Risk Allocation in Acquisitions: The Uses and Value of MAE-Exclusions.

Abstract

Acquirers and targets define and allocate interim risk through Material-Adverse-Event (MAE) exclusions in merger agreements. I examine why MAE-exclusions exist based on the risk they address and assess whether such risk allocation affects the gains in the acquisition. Targets and acquirers seem to use MAE-exclusions to signal target quality to reduce information asymmetry, and to allocate exogenous risk on the acquirer. I find little support for the use of MAE-exclusions to create commitment to alleviate moral hazard. Moreover, higher protection for the acquirer against information asymmetry on the target increases the value created by the acquisition. Overall, acquirers and targets use MAE-exclusions to preserve value in acquisitions.

Keywords: merger, acquisition, risk allocation, information asymmetry, moral hazard, material adverse event,Acquisitions, Contractual mechanisms, Material-Adverse-Change clause (MACs), Material-Adverse Event (MAE) exclusions, merger agreement, adverse selection, material adverse change clause, MAC

JEL Classification: G34, G32, G14, K12, L14, D86