Customer concentration of targets in mergers and acquisitions

Abstract

We study how customer base concentration at a target firm impacts the occurrence and structure of M&A deals. We hypothesize that customer concentration increases information asymmetry and adverse selection between bidders and targets, such that (1) firms with greater customer concentration are less likely to receive a bid and (2) bidders for targets with greater customer concentration share the risk by using more stock payment in their offer. Using data on customer concentration and M&A deals from 1985 to 2016, we find consistent evidence supporting our predictions. Our findings extend the literature by systematically documenting an important factor in M&A decisions and by quantifying the economic consequences of customer concentration.

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

“…This strand of research focuses on mechanisms to mitigate risks, especially those faced by acquirers, due to asymmetric information between the transacting parties. These risks pertain to issues such as target valuation and customer concentration at target firms (Cheng et al, 2022). 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.…”

“…These risks pertain to issues such as target valuation and customer concentration at target firms (Cheng et al, 2022). 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.…”