September 2014
The Use of Escrow Contracts in
Acquisition Agreements
Sanjai Bhagat (Univ. of Colorado - Boulder)
Sandy Klasa (Univ. of Arizona)
Lubomir P. Litov (Univ. of Arizona & WFIC, Univ. of Pennsylvania)
Escrow Contracts in Acquisition Agreements
-
A form of contingent payment contract, where buyer and seller agree that seller will
deposit a fraction of purchase price (usually 12.2% of it) into a treasury
account for a certain period of time (usually 17.4 months).
-
Employed in private firm and subsidiary acquisitions but not used in
acquisitions of publicly traded targets.
-
In our sample, escrow accounts used in 52.1% of all unlisted target deals.
-
More commonly used in (i) stock purchase acquisitions and (ii) acquisitions
of stand-alone targets.
2
Institutional Detail
Use of Escrow Contract Funds
- EBITDA & Purchase Price Adjustments.
- Working Capital Adjustments (A/R, A/P, Inventory, other current assets).
- Environmental Liabilities.
- Pending Litigation.
- Obligations Related to Collective Bargaining Agreements.
- Unpaid Taxes Due.
- Certain Other Non-Fraudulent Breach of Representations & Warranties.
Escrow Agreement Disputes Resolution
- Binding Arbitration.
- Non-binding Mediation.
Escrow Agreements vs. Transaction Insurance
- Insurance more expense, and limited in coverage.
3
Preliminary Sample Statistics
All Deals Sample
Variable
Percent of Deals with an Escrow Agreement
All Sample
(943 obs.)
52.1%
Deal with Escrow Contract
Escrow Contract
(491 obs.)
Variable
Percent Deposited Through an Escrow Agreement
Average Escrow Agreement Size (US$ m)
Average Escrow Agreement Duration (Months)
Percent of deals with:
% Stock Purchases
% Asset Purchases
% Stand-alone Targets
% Subsidiary Targets
All
73.7%
26.3%
60.30%
39.70%
Sample with
Escrow Contracts
80.0%
20.0%
75.60%
24.40%
12.2%
$11.7
17.4
Sample without
Escrow Contracts
66.8%
33.2%
43.80%
56.20%
4
Example
-
Syntax-Brillian & Vivitar Stock-for-stock Merger; - Escrow Agreement Duration: 12 months;
Escrow Agreement Size: 15% of transaction value; - Target Value: $26M;
- SEC Docs: Link
(seller)
(escrow agent)
(cap on liability)
(claims process)
5
Hypotheses
Main Hypothesis
The use of escrow contracts in unlisted target acquisitions is an efficient contracting
mechanism that:
1)
Facilitates completion of these acquisitions by allowing buyers & sellers to
manage acquisition-related transaction risks, and
2)
Allow parties to overcome information asymmetry problems.
6
Hypotheses
Several implications of the main research hypothesis follow through.
Use of Escrow Contracts - Transaction Risk Predictions
-
Stand-alone targets are likelier to use escrow contract.
-
Subsidiary targets less likely to use escrow contract.
-
Larger targets (relative to acquirer) are likelier to use escrow contract.
-
Targets with dominant shareholders are likelier to use escrow contract (to manage
joint & several liability if post-acquisition breach of reps. & warranties).
-
Stock purchases (as opposed to asset purchases) are likelier to use escrow contract.
7
Hypotheses
Use of Escrow Contracts - Informational Asymmetry Risk Predictions
-
Different industry acquisitions likelier to use escrow contract.
-
Targets w/ higher degree of earnings management likelier to use escrow contract.
-
Targets in industries w/ higher earnings volatility likelier to use escrow contract.
-
Targets in industries w/ lower analyst coverage likelier to use escrow contract.
-
Distressed targets (i.e., w/ lower interest coverage) likelier to use escrow contract.
Use of Escrow Contracts – Other Risks Predictions
-
Escrow contracts are used if reverse insurance, in the form of liability cap
limitations (or caps) is included (caps are on average 2.4 times escrow size).
8
Main Findings
Escrow agreements are more common when transaction risk is high, i.e., for:
-
Stand-alone private targets, targets with dominant shareholders, larger targets
(relative to acquirer).
