Acquirers’ Cultural Background and the Use of Earnouts

Abstract

This study investigates the effects of culture on the design of merger and acquisition (M&A) contracts. Specifically, we empirically analyze how the acquirer’s cultural background influences the contractual choice to implement an earnout. We operationalize the acquirer’s cultural background by using Hofstede’s country-level indices for individualism, power distance, uncertainty avoidance, masculinity, and long-term orientation. Using a comprehensive sample of 9,669 M&As, we find that earnout use is significantly positively associated with the acquirer’s masculinity level. Furthermore, we provide evidence that earnout use is significantly negatively associated with the acquirer’s power distance and uncertainty avoidance scores. Our study contributes to the literature by demonstrating that, in addition to economic theories, cultural differences are important in understanding the heterogeneity of earnout use.

Mergers and acquisitions research in finance and accounting: Past, present, and future

“…While studies in this frontier examine a variety of mechanisms/devices for mitigating information asymmetry, including the use of stock (Cheng et al, 2022), contingent considerations such as earnouts (Battauz et al, 2021), seller financing (Jansen, 2020), earnings smoothing (Doukas & Zhang, 2020), sharing of same industry between acquirers and targets (Perafán‐Peña et al, 2022) and other contracting and signalling mechanisms in acquisitions, the predominant focus has been on earnouts. In particular, the research in this cluster documents that in addition to information asymmetry, the acquirer's cultural background (Ewelt‐Knauer et al, 2021), acquirer's earnings quality (Prencipe & Viarengo, 2022) and change in accounting standards (Chaney et al, 2020) can also influence the use of earnouts as a payment method in acquisitions. Further, acquirers that are larger, older, advised by top‐tier/boutique firms, and also those that make acquisitions of unlisted targets benefit more from the use of earnouts (Barbopoulos & Danbolt, 2021).…”

Do Earnouts Create the Right Incentives?: Earnings Management Around Earnout-Based Acquisitions

“…State-contingent payments may be a useful tool to resolve potential valuation disagreements about private firms in M&A deals. In fact, Ewelt-Knauer et al (2021) report that 92% of targets in earnout deals are private firms.…”

Earnouts: The real value of disagreement in mergers and acquisitions

“…Elnahas et al (2017) contended that earnouts violate Islamic law and, therefore, are infrequently used in Islamic countries. Ewelt-Knauer et al (2021) found that the use of earnouts is linked to the acquirer's cultural background, measured using Hofstede's country-level indices. The authors found that the use of earnouts is significantly negatively associated with the acquirer's power distance, a measure of organizational hierarchy, and uncertainty avoidance indices.…”