Determinants of Earnout Materiality: Evidence from North America and Europe

Sammanfattning

Earnout agreements play a crucial role in Mergers and Acquisitions (M&A) transactions, bridging valuation gaps caused by information asymmetry and uncertainty surrounding the target's value. This study examines earnouts by focusing on their advantages and limitations as well as recent trends in their use. The primary objective is to examine the key determinants of earnout materiality - defined as the ratio of earnout value to total deal value - in North America, and to analyze differences across regions by assessing whether the same determinants apply to the European sample examined in the Bocconi thesis. Using a North American sample of completed M&A transactions involving earnouts announced between January 1, 2010, and December 31, 2024, we test several hypotheses on earnout materiality through a multivariate linear regression analysis. The results indicate that earnout materiality is negatively associated with the size of the target and positively associated with the presence of a toehold. Smaller targets exhibit higher earnout materiality due to greater valuation uncertainty arising from less predictable prospects and limited information. Acquirers with prior equity stakes are likely to have better insight into target risk. This increased awareness of the risks increases reliance on earnout mechanisms. A comparison with European evidence reveals significant regional differences and target size is the only determinant consistently observed across regions, reflecting shared valuation challenges for smaller firms. Overall, the results indicate that institutional and market conditions shape the determinants of earnout materiality, highlighting the importance of the geographical context.