The use of escrow contracts in acquisition agreements

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 Oklahoma - Michael F. Price College of Business and University of Pennsylvania - Wharton Financial Institutions Center

Abstract

A large fraction of acquisition deals for private firm and subsidiary targets include an escrow contract giving the bidder the opportunity to lay claim on escrow account funds if subsequent to the acquisition the seller fails to meet specific acquisition agreement terms. The likelihood of using an escrow contract is higher when buyer or seller transaction risk is larger. Also, the use of escrow contracts (i) helps to reduce bidders’ due diligence costs, (ii) enables sellers to obtain a higher sale price, and (iii) raises the extent to which an acquisition leads to an increase in bidder firm shareholder value.