and the occurrence of cash payments. The mixed and earnout payment methods both have the highest frequency around the middle index values.
Board characteristics
The proxies Yermack (1996) used are relevant for this study and are also incorporated in this research. Yermack (1996) finds that a smaller amount of board members has a positive effect on firm value. Here, the amount of board members is used as a proxy for corporate governance. A lower amount of board members is more effective and leads to higher valuation of the firm (Yermack, 1996). BOARDSIZE represents the
Governance index (GIM)
Minimum Maximum Mean Median Standard Deviation
Number of transactions per GIM
G ≤ 5 (Democracy Portfolio) 208 6,81% 18 8,65% 43 20,67% 45 21,63% 102 49,04% G = 6 207 6,78% 12 5,80% 19 9,18% 38 18,36% 138 66,67% G = 7 351 11,49% 42 11,97% 25 7,12% 55 15,67% 229 65,24% G = 8 418 13,69% 45 10,77% 21 5,02% 73 17,46% 279 66,75% G = 9 515 16,86% 54 10,49% 34 6,60% 85 16,50% 342 66,41% G = 10 350 11,46% 40 11,43% 8 2,29% 64 18,29% 238 68,00% G = 11 382 12,51% 35 9,16% 15 3,93% 82 21,47% 250 65,45% G = 12 275 9,00% 25 9,09% 10 3,64% 38 13,82% 202 73,45% G = 13 174 5,70% 16 9,20% 6 3,45% 41 23,56% 111 63,79% G ≥ 14 (Dictator Portfolio) 174 5,70% 13 7,47% 7 4,02% 36 20,69% 118 67,82% Total 3054 300 188 557 2009 2,62 3 18 9,42 9 2,54 3 17 9,4 9 2,8 2,5 4 16 8,05 8 9 Total 3 18 9,32 9
This table provides the summary statistics of the Governance Index per payment method and at the bottom the frequency distribution of every level of the GIM index is showed allocated per payment method. The Democracy Portfolio (DEM) refers to the GIM index of 5 and lower, whereas the Dictator Portfolio (DIC) refers to an index of 14 and higher. The lower part of the table displays the
number of transactions for every G - Index and the percentages. First the total number of transactions and in the following columns per payment method.
Summary statistics and frequency distribtion of GIM
Table IV
2,76
Earnout Stock Mixed Cash
3 17 9,27
number of board members. In addition, there are two dummy variables each representing both ends. Smboa is the dummy representing the small boards, which takes value 1 if the board consists of 7 members or less. Bigboa takes value 1 if the board is composed of 13 members or more.
Next to the size, the board composition is taken into account. INDEP represents the directors that are independent; in other words they are outside directors without a link to the company. EMPLOY are the inside directors who were formerly employed by the company. Finally, LINK represents the directors who have a link to the company but have not worked there before.16 I expect that rindep reduces the agency problem because they may maintain the strategies in order to protect its shareholders because they do not have any relationship to the business before. Therefore, rindep acts in the shareholders’ interest and should be positively related to earnout payments. On the other hand, I expect remploy to have a negative relation to earnout payments, because the chance of having a relation with the management is enhanced due to prior employment (could have been a manager himself).
16 The effect of the dummy LINK is always captured by the intercept of the model to prevent for multicollinearity.
Boardsize Frequency Percentage Cum. Percentage
3 2 0,07% 0,07% 4 13 0,43% 0,49% 5 86 2,82% 3,31% 6 225 7,37% 10,67% 7 358 11,72% 22,40% 8 524 17,16% 39,55% 9 602 19,71% 59,27% 10 414 13,56% 72,82% 11 365 11,95% 84,77% 12 242 7,92% 92,70% 13 126 4,13% 96,82% 14 44 1,44% 98,26% 15 37 1,21% 99,48% 16 8 0,26% 99,74% 17 6 0,20% 99,93% 18 2 0,07% 100,00%
Frequency distribution of BOARDSIZE
This table reports the frequency of boardsize (in numbers and percentages). Table V
Because the absolute values of the three types strongly depend on the board size, it is better to take the relative values. This is done by, EMPLOY, INDEP and
LINK, divided by BOARDSIZE. This creates three new variables, namely remploy, rindep and rlink.
To focus more on the composition of the board, several dummies are created. The first dummy variable is FEMALE. It takes the value of 1 if there is a female represented in the board and 0 if this is not the case. A research report of Credit Suisse (2012) summed up the benefits of gender diversity. Companies with women on high positions outperform companies in terms of higher growth and higher return on equity, compared to companies that have no women on board. Also, the combination of males and females ensures wider range of skills and better corporate governance (Barber & Odean, 2001).
