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)

September 2014

2

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.

3

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.

Institutional Detail

4

Preliminary Sample Statistics

VariableAll Sample (943 obs.)

Percent of Deals with an Escrow Agreement 52.1%

Variable

Escrow Contract

(491 obs.)Percent Deposited Through an Escrow Agreement 12.2%Average Escrow Agreement Size (US$ m) $11.7Average Escrow Agreement Duration (Months) 17.4

All Deals Sample

Deal with Escrow Contract

Percent of deals with: All

Sample with Escrow

Contracts

Sample without Escrow

Contracts% Stock Purchases 73.7% 80.0% 66.8%% Asset Purchases 26.3% 20.0% 33.2%% Stand-alone Targets 60.30% 75.60% 43.80%% Subsidiary Targets 39.70% 24.40% 56.20%

5

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

(escrow agent)

(cap on liability)

(claims process)

(seller)

6

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.

Hypotheses

7

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.

Hypotheses

8

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).

Hypotheses

9

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.

Main Findings

10

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).

Main Findings

11

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.

Prior Literature

12

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.

13

Univariate Sample StatisticsTable I. Panel A. Escrow Contracts and Target Price Discount Characteristics.

VariableAll Sample (943

obs.)Percent of Deals with an Escrow Agreement 52.1%Average Time to Completion 57.5 days

Variable

Escrow Contract

(491 obs.)

Stand-alone Targets (371

obs.)

Subsidiary Targets (120

obs.)% Deposited Through Escrow Contract 12.2% 13.0% 8.9%Escrow Contract Size (US$ m) $11.7 $11.9 $11.0Escrow Contract Duration (Months) 17.4 17.5 17.1

All Deals Sample

Deal with Escrow Contract

Unlisted Target Price Discount (Means)

DiscountAll Targets -0.243Stand-alone Private Targets -0.171Subsidiary Targets -0.333Targets With Escrow Contract -0.196Targets Without Escrow Contract -0.289

14

Univariate Sample StatisticsTable I. Panel B. Target Characteristics.

Average Target Characteristics (Medians)

All Sample

(943 obs.)

Sample with Escrow

Agreements(491 obs.)

Sample without Escrow

Agreements(452 obs.)

Target Net Sales (in U.S.$ million) 48.7 38.4 63.7

Target Total Assets (in U.S.$ million) 32.2 24.6 43.9Actual Target Price (in U.S.$ million) 73.0 68.1 80.0Relative Target Size (to Acquirer) 18.4% 17.8% 18.9%Target Interest Coverage 2.90 1.93 3.89Target ROE 0.14 0.16 0.12Target ROA 0.04 0.035 0.04

15

Percent of deals with: All

Sample with Escrow

Contracts

Sample without Escrow

Contracts% with Dominant Owner 36.70% 48.30% 24.10%% with Liability Cap 73.7% 85.3% 61.1%% with Stock Payment Only 9.0% 11.2% 6.6%% with Cash Payment Only 36.7% 31.8% 42.0%% with Earnout Contract 12.2% 13.8% 10.4%% with Installment Note 11.7% 8.8% 14.8%

Use of Escrow Contracts and Other Deal CharacteristicsTable II. Panel A. Deal Characteristics.

Table II, Panel B. Sub-sample Comparisons.Escrow Deals with row

characteristics

Escrow Deals without row

characteristicsStock Purchase 60.5% 43.5%Stand-Alone Target 65.2% 32.1%Dominant Target Owner 68.5% 42.5%Use of Liability Cap 60.3% 29.1%Payment is Stock Only 64.7% 50.8%Payment is Cash Only 45.1% 56.1%Use of Earnout Contract 59.1% 52.1%

16

Target Industry Distribution (Table III)

Code Fama-French Industry Name

% Deals w/ Escrow

Agreement & Target in Industry

% Deals w/ Target in Industry

1 Agriculture 0.2 0.52 Food Products 0.8 1.03 Candy & Soda 0.2 0.14 Beer & Liquor 0.0 0.15 Tobacco Products 0.0 0.06 Toys & Recreation 0.2 0.67 Entertainment 1.0 1.18 Printing and Publishing 2.1 2.09 Consumer Goods 0.8 1.1

