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Is a promise a promise? Analyzing performance commitment in acquisitions and target firm performance

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  • Qizhi Tao
  • Ming Liu
  • Shiman Hu
  • Yun Zhang

Abstract

Using the acquisition data in China from 2011 to 2019, we show that acquiring firms are more likely to provide target firms with performance commitment (PC) contracts when they (1) use stocks to pay acquisitions, (2) have low profits, (3) make cross-industry and domestic acquisitions, (4) are young, small, non-stated-owned enterprises and not related parties with target firms, and (5) deal value is high. Although PC increases the takeover premia, acquirers with PC experience high cumulative abnormal stock returns (CARs) during the announcement period. Double PC contracts drive acquirers' CARs even higher. Although target firms with double PC have better profitability than those with single PC during the commitment period, their profit starts to decrease sharply once the commitment period expires, and those with double PC deteriorate even further. Finally, we find that target firms with PC engage in earnings management during the commitment period to meet their promised performance. Overall, we do not support previous studies because PCs engender earnings management and impair the values of acquirers in the post-commitment period.

Suggested Citation

  • Qizhi Tao & Ming Liu & Shiman Hu & Yun Zhang, 2022. "Is a promise a promise? Analyzing performance commitment in acquisitions and target firm performance," The European Journal of Finance, Taylor & Francis Journals, vol. 28(4-5), pages 487-513, March.
    • Handle: RePEc:taf:eurjfi:v:28:y:2022:i:4-5:p:487-513
    DOI: 10.1080/1351847X.2020.1871050
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    Cited by:

    1. Sun, Zeyu & Kong, Ningning & Wu, Lei & Bao, Yu, 2024. "Does contingent payment in M&As induce acquirers’ earnings management? Evidence from performance commitment," Research in International Business and Finance, Elsevier, vol. 69(C).
    2. Dahlen, Niklas & Lahmann, Alexander & Schreiter, Maximilian, 2024. "Panacea for M&A dealmaking? Investor perceptions of earnouts," Finance Research Letters, Elsevier, vol. 60(C).
    3. Song, Di & Shen, Na & Su, Jun, 2023. "A catering perspective of performance commitment-evidence from acquisitions in China," Pacific-Basin Finance Journal, Elsevier, vol. 78(C).

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