Another dummy is FAMILY. It takes value 1 if there is a family relationship between a board member and the founders or the owners of the company at the time of the transaction and zero otherwise. Within this sample that is the case in 185
Variable BOARDSIZE Employee Independent Linked Variable BOARDSIZE Employee Independent Linked 9,033 9,275 1,476 6,957 6,757 8,849 1,763 6,043 9,078 6,551 1,572 1,490 0 16 7 18 3 0 0,787 1,043 0,940 0,826 9,1971 1,5138 6,8098 7 2,2973 0,7961 2,2220 9 1 0,8605 1 1,1054 0 8
Earnout Stock Mixed Cash
Table VI.a
Summary statistics and mean values of variables BOARDSIZE, Employees, Independent and Linked
This table reports the summary statistics in the upper part of the table. The absolute mean values of variables BOARDSIZE, Employees, Independent and Linked for every payment method are presented in the line below. BOARDSIZE is the total number of board members of the acquirer measured in the year when the transaction was announced. There are 3 types of members: Employees, Independent, and Linked represent the number of employed, independent
and linked members, respectively.
Mean Median Std. Dev. Min. Max.
Variable remploy rindep rlink Variable remploy rindep rlink Table VI.b
Summary statistics and mean values of the relative variables remploy, rindep and rlink
This table reports the summary statistics in the upper part of the table. The relative mean values of variables RelativeEmployees, RelativeIndependent and RelativeLinked for every payment method are presented in the line below. remploy represents the percentage of the board members that where employees
before (EMPLOY/BOARDSIZE). rindep represents the percentage of the board members that has no strings or connections to the company (INDEP/BOARDSIZE). rlink measures the percentage of board members that have a link to the company (LINK/BOARDSIZE).
0,743 0,666 0,716 0,745
0,171 0,212 0,179 0,164
0,0937 0,0769 0,1175 0 0,6667
0,086 0,122 0,104 0,089
Earnout Stock Mixed Cash
0,1706 0,1429 0,0896 0 0,6667
0,7343 0,7692 0,1522 0 1
transactions. Because of the family relationship, it may be assumed that the agency costs are lower then when there is no acquaintance and when one acts in the interest of the founders. Therefore I assume a positive relation between FAMILY and contingent payments.
B2.2. Control variables Market-to-book ratio (Tobin’s Q)
I use the market-to-book ratio to measure the investment opportunity of the acquirer. Jung, et al. (1996), Martin (1996) and Masulis, et al. (2007) all found evidence for higher use of stock payments when a firm has greater investment opportunities. The market-to-book ratio is a proxy for Tobin’s Q ratio and is calculated as follows:
Q = !"#$%& !"#$% !" !"##"$ !"#$%&!!""# !"#$% !" !"##"$ !"#$%&!!""# !"#$% !" !""#$"!""# !"#$% !" !""#$"
Table VII presents the summary statistics in the upper part of the table and the mean values for variable Q for every payment method below. Following prior research, stock payments should be related to a higher Q, which is the proxy for Tobin’s Q ratio. The mean value of Q is almost twice the mean value for the cash payments, which is consistent with the literature.
Firm size
Hansen (1987) showed that the acquirer prefers stock payments when the asymmetric information problem becomes more extensive. More exposure to valuation risks gives the acquirer the desire to share the risk. This risk enhances when the size of the target increases, because the magnitude of the risk increases. If the firm size of the target is
Variable Q Variable
Q
Table VII
Summary statistics and mean values of Tobin's Q
This table reports the summary statistics in the upper part of the table. The mean values of variable Tobin's Q for every payment method is presented in the line below. Tobin's Q is calculated as the (market value of equity - book value of equity + book value of assets) divided by
the book value of assets of the acquirer.
2,150 4,052 1,993 2,038
Earnout Stock Mixed Cash
2,1549 Mean 1,6830 1,6710 0,2698 29,5355 Max. Min. Std. Dev. Median
big relative to the acquirer, stock payments are more common. These findings of Hansen are in line with the outcomes of Cain, et al. (2011) and Barbopoulos & Sudarsanam (2012) discussing earnout payments. They state the main reason for an earnout in M&A is to minimize the costs of valuation risk and information asymmetry. With an earnout offer, the acquirer forces the target to share information. As the study of Martin (1996) I control for relative firm size with RVALUE. The market value of equity of the acquirer is denoted as ACQVAL. The target value is measured by the transaction value, denoted as DEALVAL. RVALUE is calculated the ratio of the deal value over the total value of both companies.
RVALUE = !"#$!% ! !"#$%#$!"#$%#$
Moreover, large companies can have better access to debt and therefore pay more frequent with cash. In order to control for firm size, I follow Masulis, et al. (2007) where firm size is measured as the log function of the total assets of the acquirer, denoted as ASSVAL. As I expected, the higher mean value for cash payments represent the fact the acquirer is of bigger size when the payment is in cash.
Variable RVAL Variable RVAL
Table VIII
Summary statistics and mean values of variable relative firm size
This table reports the summary statistics in the upper part of the table. The mean values of variable RVAL for every payment method are presented in the line below. RVAL is calculated by the value of the target divided by the total value of the target and acquirer together. The
deal value represents the value of the target and the market value of equity the value of the acquirer.
