The Use of Escrow Contracts in Acquisition Agreements

June 7, 2013 Leave a comment

The Use of Escrow Contracts in Acquisition Agreements

Sanjai Bhagat University of Colorado at Boulder – Department of Finance

Sandy Klasa University of Arizona – Department of Finance

Lubomir P. Litov University of Arizona – Department of Finance; University of Pennsylvania – Wharton Financial Institutions Center

May 28, 2013

Abstract: 
Many private firm and subsidiary acquisition deals make use of escrow contracts, whereby a fraction of the total sale proceeds are placed in an escrow account. These contracts give the bidder the opportunity to lay claim on these funds subsequent to the acquisition if the seller fails to meet specific terms of the acquisition agreement or it is found that negative information about the target was hidden from the bidder. We hypothesize that escrow contracts are an efficient contracting mechanism that helps bidders and targets to manage acquisition-related transaction risk and mitigate information asymmetry problems. Supporting our hypothesis, we show using hand-collected data that the likelihood an escrow contract is used in a private firm or subsidiary acquisition is higher when bidder transaction risk or information asymmetry about the value of the target is larger. Further, we document that escrow contracts enable the seller to obtain a higher sale price and that the use of these contracts positively impacts the extent to which a private firm or subsidiary acquisition results in value creation for the bidder.

Filed under Research

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Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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