10 Clothing & Apparel 1.4 1.511 Healthcare 3.9 3.012 Medical Equipment 3.5 3.013 Pharmaceutical Products 3.7 4.914 Chemicals 0.8 1.415 Rubber and Plastic Products 1.0 1.316 Textiles 0.0 0.217 Construction Materials 0.8 1.618 Construction 2.7 2.419 Steel Works, Etc. 1.7 1.420 Fabricated Products 0.0 0.021 Machinery 2.9 2.222 Electrical Equipment 1.4 1.923 Automobiles and Trucks 1.2 1.124 Aircraft 1.0 0.925 Shipbuilding, Railroad Equipment 0.6 0.426 Defense 0.8 0.427 Precious Metals 0.0 0.2

(continued)

17

Code Fama-French Industry Name

% Deals w/ Escrow

Agreement & Target in Industry

% Deals w/ Target in Industry

28Non-Metallic and Industrial Metal Mining 0.0 0.1

29 Coal 0.2 0.130 Petroleum and Natural Gas 2.3 2.231 Utilities 0.2 0.632 Telecommunication 3.7 3.533 Personal Services 1.7 1.234 Business Services* 10.3 10.535 Computers 2.9 2.536 Computer Software* 19.1 13.937 Electronic Equipment* 8.0 8.5

38Measuring and Control Equipment 3.7 3.4

39 Business Supplies 0.8 0.840 Shipping Containers 0.0 0.241 Transportation 2.1 2.242 Wholesale 4.1 4.543 Retail 2.5 3.544 Restaurants, Hotels, Motels 1.2 1.245 Banking 0.8 1.246 Insurance 0.6 1.547 Real Estate 0.2 0.348 Financial Trading 1.9 2.649 Other 0.8 1.3

Target Industry Distribution (Table III, continued)

18

Determinants of Escrow Contract Use in Unlisted Target Acquisitions (Table IV)

(Probit Models) Use of Escrow Agreement

Variables:All

Targets

Stand-alone

TargetsSubsidiary Targets

Target is Stand-alone Private Firm 0.223***

(t-stat) (5.68)Indicator for Asset Sale -0.017 -0.03 -0.003

(0.41) (0.47) (0.05)Relative Size of Target to Acquirer 0.019* 0.021** 0.008

(1.66) (2.53) (1.18)Top Quintile Earnings Volatility Target Industry 0.009** 0.086** 0.108Indicator (2.04) (2.27) (1.20)Low Analyst Coverage Target Industry 0.038* 0.043* 0.112**

Indicator (1.79) (1.87) (2.12)Target & Acquirer are in Different Industry 0.016** 0.041*** 0.025

(2.48) (2.95) (0.43)Target Accruals 0.542** 0.515* 0.799*

(2.15) (1.71) (1.82)Target Interest Coverage -0.079* -0.069** -0.031

(1.88) (2.00) (1.58)Indicator for Target Dominant Shareholder 0.161*** 0.125*** 0.218***

(4.51) (2.95) (2.75)Indicator for Use of Liability Caps 0.267*** 0.312*** 0.228***

(6.97) (5.53) (3.70)C&I Loan Rate Spread -0.005 -0.023 -0.073

(0.10) (0.36) (0.73)Ln (Deal Value) -0.046*** -0.024 -0.073***

(2.78) (1.06) (2.72)% Deals Target Industry Using Escrow Contract 0.208* 0.426** 0.046

(1.68) (2.23) (1.21)% Bidder Use of Hybrid Method of Payment 0.012* 0.010** 0.047**

(1.92) (2.08) (2.48)

(continued)

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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).