-
Escrow contract use shortens time-to-complete transaction by 35.5-51.0%.
Escrow agreements are more common if information asymmetry risk is high, i.e., for:
-
Targets in cross-industry acquisitions, targets w/ high accruals, targets in
industries w/ high earnings volatility or low analyst coverage, targets that
are financially constrained.
Escrow agreements are more common when other risks may be present, i.e.:
-
If no reverse insurance in form of liability cap limitations (or caps) is included.
9
Main Findings
Escrow contracts are associated with significantly smaller target discount:
- Adoption of escrow agreement increases valuation of a private target
(price-to-sales multiple compared to similar public target) by 3.5-6.1%.
- Valuation impact stronger for stand-alone targets (7.4-9.1%) and weaker
for subsidiary targets (0.8-2.2%).
Escrow contracts benefit bidder:
- For every dollar in escrow contract deposit, market capitalization to
bidder shareholders is increased by 89 cents.
- Bidder benefits from reduced losses (due to unrecorded or uncovered
target liabilities), reduced information gathering (due diligence) costs, and
reduced litigation costs (in case of dispute with target after closing).
10
Prior Literature
Contingent payments
Limited literature on contingent payments in private target acquisitions:
- Anecdotal evidence in Deal Points studies, 2008-2012 (by American Bar Association).
More academic research for such payments in public target acquisitions:
- Stock payments
- Officer, Poulsen, & Stegemoller (2009).
- Earnouts
- Kohers & Ang (2000); Datar, Frankel & Wolfson (2001); Cain, Denis & Denis (2011).
- However, escrow contracts & earnouts usually address different frictions.
- Other
- Officer (2004) – collars.
- Burch (1996) – lock-up provisions.
- Bates & Lemmon (2005) – termination fees.
Private Target Discount
Officer (2007) – unlisted target discount & liquidity.
11
Data
Collect Data from a novel database Business Valuation Resources LLC data.
- Information on private target financials from 8K, DEF 14A, 10Q, & 10K.
Collect data on 943 acquisitions:
- Involve private target & public acquirer.
- Target value above $25 million.
- Completed 1994-2009.
- Available information on target financials & consideration structure.
We hand collect data on the presence of escrow contracts, caps, & earn outs.
Collect data on size, maturity & type of consideration offered in escrow contract.
Other: exclusive access to J.P. Morgan Chase escrow services client proprietary data.
12
Univariate Sample Statistics
Table I. Panel A. Escrow Contracts and Target Price Discount Characteristics.
All Deals Sample
Variable
Percent of Deals with an Escrow Agreement
Average Time to Completion
All Sample (943 obs.)
52.1%
57.5 days
Deal with Escrow Contract
Variable
% Deposited Through Escrow Contract
Escrow Contract Size (US$ m)
Escrow Contract Duration (Months)
Escrow Contract
(491 obs.)
12.2%
$11.7
17.4
Stand-alone
Targets (371 obs.)
13.0%
$11.9
17.5
Subsidiary
Targets (120 obs.)
8.9%
$11.0
17.1
Unlisted Target Price Discount (Means)
Discount
All Targets
-0.243
Stand-alone Private Targets
-0.171
Subsidiary Targets
-0.333
Targets With Escrow Contract
-0.196
Targets Without Escrow Contract
-0.289
13
Univariate Sample Statistics
Table I. Panel B. Target Characteristics.
All
Sample
Average Target Characteristics
(Medians)
Sample with
Escrow
Agreements
Sample without
Escrow
Agreements
(943 obs.)
(491 obs.)
(452 obs.)
Target Net Sales (in U.S.$ million)
48.7
38.4
63.7
32.2
73.0
18.4%
2.90
0.14
0.04
24.6
68.1
17.8%
1.93
0.16
0.035
43.9
80.0
18.9%
3.89
0.12
0.04
Target Total Assets (in U.S.$ million)
Actual Target Price (in U.S.$ million)
Relative Target Size (to Acquirer)
Target Interest Coverage
Target ROE
Target ROA
14
Use of Escrow Contracts and Other Deal Characteristics
Table II. Panel A. Deal Characteristics.