Mean Median Std. Dev. Min. Max.
Earnout Stock Mixed Cash
0,4286 0,0302 11,2405 0 580,0912 0,659 0,765 0,396 0,372 Variable ASSVAL Variable ASSVAL Table IX
Summary statistics and mean values of variable Asset Value
This table reports the summary statistics in the upper part of the table. The mean values of variable ASSVAL for every payment method are presented in the line below. ASSVAL is calculated by taking the LOG - function of the book value of assets of the acquirer.
Mean Median Std. Dev. Min. Max.
8,1155 7,9656 1,5922 1,0445 13,5694
7,698 8,395 7,975 8,188
Leverage-ratio and Cash availability
The financing structure of the acquirer has effect on the choice of the payment method. Bigger companies have better and cheaper access to debt compared to smaller companies and debt is an effective instrument to delimit the agency problem.17 Like Masulis (2007), LEVER is calculated as follows:
LEVER = !""# !"#$% !" !"!#$ !"#$ (!"#$!!!!"#)!"#$%& !"#$% !" !"!#$ !""#$"
I expect leverage to have a positive effect on earnout payments, because higher leverage reduces the free cash flow and ensures stronger incentives for the managers to act in shareholders’ interest due to the monitoring of creditors and shareholders.
Moreover, large amounts of cash lead to more cash financing acquisitions (Jensen, 1986). As Martin (1996), to express the ability for the acquirer to finance the expansion with cash, the capability to generate cash of the acquirer is taken into account, denoted as FCFF. This is calculated as the operating income before depreciation minus the interest expenses, income taxes and capital expenditures, and the total of that divided by the book value of assets.
FCFF = !!"#$%&'( !"#$%& !"#$%" !"#$"%&'(&)*!!"#$%$&# !"#!$%!!!"#$%& !"#$%!!"#$%!""# !"#$% !" !""#$"
17 Debt decreases the free cash flow of the management, and therefore lowers the ability for self-dealing acquisitions Variable
LEVER Variable
LEVER
Table X
Summary statistics and mean values of variable leverage ratio
This table reports the summary statistics in the upper part of the table. The mean values of variable LEVER for every payment method are presented in the line below. LEVER refers to the total book value of debt (long + short) divided by the market value of assets of the acquirer.
Mean Median Std. Dev. Min. Max.
Earnout Stock Mixed Cash
0,1362 0,1133 0,1235 0,0000 0,9399
Higher free cash flows of the acquirer may increase the frequency of cash payments. That is apparent from Table XI above, as is the lower average value of
FCFF with stock payments.
Target, acquirer and deal characteristics
Other control variables are more general acquirer-, bidder- and transaction specific characteristics. As mentioned before DEALVAL is the transaction value in US dollars. For the first hypothesis the log-function, LOGDEAL, is taken into account, because the transaction values are very dispersed. To test the second hypothesis the fraction of the earnout over the total deal value is the dependent variable. EARNVAL is the value of the earnout payment in dollars.
The most noticeable values are the differences in mean values of the deal between payment methods. The transactions paid with contingent payments and cash are considerably low compared to the stock and mixed deals.
Results of Datar, et al. (2001) indicate that earnouts are more frequently used when the target and acquirer are operating in different countries and/or industries and when there is less acquisition activity within that specific industry. Moreover, Kohli and Mann (2013) find it more probable of using an earnout when the target company is in the high-tech industry and/or services sector because of the higher valuation risk.
Variable FCFF Variable FCFF
Table XI
Summary statistics and mean values of variable free cash flow
This table reports the summary statistics in the upper part of the table. The mean values of variable FCFF for every payment method are presented in the line below. FCFF is (income before depreciation - interest expenses - income taxes - capital expenditures) divided by the
book value of assets of the acquirer.
Mean Median Std. Dev. Min. Max.
Earnout Stock Mixed Cash
0,0524 0,0578 0,0851 -1,8296 0,4685 0,071 0,026 0,039 0,056 Variable DEALVALUE EARNVALUE LOGDEAL Variable DEALVALUE LOGDEAL 4,378 5,609 5,608 4,400 242,535 1972,911 1963,991 329,188 4,6928 4,7005 1,8125 0 11,1937
Earnout Stock Mixed Cash
723,8447 110 3566,431 1 72671
Table XII
Summary statistics and mean values of variables DEALVALUE, EARNVALUE and LOGDEAL
This table reports the summary statistics in the upper part of the table. The mean values of variables DEALVALUE and LOGDEAL for every payment method are presented in the line below. DEALVALUE represents the deal value and LOGDEAL is the log-function of the deal value (LOGDEAL is the variable incorporated in the regressions after). EARNVALUE is the value of the earnout paid in a transaction with contingent payment consideration.
Mean Median Std. Dev. Min. Max.
21
