The Role of Tax Planning Incentives in the Use of Earnouts in Taxable Acquisitions

Dennis Ahn and Terry Shevlin ()
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Dennis Ahn: Fowler College of Business, San Diego State University, San Diego, CA 92182, USA
Terry Shevlin: The Paul Merage School of Business, University of California, Irvine, CA 92697, USA

JRFM, 2025, vol. 18, issue 5, 1-29

Abstract: In an acquisition, an earnout is a component of transaction price that is contingent upon future events. Despite its usefulness to acquirers in mitigating valuation risk, using an earnout also has a potentially undesirable tax consequence for the acquirer because there is no immediate step-up in tax basis for the earnout portion of deal consideration until the resolution of associated contingencies. We thus hypothesize that acquiring firms with high marginal tax rates (MTRs) are less likely to use earnouts. We analyze a sample of taxable acquisitions by U.S. public companies, holding constant other non-tax determinants of earnout use from prior research, and we find results consistent with our prediction. We also find some evidence that strong tax incentives can offset the effect of target valuation uncertainty, suggesting that acquiring firms facing sufficiently high MTRs are willing to trade off mitigating valuation risk for a full, immediate step-up in tax basis. We contribute to the prior literature on determinants of earnout use as well as the role of tax planning incentives in firm choices within mergers and acquisitions.

Keywords: mergers and acquisitions; earnout; tax planning in acquisitions (search for similar items in EconPapers)
JEL-codes: C E F2 F3 G (search for similar items in EconPapers)
Date: 2025
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