Implicit regulation in M&As: Evidence from voluntary earnouts in China

Earnout provisions (“earnouts” hereafter) provide for contingent payments in M&A agreements and play a role in reducing information asymmetry. However, in China, earnouts are not solely driven by negotiations between acquirers and targets but are also related to regulatory preference. The CSRC amended the M&A regulation in 2014, deregulating mandatory earnouts while retaining the approval system. Leveraging on this context, we explore whether regulators implement implicit regulation by encouraging the usage of voluntary earnouts, and the economic consequences of such action. Our results show that earnouts are more likely to be included in an M&A contract when the deal requires CSRC approval. M&As that involve earnouts are also more likely to obtain regulatory approval and in a shorter time. These findings suggest that regulators may still prefer earnouts even after deregulation. In addition, we find that the association between voluntary earnouts and acquirers’ post-acquisition performance is negative when the M&A deal requires regulatory approval, suggesting that voluntary earnouts influenced by regulatory preference can potentially have a negative impact. Further analyses indicate that this impact can be alleviated by comment letters and market monitoring. Our findings provide regulators with insights into the effects of the regulatory reform in the M&A market.