Percent of deals with:
% with Dominant Owner
% with Liability Cap
% with Stock Payment Only
% with Cash Payment Only
% with Earnout Contract
% with Installment Note
All
36.70%
73.7%
9.0%
36.7%
12.2%
11.7%
Sample with
Escrow Contracts
48.30%
85.3%
11.2%
31.8%
13.8%
8.8%
Sample without
Escrow
Contracts
24.10%
61.1%
6.6%
42.0%
10.4%
14.8%
Table II, Panel B. Sub-sample Comparisons.
Stock Purchase
Stand-Alone Target
Dominant Target Owner
Use of Liability Cap
Payment is Stock Only
Payment is Cash Only
Use of Earnout Contract
Escrow Deals with row
characteristics
60.5%
65.2%
68.5%
60.3%
64.7%
45.1%
59.1%
Escrow Deals without
row characteristics
43.5%
32.1%
42.5%
29.1%
50.8%
56.1%
52.1%
15
Target Industry Distribution (Table III)
Code
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
Fama-French Industry Name
Agriculture
Food Products
Candy & Soda
Beer & Liquor
Tobacco Products
Toys & Recreation
Entertainment
Printing and Publishing
Consumer Goods
Clothing & Apparel
Healthcare
Medical Equipment
Pharmaceutical Products
Chemicals
Rubber and Plastic Products
Textiles
Construction Materials
Construction
Steel Works, Etc.
Fabricated Products
Machinery
Electrical Equipment
Automobiles and Trucks
Aircraft
Shipbuilding, Railroad Equipment
Defense
Precious Metals
% Deals w/ Escrow
Agreement & Target
in Industry
0.2
0.8
0.2
0.0
0.0
0.2
1.0
2.1
0.8
1.4
3.9
3.5
3.7
0.8
1.0
0.0
0.8
2.7
1.7
0.0
2.9
1.4
1.2
1.0
0.6
0.8
0.0
% Deals w/ Target in
Industry
0.5
1.0
0.1
0.1
0.0
0.6
1.1
2.0
1.1
1.5
3.0
3.0
4.9
1.4
1.3
0.2
1.6
2.4
1.4
0.0
2.2
1.9
1.1
0.9
0.4
0.4
0.2
(continued)
16
Target Industry Distribution (Table III, continued)
Code
28
29
30
31
32
33
34
35
36
37
38
39
40
41
42
43
44
45
46
47
48
49
Fama-French Industry Name
Non-Metallic and Industrial Metal Mining
Coal
Petroleum and Natural Gas
Utilities
Telecommunication
Personal Services
Business Services*
Computers
Computer Software*
Electronic Equipment*
Measuring and Control Equipment
Business Supplies
Shipping Containers
Transportation
Wholesale
Retail
Restaurants, Hotels, Motels
Banking
Insurance
Real Estate
Financial Trading
Other
% Deals w/ Escrow
Agreement & Target
in Industry
0.0
0.2
2.3
0.2
3.7
1.7
10.3
2.9
19.1
8.0
3.7
0.8
0.0
2.1
4.1
2.5
1.2
0.8
0.6
0.2
1.9
0.8
% Deals w/ Target in
Industry
0.1
0.1
2.2
0.6
3.5
1.2
10.5
2.5
13.9
8.5
3.4
0.8
0.2
2.2
4.5
3.5
1.2
1.2
1.5
0.3
2.6
1.3
17
Determinants of Escrow Contract Use in Unlisted Target Acquisitions
(Table IV)
(Probit Models)
Use of Escrow Agreement
All
Stand-alone
Subsidiary
Targets
Targets
Targets
***
0.223
Variables:
Target is Stand-alone Private Firm
(t-stat)
Indicator for Asset Sale
Relative Size of Target to Acquirer
(5.68)
-0.017
(0.41)
0.019*
(1.66)
Top Quintile Earnings Volatility Target Industry
Indicator
Low Analyst Coverage Target Industry
Indicator
Target & Acquirer are in Different Industry
0.009**
(2.04)
0.038*
(1.79)
0.016**
(2.48)
Target Accruals
0.542**
(2.15)
Target Interest Coverage
-0.079*
Indicator for Target Dominant Shareholder
0.161***
