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Auditor monitoring and verification in financial contracts: evidence from earnouts and SFAS 141(R)

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  • Kristian D. Allee

    (University of Arkansas)

  • Daniel D. Wangerin

    (University of Wisconsin – Madison)

Abstract

We study how monitoring and verification of accounting-based performance benchmarks influences the design and efficiency of earnout contracts. Earnouts are commonly used to resolve agency conflicts arising in mergers and acquisitions, but these contracts create measurement and other agency problems when contingent payments are tied to future accounting-based performance. Exploiting changes in auditor monitoring of earnouts that arose as\ a consequence of SFAS 141(R), we find that acquisition contracts are more likely to incorporate accounting-based earnouts and that contingent payments tied to accounting-based performance benchmarks make up a larger portion of the consideration when acquiring firms have high-quality auditors. We also find that market reactions to announcements of earnout deals are more positive after SFAS 141(R) for acquisitions most susceptible to disputes over accounting-based performance metrics and these results are more pronounced for acquiring firms with high-quality auditors. By exploiting the features of this unique setting, we illuminate the role of monitoring and verification of accounting information in financial contracts.

Suggested Citation

  • Kristian D. Allee & Daniel D. Wangerin, 2018. "Auditor monitoring and verification in financial contracts: evidence from earnouts and SFAS 141(R)," Review of Accounting Studies, Springer, vol. 23(4), pages 1629-1664, December.
    • Handle: RePEc:spr:reaccs:v:23:y:2018:i:4:d:10.1007_s11142-018-9472-0
    DOI: 10.1007/s11142-018-9472-0
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    Cited by:

    1. Dahlen, Niklas & Lahmann, Alexander & Schreiter, Maximilian, 2024. "Panacea for M&A dealmaking? Investor perceptions of earnouts," Finance Research Letters, Elsevier, vol. 60(C).
    2. Gao, Xin & Xu, Weidong & Li, Donghui & Xing, Lu, 2021. "Media coverage and investment efficiency," Journal of Empirical Finance, Elsevier, vol. 63(C), pages 270-293.
    3. Fan, Cunbin & Zou, Guohao & Wang, Jiawen, 2024. "M&A performance commitments and insider trading: ‘Listen to their words’ or ‘watch their actions’?," International Review of Financial Analysis, Elsevier, vol. 91(C).

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    More about this item

    Keywords

    Acquisitions; Earnouts; Financial contracting; Auditors;
    All these keywords.

    JEL classification:

    • G34 - Financial Economics - - Corporate Finance and Governance - - - Mergers; Acquisitions; Restructuring; Corporate Governance
    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting
    • M42 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Auditing

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