Trading Activity and Liquidity Effects Around Private Firm Acquisition Announcements: The Case of Earnouts Versus Other Methods of Payment

Abstract

We investigate trading activity and liquidity effects of methods of payment on the stock prices of acquiring firms around private firm acquisition announcements. We find significant rises in trading activity around acquisition announcement dates irrespective of the payment method used; however, fluctuations are lower for earnouts and cash payment options. Stocks of acquirers using earnouts also benefit from enhanced post-announcement liquidity. These effects of earnouts are linked to acquirers’ lower risk of being adversely selected when acquiring private firms, given that information asymmetry is inherently lower when using a staggered payment term linked to performance than otherwise.

Keywords: earnout, method of payment, information asymmetry, liquidity, acquisition announcements

JEL Classification: G14, G34