Indicator for Use of Liability Caps
0.267***
(1.88)
(4.51)
C&I Loan Rate Spread
Ln (Deal Value)
(6.97)
-0.005
(0.10)
-0.046***
(2.78)
% Deals Target Industry Using Escrow Contract
0.208*
% Bidder Use of Hybrid Method of Payment
0.012*
(1.68)
(1.92)
-0.03
(0.47)
0.021**
(2.53)
0.086**
(2.27)
0.043*
(1.87)
0.041***
(2.95)
0.515*
(1.71)
-0.069**
(2.00)
0.125***
(2.95)
0.312***
(5.53)
-0.023
(0.36)
-0.024
(1.06)
0.426**
(2.23)
0.010**
(2.08)
-0.003
(0.05)
0.008
(1.18)
0.108
(1.20)
0.112**
(2.12)
0.025
(0.43)
0.799*
(1.82)
-0.031
(1.58)
0.218***
(2.75)
0.228***
(3.70)
-0.073
(0.73)
-0.073***
(2.72)
0.046
(1.21)
0.047**
(2.48)
(continued)
18
Endogeneity & Instrumental Variables Choice
Adoption of escrow contract is endogenous w.r.t. valuation.
Need instruments that are both (i) relevant & (ii) exclusive to determine choice of
escrow adoption.
Two instruments:
- Propensity of peer target industry group to use such contracts.
- Bidder reputation to use hybrid securities (including escrow contracts).
Verify validity of such instruments through series of tests:
- Overidentification test (Sargan stat).
- Underidentification tests (partial R-squared, F-stat excluded instruments).
19
Determinants of Escrow Contract Use in Unlisted Target Acquisitions
(Table IV)
Excluded Instruments:
Industry
proxy
Escrow Use
Reputation
proxy
Percent of Deals in Target Industry that Use
Escrow Agreement in the Previous Year
(t-stat)
Indicator Previous Use of Hybrid Securities by
Acquirer
Observations
Pseudo R-squared
All
Targets
Stand-alone
Targets
Subsidiary
Targets
0.208*
(1.68)
0.426**
(2.23)
0.046
(1.21)
0.012*
(1.92)
0.010**
(2.08)
0.047**
(2.48)
837
520
317
0.205
0.278
0.358
20
Economic Significance of Estimates in Determinants Model
Model of Escrow Contract Use Determinants
Independent Variables:
∆ in Probability
Main Determinants
Indicator for Use of Caps
Target is Stand-alone Private Firm
26.70%
22.30%
Indicator for Presence of Dominant Shareholder
16.10%
Low Analyst Coverage Target Industry Indicator
3.80%
Target Accruals*
3.69%
Target & Acquirer are in Different Industry
1.60%
Top Quintile Earnings Volatility Target Industry Indicator
0.90%
Target Relative Value*
0.64%
Target Interest Coverage*
-0.22%
C&I Spread*
-0.93%
Indicator for Asset Sale
-1.70%
Ln (Target Value)*
-7.05%
Instrumental Variables
% of Deals in Target Industry that Use Escrow Prior Year
4.65%
Indicator if Bidder Uses a Hybrid Payment in Prior Year
1.20%
21
Due Diligence Costs Analysis
Bidders use escrow accounts to diminish due diligence costs.
No direct proxy for such costs.
We proxy for due diligence costs by time-to-deal completion.
- Due diligence costs proportionate to time-to-deal completion.
We find supporting results using litigation propensity.
- Due diligence costs may be direct or indirect.
- Inexpensive due diligence may result in future losses & litigation.
- We can use litigation as another proxy for such costs.
Our findings support hypothesis that escrow contracts diminish due diligence
costs.