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Excluded Instruments:All

Targets

Stand-alone

TargetsSubsidiary Targets

Percent of Deals in Target Industry that Use Escrow Agreement in the Previous Year 0.208* 0.426** 0.046

(t-stat) (1.68) (2.23) (1.21)

Indicator Previous Use of Hybrid Securities by Acquirer 0.012* 0.010** 0.047**

(1.92) (2.08) (2.48)

Observations 837 520 317

Pseudo R-squared 0.205 0.278 0.358

Escrow Use Reputation

proxy

Industryproxy

Determinants of Escrow Contract Use in Unlisted Target Acquisitions (Table IV)

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Economic Significance of Estimates in Determinants ModelModel of Escrow Contract Use Determinants

Independent Variables: ∆ in Probability

Main Determinants

Indicator for Use of Caps 26.70%

Target is Stand-alone Private Firm 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%

22

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.

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Time-to-Deal Completion Analysis (Table V)

All TargetsStand-alone

TargetsSubsidiary

TargetsIndependent Variables: OLS 2SLS OLS 2SLS OLS 2SLS

Escrow Agreement Indicator

-20.385*

**   -18.714*  -

24.175**  (t-stat) (2.68)   (1.71)   (1.99)  

Instrumented Escrow Agreement Indicator  

-53.841*

*  -

40.173**  -

21.001**

  (2.57)   (2.58)   (2.36)Target is a Stand-alone Private Firm 0.740 15.811        

(0.08) (0.74)        Acquisition is Considered an Asset Sale 0.835 0.874 0.097 2.414 10.601 8.838

(0.08) (0.08) (0.01) (0.15) (0.91) (0.70)Relative Size of Target to Acquirer 3.286 5.677 3.997 6.273 -0.133 -3.071

(0.55) (0.91) (0.47) (0.72) (0.01) (0.31)Top Quintile Earnings Volatility Target Industry 6.866** 8.904** 15.416* 18.900** -11.318 -14.321Indicator (2.45) (2.58) (1.76) (1.97) (0.78) (0.95)Low Analyst Coverage Target Industry Indicator 23.361**

28.635**

*

36.011**

*

39.560**

* 0.768 2.102(2.32) (2.77) (2.87) (2.75) (0.05) (0.12)

Target & Acquirer are in Different Industries 3.714*** 0.803 -0.801 0.172 10.641* 1.210

(2.64) (1.13) (0.13) (0.03) (1.82) (0.70)Target Accruals 12.088 25.819 -23.223 -64.083 61.004 31.847

(0.39) (0.41) (0.57) (1.04) (1.04) (0.47)Target Interest Coverage (scaled by 1,000) 35.997 40.263 65.249 70.500 0.623 6.413

(0.91) (0.89) (0.91) (0.93) (0.06) (0.42)Indicator for Target Dominant Shareholder -3.554 -2.950 -11.566 -16.647 7.439 -16.441

(0.54) (0.18) (1.38) (1.19) (0.53) (0.90)Indicator for Use of Liability Cap in Acquisition 8.968 18.447 11.587 -10.284 8.842 0.454

(1.17) (0.75) (1.13) (0.45) (0.78) (0.02)Commercial & Industrial Loan Rate Spread 6.572 9.397 27.010** 31.554** -14.291 -7.426

(0.73) (0.92) (2.13) (2.14) (0.98) (0.42)

Ln (Deal Value) 11.238** 8.420 5.916 6.50521.079**

*

23.665**

*

(2.25) (1.21) (1.19) (1.36) (3.19) (2.86)Observations 884 837 536 520 348 317Adjusted R-squared 0.086 0.090 0.133 0.132 0.034 0.027

24

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.

25

Analysis of Unlisted Target DiscountTable VI. Panel A.

