Ch. 3: Auctions in Corporate Finance 109
equally likely. Then each bidder has an expected value of 150, and an open auction will
yield a price of 150. Now let the seller release public information which discloses pre-
cisely which state prevails. In either state, an open auction will yield a sale price of only
100, the second-highest valuation. Release of information therefore lowers the expected
price, contrary to the Milgrom and Weber findings. Interestingly, there is also now a
tension between the seller’s objective and economic efficiency: additional information
improves efficiency by allocating the asset to its highest-valued use, but it lowers the
seller’s revenue. Little work has been done on the relative efficiency of auctions under
circumstances such as this, but seeKrishna (2002)for an excellent summary of effi-
ciency in auctions. In corporate finance, it would seem that the issue of information and
efficiency will be closely related: does additional information increase the efficiency of
an auction (bearing in mind the cost of producing the information, possibly by multiple
bidders) and does this create a conflict between revenue maximization and efficiency?
- Applications of auction theory to corporate finance
4.1. Introduction
We now turn to survey the more important applications of auction theory to corporate
finance. We begin with the market for corporate control and auctions in bankruptcy,
which are the two largest areas of application. Then we turn to share repurchases, IPOs,
and a limited review of corporate finance issues in the Federal Communication Com-
mission’s auction of radio spectrum. We do not cover applications of auctions to capital
markets finance, for instance to models of the stock trading process or to auctions of
bonds by governments and companies. Our intent in this survey is to go beyond a sim-
ple review and to point out how well auction theory can actually be used to “inform”
corporate finance.
4.2. Applications to the market for corporate control
Auctions of one form or another typically occur in the market for corporate control.
The field has proved fruitful for a variety of auction-based models to be constructed that
explain many aspects of the market. One aspect is to explain the wealth gains to bidders
and targets, as well as the combined wealth gains, on announcements of acquisitions.
4.2.1. Returns to bidders and targets
Many studies have documented the evidence on stock returns to bidders and targets in
corporate acquisitions, and the overall evidence is that returns to targets are large and
positive, while returns to acquirers are generally negative but statistically insignificant.
Jarrell, Brikley and Netter (1988)provide evidence prior to 1988;Andrade, Mitchell and
Stafford (2001)provide a recent update: over the period 1973–1998, with a database of