22
Time-to-Deal Completion Analysis (Table V)
All Targets
OLS
2SLS
***
-20.385
Independent Variables:
Escrow Agreement Indicator
(t-stat)
(2.68)
-53.841**
Instrumented Escrow Agreement Indicator
(2.57)
Target is a Stand-alone Private Firm
Acquisition is Considered an Asset Sale
Relative Size of Target to Acquirer
Top Quintile Earnings Volatility Target Industry
Indicator
Low Analyst Coverage Target Industry Indicator
Target & Acquirer are in Different Industries
Target Accruals
Target Interest Coverage (scaled by 1,000)
Indicator for Target Dominant Shareholder
Indicator for Use of Liability Cap in Acquisition
Commercial & Industrial Loan Rate Spread
Ln (Deal Value)
Observations
Adjusted R-squared
Stand-alone Targets
OLS
2SLS
*
-18.714
(1.71)
-40.173**
(2.58)
Subsidiary Targets
OLS
2SLS
**
-24.175
(1.99)
-21.001**
(2.36)
0.740
(0.08)
0.835
(0.08)
3.286
(0.55)
6.866**
(2.45)
23.361**
(2.32)
3.714***
(2.64)
12.088
(0.39)
35.997
(0.91)
-3.554
(0.54)
8.968
(1.17)
6.572
(0.73)
11.238**
(2.25)
15.811
(0.74)
0.874
(0.08)
5.677
(0.91)
8.904**
(2.58)
28.635***
(2.77)
0.803
(1.13)
25.819
(0.41)
40.263
(0.89)
-2.950
(0.18)
18.447
(0.75)
9.397
(0.92)
8.420
(1.21)
0.097
(0.01)
3.997
(0.47)
15.416*
(1.76)
36.011***
(2.87)
-0.801
(0.13)
-23.223
(0.57)
65.249
(0.91)
-11.566
(1.38)
11.587
(1.13)
27.010**
(2.13)
5.916
(1.19)
2.414
(0.15)
6.273
(0.72)
18.900**
(1.97)
39.560***
(2.75)
0.172
(0.03)
-64.083
(1.04)
70.500
(0.93)
-16.647
(1.19)
-10.284
(0.45)
31.554**
(2.14)
6.505
(1.36)
10.601
(0.91)
-0.133
(0.01)
-11.318
(0.78)
0.768
(0.05)
10.641*
(1.82)
61.004
(1.04)
0.623
(0.06)
7.439
(0.53)
8.842
(0.78)
-14.291
(0.98)
21.079***
(3.19)
8.838
(0.70)
-3.071
(0.31)
-14.321
(0.95)
2.102
(0.12)
1.210
(0.70)
31.847
(0.47)
6.413
(0.42)
-16.441
(0.90)
0.454
(0.02)
-7.426
(0.42)
23.665***
(2.86)
884
0.086
837
0.090
536
0.133
520
0.132
348
0.034
317
0.027
23
Unlisted Target Discount
We select to study valuation impact for target based on deal-value-to-sales multiple.
- Officer (2007) uses deal-value-to-EBITDA multiples.
- We do not use such multiples because:
* EBITDA could be <0 (for public bidder or private target).
* EBITDA defined discretionary across private targets.
We calculate discount as ratio of private target multiple to similar public target
multiple (net of one).
Matching of public to private target counterparts:
- Same industry (2-digit SIC).
- Within 20% difference ideal size.
- Within 36-months window centered on acquisition announcement date.
24
Analysis of Unlisted Target Discount
Table VI. Panel A.
