Risk allocation and flexibility in acquisitions: The economic impact of material -adverse -change (MACs) clauses

Material-Adverse-Change (MACs) clauses in merger agreements allow for the allocation of risk between the target and acquirer over the time period from the announcement to the completion of the acquisition. I find that MACs are more prevalent as a condition for completing the acquisition than any other contractual mechanism. My analysis documents that the number and variation of Material-Adverse-Event (MAE) exclusions, which limit the acquirer’s abandonment option defined through MACs, have increased substantially in the last decade. I show that the economic consequences of MACs are significant in at least four ways. First, the number of MAE exclusions is negatively related to the premium offered to the target. Second, consistent with the view that having a weaker abandonment option decreases the probability of termination, arbitrage-spreads decrease with the number of MAE exclusions. Third, limiting the abandonment option through MAE exclusions significantly reduces the probability and hazard rate of acquisition renegotiation or termination. Finally, acquirers that renegotiate an acquisition after the target experienced a firm-specific MAE obtain, on average, a 14% reduction in the premium paid. Collectively, these findings indicate that MACs are important contractual mechanisms for allocating risk between target and acquirer firms