Do earnouts create the right incentives? Earnings management around earnout‐based acquisitions

We investigate whether acquiring firms with earnout agreements engage in earnings management during the earnout period. Using a sample of completed deals between 1998 and 2017, we find that acquirers manage their earnings downward during the earnout period to avoid or reduce the earnout payment to the target. This earnings manipulation is more likely to be performed through real activities than accruals. We find evidence that earnings manipulation does indeed lead to lower earnout payments. Our findings also suggest that earnout deals predominantly paid in cash are most likely to create the incentives for downward earnings manipulation through real activities.