Escrow Agreement Indicator
(t-stat)
Instrumented Escrow Agreement Indicator
All Targets
OLS
2SLS
0.084**
(2.30)
0.202***
(3.16)
Target is a Stand-alone Private Firm
Acquisition is Considered Asset Sale
Relative Size of Target to Acquirer
Target & Acquirer in Different Industries
Top Quintile Earnings Volatility Target
Industry
Low Target Industry Analyst Coverage
Method of Payment is Only Cash
Commercial & Industrial Loan Rate Spread
Ln (Deal Value)
Observations
Adjusted R-squared
0.159***
Stand-alone Targets
OLS
2SLS
0.126**
(2.35)
0.228***
(3.28)
Subsidiary Targets
OLS
2SLS
0.044*
(1.65)
0.139***
(2.73)
(4.00)
0.025
(0.63)
-0.051***
(2.72)
0.070*
(1.92)
0.197***
(3.82)
0.029
(0.69)
-0.04**
(2.26)
0.061
(1.60)
0.121*
(1.94)
0.012
(0.18)
0.050
(0.95)
0.141**
(2.16)
0.019
(0.29)
0.039
(0.71)
-0.019
(0.34)
-0.093***
(2.84)
0.088**
(2.47)
-0.009
(0.16)
-0.069*
(1.79)
0.056*
(1.86)
0.121**
(1.99)
-0.133*
(1.93)
-0.011
(0.29)
-0.019
(0.33)
0.042**
(2.23)
0.133**
(2.15)
-0.130*
(1.81)
-0.014
(0.38)
-0.019
(0.33)
0.039*
(1.85)
0.187**
(2.10)
-0.066
(0.70)
-0.038
(1.63)
-0.019
(0.24)
0.044
(1.52)
0.177**
(1.97)
-0.096
(1.00)
-0.039
(1.61)
-0.046
(0.56)
0.039
(1.32)
0.060
(0.67)
-0.203*
(1.84)
0.028
(0.52)
-0.013
(0.15)
0.046*
(1.76)
0.062
(0.62)
-0.222*
(1.75)
0.020
(0.35)
0.019
(0.19)
0.060*
(1.88)
889
0.218
825
0.226
530
0.179
508
0.191
359
0.225
317
0.264
25
Economic Effects
OLS estimate shows reduction by 8.4% in discount (24.3%) to 15.9%.
2SLS estimate shows reduction by 11.0% in discount (24.3%) to 13.3%.
Such estimates do not account for claims from escrow fund by bidder after closing.
- Escrow Services at J.P. Morgan Chase report average 60% of escrow
funds returned to seller.
- This implies that 4.9% (=0.4*12.2%) of sales proceeds are kept by bidder.
- Reversal in discount is approximately:
3.5% = 8.4% -4.9% (OLS)
6.1% =11.0% - 4.9% (2SLS)
26
Economic Effects
Estimates higher for stand-alone targets:
- discount 17.1%.
- reversal 12.6%-14.3% (before deducting funds kept by bidder).
- net reversal is 7.4%-9.1% (net of 0.4*13% funds kept by bidder).
Estimates lower for subsidiary targets:
- discount 33.3%.
- reversal 4.4%-5.8% (before deducting funds kept by bidder).
- net reversal is 0.8%-2.2% (net of 0.4*8.9% funds kept by bidder).
27
Analysis of Unlisted Target Discount: Interactions (Selected Estimates)
Table VI. Panel B.
Escrow Agreement Indicator
(t-test)
Instrumented Escrow Agreement Indicator
Target is Stand-alone Private Firm * Escrow
Agreement Indicator
OLS
(1)
0.079**
(2.52)
2SLS
(2)
OLS
(3)
0.066
(1.56)
0.153*
(1.68)
2SLS
(4)
OLS
(5)
0.087**
(2.26)
0.161*
(1.73)
2SLS
(6)
OLS
(7)
0.089**
(2.35)
0.150*
(1.65)
0.159
(1.48)
0.011**
(2.15)
Target is a Stand-alone Private Firm *
Instrumented Escrow Agreement Indicator
0.041**
(2.38)
Demeaned Relative Size of Target to Acquirer *
Escrow Agreement indicator
0.041**
(2.18)
Demeaned Relative Size of Target to Acquirer *
Instrumented Escrow Agreement Indicator
0.016*
(1.69)
Top Quintile Earnings Volatility Target Industry
* Escrow Agreement Indicator
0.008
(1.09)
Top Quintile Earnings Volatility Target Industry
* Instrumented Escrow Agreement Indicator
0.016*
(1.83)
Low Target Industry Analyst Coverage *
Escrow Agreement Indicator
0.027**
(2.26)
0.044**
(2.05)
Low Target Industry Analyst Coverage *
Instrumented Escrow Agreement Indicator
Observations
Adjusted R-squared
2SLS
(8)
889
0.217
825
0.229
889
0.218
825
0.230
889
0.217
825
0.228
889
0.218
825
0.234
28
Analysis of Bidder Announcement Returns (-1 days to +1 days)
Table VII. Panel A.