All Targets Stand-alone Targets Subsidiary Targets  OLS 2SLS OLS 2SLS OLS 2SLSEscrow Agreement Indicator 0.084** 0.126**   0.044*  

(t-stat) (2.30) (2.35)   (1.65)  Instrumented Escrow Agreement Indicator 0.202***   0.228***   0.139***

(3.16)   (3.28)   (2.73)Target is a Stand-alone Private Firm 0.159*** 0.197***        

(4.00) (3.82)        Acquisition is Considered Asset Sale 0.025 0.029 0.121* 0.141** -0.019 -0.009

(0.63) (0.69) (1.94) (2.16) (0.34) (0.16)Relative Size of Target to Acquirer -0.051*** -0.04** 0.012 0.019 -0.093*** -0.069*

(2.72) (2.26) (0.18) (0.29) (2.84) (1.79)Target & Acquirer in Different Industries 0.070* 0.061 0.050 0.039 0.088** 0.056*

(1.92) (1.60) (0.95) (0.71) (2.47) (1.86)Top Quintile Earnings Volatility Target Industry 0.121** 0.133** 0.187** 0.177** 0.060 0.062

(1.99) (2.15) (2.10) (1.97) (0.67) (0.62)Low Target Industry Analyst Coverage -0.133* -0.130* -0.066 -0.096 -0.203* -0.222*

(1.93) (1.81) (0.70) (1.00) (1.84) (1.75)Method of Payment is Only Cash -0.011 -0.014 -0.038 -0.039 0.028 0.020

(0.29) (0.38) (1.63) (1.61) (0.52) (0.35)Commercial & Industrial Loan Rate Spread -0.019 -0.019 -0.019 -0.046 -0.013 0.019

(0.33) (0.33) (0.24) (0.56) (0.15) (0.19)Ln (Deal Value) 0.042** 0.039* 0.044 0.039 0.046* 0.060*

(2.23) (1.85) (1.52) (1.32) (1.76) (1.88)             Observations 889 825 530 508 359 317Adjusted R-squared 0.218 0.226 0.179 0.191 0.225 0.264

26

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)

27

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).

28

Analysis of Unlisted Target Discount: Interactions (Selected Estimates)Table VI. Panel B.  OLS 2SLS OLS 2SLS OLS 2SLS OLS 2SLS

(1) (2) (3) (4) (5) (6) (7) (8)Escrow Agreement Indicator 0.079**   0.066   0.087**   0.089**  

(t-test) (2.52)   (1.56)   (2.26)   (2.35)  Instrumented Escrow Agreement Indicator 0.153*   0.161*   0.150*   0.159

(1.68)   (1.73)   (1.65)   (1.48)Target is Stand-alone Private Firm * Escrow Agreement Indicator 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)  Low Target Industry Analyst Coverage *               0.044**

Instrumented Escrow Agreement Indicator               (2.05)

Observations 889 825 889 825 889 825 889 825Adjusted R-squared 0.217 0.229 0.218 0.230 0.217 0.228 0.218 0.234

29

Analysis of Bidder Announcement Returns (-1 days to +1 days)Table VII. Panel A. All Targets

Stand-alone Targets

Subsidiary Targets

OLS 2SLS OLS 2SLS OLS 2SLSEscrow Agreement Indicator 0.014* 0.016**   0.014*  

(t-stat) (1.92) (1.96)   (1.80)  Instrumented Escrow Agreement Indicator 0.033*   0.037**   0.019

(1.85)   (1.94)   (1.57)Target is a Stand-alone Private Firm 0.002 -0.008        

(0.26) (0.83)        Acquisition is Considered an Asset Sale 0.006 0.009 -0.015 -0.014 0.023** 0.034**

(0.79) (1.09) (1.34) (1.01) (2.13) (2.81)Relative Size of Target to Acquirer 0.012 0.020** 0.022* 0.024** 0.005 0.020

(1.55) (2.04) (1.77) (1.97) (0.44) (1.18)Target & Acquirer in Different Industries -0.006* -0.009** -0.010** -0.012** -0.001 -0.004

(1.79) (2.24) (2.03) (2.15) (1.05) (1.36)Log(Market Value of Acquirer Assets) -0.004 -0.006 -0.005 -0.007 -0.002 -0.001

(1.20) (1.41) (0.91) (1.19) (0.42) (0.26)Top Quintile Earnings Volatility Target Industry -0.015 -0.017 -0.026* -0.025* -0.006 -0.009

(1.28) (1.34) (1.71) (1.83) (0.36) (0.46)Low Analyst Coverage Target Industry -0.005 -0.001 -0.014 -0.001 -0.004 -0.021

