Is SPAC Sponsor Compensation Evolving? A Sober Look at Earnouts

SPACs have been widely criticized for imposing high costs on SPAC shareholders and for the incentive they create for sponsors to enter into mergers that are bad deals. Some SPACs adopt sponsor earnouts, which reduce a sponsor’s compensation unless specified post-merger share price targets are met. The claim in favor of earnouts is that they respond to these two flaws in the basic SPAC design. We find, however, that earnouts as currently structured have a minimal impact on either cost or incentive misalignment. We further find that there are inherent limits to what an earnout can accomplish. At best, a well-structured earnout, when coupled with a substantial investment in a merger by a sponsor, can deter a sponsor from proceeding with a merger that would be a seriously bad deal for shareholders. It will not deter a deal that is simply bad. We conclude with a proposal for more accurate disclosure of earnouts