Escrow Agreement Indicator
(t-stat)
Instrumented Escrow Agreement Indicator
Target is a Stand-alone Private Firm
Acquisition is Considered an Asset Sale
Relative Size of Target to Acquirer
Target & Acquirer in Different Industries
Log(Market Value of Acquirer Assets)
Top Quintile Earnings Volatility Target Industry
Low Analyst Coverage Target Industry
Method of Payment is Only Cash
Method of Payment is Only Stock
Commercial & Industrial Loan Rate Spread
Observations
Adjusted R-squared
All Targets
OLS
2SLS
*
0.014
(1.92)
0.033*
(1.85)
0.002
-0.008
(0.26)
(0.83)
0.006
0.009
(0.79)
(1.09)
0.012
0.020**
(1.55)
(2.04)
*
-0.006
-0.009**
(1.79)
(2.24)
-0.004
-0.006
(1.20)
(1.41)
-0.015
-0.017
(1.28)
(1.34)
-0.005
-0.001
(0.48)
(0.05)
0.006
0.001
(0.88)
(0.08)
0.038**
0.041**
(2.29)
(2.33)
0.009
0.015
(1.08)
(1.48)
844
0.019
783
0.011
Stand-alone Targets
OLS
2SLS
**
0.016
(1.96)
0.037**
(1.94)
Subsidiary Targets
OLS
2SLS
*
0.014
(1.80)
0.019
(1.57)
-0.015
(1.34)
0.022*
(1.77)
-0.010**
(2.03)
-0.005
(0.91)
-0.026*
(1.71)
-0.014
(0.96)
0.009
(0.95)
0.046**
(2.38)
0.001
(0.02)
-0.014
(1.01)
0.024**
(1.97)
-0.012**
(2.15)
-0.007
(1.19)
-0.025*
(1.83)
-0.001
(0.08)
0.011
(0.09)
0.049**
(2.51)
0.012
(0.85)
0.023**
(2.13)
0.005
(0.44)
-0.001
(1.05)
-0.002
(0.42)
-0.006
(0.36)
-0.004
(0.21)
0.002
(0.15)
-0.006
(0.01)
0.015
(1.01)
0.034**
(2.81)
0.020
(1.18)
-0.004
(1.36)
-0.001
(0.26)
-0.009
(0.46)
-0.021
(0.93)
0.001
(0.07)
-0.020
(0.57)
0.026
(1.29)
504
0.047
483
0.040
340
-0.013
300
-0.014
29
Analysis of Bidder Announcement Returns: Interactions (Selected Estimates)
Table VII. Panel B.
Escrow Agreement Indicator
(t-stat)
Instrumented Escrow Agreement Indicator
Target is a Stand-alone Private Firm * Escrow
Agreement Indicator
OLS
(1)
0.007*
(1.67)
2SLS
(2)
OLS
(3)
0.009
(1.00)
0.022*
(1.80)
2SLS
(4)
OLS
(5)
0.013*
(1.76)
0.025*
(1.68)
2SLS
(6)
OLS
(7)
0.011
(1.38)
0.021*
(1.72)
0.029**
(1.96)
0.012*
(1.73)
Target is a Stand-alone Private Firm *
Instrumented Escrow Agreement Indicator
0.019*
(1.65)
Demeaned Relative Size of Target to Acquirer
* Escrow Agreement Indicator
0.009***
(2.62)
Demeaned Relative Size of Target to Acquirer
* Instrumented Escrow Agreement Indicator
0.005*
(1.70)
Top Quintile Earnings Volatility Target
Industry * Escrow Agreement Indicator
0.002**
(2.12)
Top Quintile Earnings Volatility Target
Industry * Instrumented Escrow Agreement
0.024
(1.37)
Low Analyst Coverage Target Industry *
Escrow Agreement Indicator
0.014*
(1.81)
Low Analyst Coverage Target Industry *
Instrumented Escrow Agreement Indicator
Observations
Adjusted R-squared
2SLS
(8)
844
0.018
783
0.010
844
0.018
783
0.013
844
0.017
783
0.014
844
0.018
0.018
(1.16)
783
0.012
30
Implications
If both bidders & sellers gain on average by using escrow contracts, shouldn’t all
unlisted target acquisitions use it?
