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Contemporary Issues in Banking pp 303–327Cite as

Palgrave Macmillan

Earn-outs in Debt Restructuring Plans: Economics and Valuation

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Abstract

This topic is of particular relevance within the more general issue of troubled debt restructuring and option pricing methodologies. In general terms, earnouts are linked to the company’s performance. They are often structured as long-term long or short options (often, European call options) in which the underlying option is related to certain financial margins, ratios, or cash flows (revenues, EBITDA, operational cash flows, free cash flow, return on investments, or return on assets).

This chapter first aims to provide insight into the rationale behind earnout provisions for financially distressed firms that agree upon debt restructuring plans with creditors. Moreover, the study investigates the basic principles of the economic valuation of earnouts. After discussing the main implications of earnout value estimation in the light of the existing literature on corporate restructuring and option pricing-related issues, we propose a valuation methodology based on a Monte Carlo simulation approach which allows the representation of a variety of projections of a few relevant financial variables, along with the related probability distribution. Besides obtaining an assessment of economic values, our model enables a probabilistic representation (not necessarily under a risk-neutral environment) of the wide spectrum of the restructured debt pay-offs, for both the company and the bank.

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Authors and Affiliations

  1. Department of Economics and Statistics, University of Udine, Udine, Italy

    Josanco Floreani, Maurizio Polato & Maurizio Massaro

Authors
  1. Josanco Floreani
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  2. Maurizio Polato
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  3. Maurizio Massaro
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Correspondence to Josanco Floreani .

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Editors and Affiliations

  1. Facultad de Económicas, University of Cantabria, Santander, Spain

    Myriam García-Olalla

  2. Facultad de Económicas, University of Cantabria, Santander, Spain

    Judith Clifton

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Floreani, J., Polato, M., Massaro, M. (2018). Earn-outs in Debt Restructuring Plans: Economics and Valuation. In: García-Olalla, M., Clifton, J. (eds) Contemporary Issues in Banking. Palgrave Macmillan Studies in Banking and Financial Institutions. Palgrave Macmillan, Cham. https://doi.org/10.1007/978-3-319-90294-4_14

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  • DOI: https://doi.org/10.1007/978-3-319-90294-4_14

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  • Publisher Name: Palgrave Macmillan, Cham

  • Print ISBN: 978-3-319-90293-7

  • Online ISBN: 978-3-319-90294-4

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