Earnout financing in the financial services industry

This paper explores the effects of earnout contracts used in US financial services M&A. We use propensity score matching (PSM) to address selection bias issues with regard to the endogeneity of the decision of financial institutions to use such contracts. We find that the use of earnout contracts leads to significantly higher acquirer abnormal returns (short- and long-run) compared to counterpart acquisitions (control deals) which do not use such contracts. The larger the size of the deferred (earnout) payment, as a fraction of the total transaction value, the higher the acquirers' gains in the short- and long-run. Both acquirer short- and long-run gains increase when the management team of the target institution is retained in the post-acquisition period. •The US financial services industry offers a laboratory to explore acquirers’ gains in earnout vs. non-earnout financed M&As.•The PSM deals with selection-bias concerns with regards to the endogeneity of the decision of merging firms to use earnout.•Acquirers enjoy higher short- and long-run abnormal returns when using earnout than non-earnout payment methods.•The retention of target firms’ management plays an important role in determining acquirer abnormal returns in earnout M&As.