Potential reasons for why these contracts are not used in all deals:
-
Sellers who are aware of potential misstatements in reps. and warranties.
-
Discord among target shareholders with respect to including an escrow.
-
Sellers with urgent need of liquidity (escrows reduce liquidity).
Positive association b/n use of escrow contract & bidder acquisition
announcement returns does not imply all bidders should use escrow contract.
31
Conclusions
-
Escrow contracts are commonly used in unlisted target acquisitions.
-
Used in 52.1% of all unlisted target acquisitions.
-
Common for stand-alone targets (75.6% of escrows) and stock purchases (80.0% of escrows).
-
Efficient contracting mechanism, aimed at reducing transaction risk and
reducing informational asymmetry and related due diligence costs.
-
Has important valuation impact on target & increases bidder acquisition
announcement returns.
-
On average, reduces unlisted target discount by 3.5-6.1%.
32
Acknowledgements
We are indebted for proprietary data access by:
JP Morgan Escrow Services
We recognize use of proprietary data from J.P. Morgan Escrow Services.
Kevin Ryan (VP) (Chicago)
Daniel Levin (NYC)
And for discussions, comments and suggestions by:
Greensfelder LLP
Joseph Lehrer (Head, Corporate Group)
Bryan Cave LLP
Bob Newmark (Vice President, St. Louis Office)
33
(Show if time permits)
Post-Deal-Closure Litigation Analysis (Not in Paper)
Dependent Variable: Prob. Of Litigation
Escrow Agreement Indicator
(t-stat)
All Targets
Probit
-0.24***
(6.01)
All Targets
Probit
-0.76***
(15.58)
Instrumented Escrow Agreement Indicator
Relative Escrow Size
Indicator for Use of Liability Cap in Acquisition
Indicator for Presence of Dominant Shareholder
Acquisition is Considered an Asset Sale
Target is Stand-alone Private Firm
Target & Acquirer are in Different Industry
Target Interest Coverage (scaled by 1,000)
Target Accruals
Ln (Target Value)
Deals w/ Escrow
Contracts
OLS
0.06
(1.24)
-0.155***
(3.81)
0.28***
(6.37)
-0.96***
(8.78)
0.048
(1.18)
-0.051*
(1.74)
0.679**
(2.55)
-0.035*
(1.71)
0.88***
(12.97)
0.86***
(10.36)
0.002
(0.03)
-0.64***
(5.37)
-0.013
(0.17)
-0.59***
(8.11)
4.91***
(9.67)
-0.407***
(9.73)
-0.042*
(1.76)
0.019
(0.53)
-0.022
(0.91)
0.025
(0.76)
-0.872***
(9.37)
0.022
(0.92)
0.022
(0.72)
0.135
(1.02)
-0.014
(1.13)
(continued)
34
(Show if time permits)
Post-Deal-Closure Litigation Analysis (Not in Paper)
Dependent Variable: Prob. Of Litigation
Relative Size of Target to Acquirer
(t-stat)
Indicator for Earnout Use
Commercial & Industrial Loan Rate Spread
Top Quintile Earnings Volatility Target Industry Indicator
Low Analyst Coverage Target Industry Indicator
Observations
Pseudo R-squared
R-squared
All Targets
Probit
All Targets
Probit
Deals w/ Escrow
Contracts
OLS
0.087**
(2.41)
-0.26***
(4.29)
-0.007
(1.09)
0.015
(0.26)
0.056
(0.93)
0.195***
(3.48)
0.034
(0.38)
-0.91***
(11.05)
-0.165**
(2.26)
0.019
(0.20)
-0.024
(1.13)
-0.014
(0.42)
0.016
(1.0)
-0.054
(1.54)
0.056
(1.37)
826
22.9%
-
826
73.8%
-
469
76.9%
35
(Show if time permits)
Claims Post-closing (source: J.P. Morgan Chase Escrow Services, 2009)
36