Real-Option Pricing of Earnouts in the Brazilian Market

Abstract

This paper proposes a pricing model for contingent payment structures in mergers and acquisitions in the Brazilian market, treating the earnout as a European call option on the target firm’s future performance. The approach uses analytical modeling with a numerical illustration, suited to contexts of scarce public contractual disclosure. The model applies the Black-Scholes-Merton framework with parameters calibrated to local conditions: 30% annual operating volatility and a 15% risk-free rate. The numerical analysis indicates that the earnout value in the Brazilian context exceeds by about 178% the value computed with developed-market parameters — a result conditional on the calibration assumptions, not evidence of systematic underpricing, driven mainly by the level of the risk-free rate. The study derives four analytical propositions on the determinants of contingent value, including the formalization of an enforcement-risk discount in jurisdictions with limited contract enforceability, an original extension of the model to emerging markets.