Sticky Pricing in Corporate M&A Bargaining

Corporate M&A presents a curious puzzle that should bother anyone who takes contract theory seriously. The canonical economic account of contract design gives an intuitively clean instruction: settle your non-price terms first — covenants, conditions, warranties, indemnities, all the provisions that actually allocate risk and rarely net to zero — reserving price to be set at the very end. The reasoning is simple: price is the perfect zero-sum numeraire, welfare-neutral by construction, and thus the ideal instrument for truing up whatever payoff imbalances are left in the wake of the surplus maximizing non-price terms. Put simply, setting the price at the end seems best situated to grease the wheels with a maximally value-enhancing transfer. This prediction is about as consequential as anything in the theory of contract design; it more or less falls out of any number of canonical texts on the topic.

And yet, the practitioners who negotiate the largest, most lawyered transactions on the planet do precisely the opposite of what theory prescribes. Principals to large corporate acquisitions lock in the headline price early — often in a terse term sheet produced before outside counsel has entered the room — and lawyers are thereafter told to treat that top-line number as close to inviolable as they dicker over the remaining non-price provisions. Stranger still, the inversion intensifies with deal size, which is genuinely perplexing on the standard view: the larger the transaction, the larger the contingent risks and incentives that the non-price terms must govern, and hence the more often you’d expect the flexibility of late-stage compensating price adjustments to matter. In contrast, oddly, smaller-stakes negotiations (used cars, residential real estate) track the economic theory reasonably well, keeping pricing in flux until late in the game.

In a recent paper, we offer a theoretical resolution to this puzzle based on the costs and risks of contract design itself: efficient non-price terms aren't sitting in a drawer and fungible for every deal. In complex deals, the best terms effectively have to be discovered, through costly, non-contractible search — and the party best at finding a clever provision need not be the party holding the bargaining power. Once one factors in contract design efforts, price-last protocols generate a two-sided holdup problem. Any value a weak-but-creative party unearths becomes sunk the moment it's revealed, whereupon a stronger bargainer simply recaptures it through price concessions. Anticipating the expropriation, our creative searcher simply doesn’t search. Fixing price up front can substantially defuse this dynamic, insulating each party’s discovered value from the other's leverage and thereby sharpening everyone's incentive to search. To formalize this argument, we embed a discrete “bartering” stage over terms inside a larger search game, showing that across a dense parameter space the price-first protocol is weakly superior to price-last on conventional efficiency metrics. Key to our theoretical argument is a modeling innovation where we represent search across complex, dense, semantic spaces by mapping search efforts the into certainty-equivalent payoff vectors.

We then take our theoretical insights to the data in two ways. First, to build intuition, we present a survey of 87 seasoned M&A practitioners — a battle-tested sample, nearly half having negotiated 100-plus deals in the past decade. The responses corroborate the folk wisdom almost embarrassingly well. Term sheets initiate roughly 80% of deals; in 85–90% of those the headline price is pegged before definitive-agreement drafting begins; and that price is sticky — about 83% report that even a request to reopen it is uncommon, and two-thirds say such requests, when made, typically fail. The free-text answers supply the mechanism the model is quiet about: re-trading price, one respondent noted, reads as “a bait and switch that would damage their credibility”; another, more tersely, that “breaking the core financial terms generally breaks trust.” That’s not a numeraire being nudged at the margin but rather is a norm with reputational teeth. The size gradient shows up too: to the extent respondents perceived any pattern at all, price flexibility concentrated in smaller deals, by a two-to-one margin.

Second we exploit a natural experiment in which term sheet pricing became stickier in a single jurisdiction, allowing us to tease out causality. In 2013 the Delaware Supreme Court decided SIGA v. PharmAthene, holding that a party who signs a preliminary agreement and then holds out for materially better economics may be liable for bad faith — and, decisively, that party can then be exposed to full expectation damages rather than the milder reliance ceiling other jurisdictions impose. The precedent sharply enhanced the credibility of sticky pricing, but only for Delaware-governed deals, which is amenable to a difference-in-differences design with non-Delaware deals as controls. The model predicts that reinforcing the price-first norm should ratchet up search for bespoke terms and thus yield more heterogeneous contract language. Using nearly 2,000 definitive agreements from the Adelson et al. corpus, we tracked the textual similarity of Material Adverse Effect clauses — the heavily bargained “Act of God” provisions that let a buyer walk. Post-SIGA, Delaware MAE clauses grew measurably less similar to one another. The effect is statistically significant, survives law-firm fixed effects and financial controls, is stable across five similarity measures, and rests on a satisfyingly flat pre-trend. Precisely what the model ordered.

The broader take-away here is something we would press on theorists and practitioners alike. The standard contract-design framework treats dealmaking as pie-splitting, with price and terms quarantined in separate rooms. Real contracting is pie-making, and the sequence one imposes on the negotiation shapes how large the pie becomes. Price-first is not simply an inexplicable tradition that sophisticated parties stubbornly cling to. It also provides an incentive mechanism -- a rather elegant one in large deals.

______________

Josh Higbee is an Assistant Professor of Economics at The Ohio State University.

Cree Jones is an Associate Professor of Law at Brigham Young University. 

Matthew Christopher Jennejohn is the Marion & Rulon Earl Professor of Law at BYU Law School, and an ECGI Research Member.

Eric Talley is a Professor of Law and Business at Columbia Law School, and an ECGI Research Member.

This blog is based on a paper presented at the Tenth Annual Mergers and Acquisitions Research Centre (MARC) Conference, held in London and hosted by Bayes Business School in collaboration with ECGI. Visit the event page to explore more conference-related blogs.

The ECGI does not, consistent with its constitutional purpose, have a view or opinion. If you wish to respond to this article, you can submit a blog article or 'letter to the editor' by clicking here.