(0.48) (0.05) (0.96) (0.08) (0.21) (0.93)Method of Payment is Only Cash 0.006 0.001 0.009 0.011 0.002 0.001

(0.88) (0.08) (0.95) (0.09) (0.15) (0.07)Method of Payment is Only Stock 0.038** 0.041** 0.046** 0.049** -0.006 -0.020

(2.29) (2.33) (2.38) (2.51) (0.01) (0.57)Commercial & Industrial Loan Rate Spread 0.009 0.015 0.001 0.012 0.015 0.026  (1.08) (1.48) (0.02) (0.85) (1.01) (1.29)             Observations 844 783 504 483 340 300Adjusted R-squared 0.019 0.011 0.047 0.040 -0.013 -0.014

30

Analysis of Bidder Announcement Returns: Interactions (Selected Estimates)Table VII. Panel B.   OLS 2SLS OLS 2SLS OLS 2SLS OLS 2SLS

(1) (2) (3) (4) (5) (6) (7) (8)

Escrow Agreement Indicator0.007

*   0.009   0.013*   0.011  (t-stat) (1.67)   (1.00)   (1.76)   (1.38)  

Instrumented Escrow Agreement Indicator   0.022*   0.025*   0.021*   0.029**

  (1.80)   (1.68)   (1.72)   (1.96)Target is a Stand-alone Private Firm * Escrow Agreement Indicator

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               0.018

              (1.16)Observations 844 783 844 783 844 783 844 783Adjusted R-squared 0.018 0.010 0.018 0.013 0.017 0.014 0.018 0.012

31

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.

32

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%.

33

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)

Acknowledgements

34

Post-Deal-Closure Litigation Analysis (Not in Paper)

Dependent Variable: Prob. Of LitigationAll Targets  All Targets

Deals w/ Escrow

ContractsProbit Probit OLS

Escrow Agreement Indicator -0.24***    (t-stat) (6.01)    

Instrumented Escrow Agreement Indicator   -0.76***    (15.58)  

Relative Escrow Size     -0.042*

    (1.76)Indicator for Use of Liability Cap in Acquisition 0.06 0.88*** 0.019

(1.24) (12.97) (0.53)Indicator for Presence of Dominant Shareholder -0.155*** 0.86*** -0.022

(3.81) (10.36) (0.91)Acquisition is Considered an Asset Sale 0.28*** 0.002 0.025

(6.37) (0.03) (0.76)Target is Stand-alone Private Firm -0.96*** -0.64*** -0.872***

(8.78) (5.37) (9.37)Target & Acquirer are in Different Industry 0.048 -0.013 0.022

(1.18) (0.17) (0.92)Target Interest Coverage (scaled by 1,000) -0.051* -0.59*** 0.022

(1.74) (8.11) (0.72)Target Accruals 0.679** 4.91*** 0.135

(2.55) (9.67) (1.02)Ln (Target Value) -0.035* -0.407*** -0.014

(1.71) (9.73) (1.13)(continued)

(Show if time permits)

35

Post-Deal-Closure Litigation Analysis (Not in Paper)

Dependent Variable: Prob. Of LitigationAll Targets  All Targets

Deals w/ Escrow

ContractsProbit Probit OLS

Relative Size of Target to Acquirer 0.087** 0.195*** -0.024(t-stat) (2.41) (3.48) (1.13)

Indicator for Earnout Use -0.26*** 0.034 -0.014(4.29) (0.38) (0.42)

Commercial & Industrial Loan Rate Spread -0.007 -0.91*** 0.016(1.09) (11.05) (1.0)

Top Quintile Earnings Volatility Target Industry Indicator 0.015 -0.165** -0.054

(0.26) (2.26) (1.54)Low Analyst Coverage Target Industry Indicator 0.056 0.019 0.056

(0.93) (0.20) (1.37)

Observations 826 826 469Pseudo R-squared 22.9% 73.8% -R-squared - - 76.9%

(Show if time permits)

36

Claims Post-closing (source: J.P. Morgan Chase Escrow Services, 2009)

(Show if time permits)