Ch. 3: Auctions in Corporate Finance 129
4.7. Auctions in bankruptcy
One of the most fruitful areas for the application of auction theory in corporate finance
is in the context of corporate bankruptcy. The theoretical efficiency of auctions in allo-
cating assets to their most highly-valued use has led many scholars to propose auctions
as a means to resolve some of the issues in bankruptcy. As an auction also yields a
price for the corporation, the question of determining value (for the purpose of settling
claims) is also solved. Unfortunately, the informational issues in bankruptcy are quite
severe; so any complete auction-based model of the process which will yield predictions
on total cost must include the cost of information acquired by bidders. There is also a
fairly prevalent view that credit markets may not always allocate financing efficiently
to potential buyers of bankrupt companies, so prices may be low because of a dearth of
bidders. Some of these issues have been addressed empirically by examining the bank-
ruptcy process in Sweden, where auctions of bankrupt companies are mandatory (see
related discussion below).^41
Baird (1986)was one of the first to point out that auctions may be preferable to the
court-supervised reorganization process of the United States’ Chapter 11 bankruptcy
code. Baird, among others, used the auction processes and results of the corporate
takeover market as an analogy to estimate the gains that may be achieved if auctions
were used to transfer control of bankrupt companies’ assets. Other researchers,We i s s
(1990)in particular, turned to estimating the direct cost of Chapter 11 procedures—with
those costs being estimated at between 2.8% and 7.5% of assets.Easterbrook (1990)ar-
gues against auctions, maintaining that the costs associated with the IPO process is a
good analogy for estimating the costs of determining a firm’s value, and calculates IPO
direct costs at roughly 14% of proceeds.Hansen and Thomas (1998)argue that Easter-
brook’s figures need to be adjusted and put on a total asset, not proceeds, basis, and that
the so-called “dealer’s concession” built into IPO costs should also be subtracted as it is
a cost of distribution, not of the auction process per se. Their resulting figure of 2.7% is
then roughly equal to Weiss’ estimates of the direct cost of bankruptcy. Thus, auctions
and Chapter 11 would seem to have similar direct costs, leaving their relative efficiency
to be determined by either theory or further empirical work.
On the empirical side,Thorburn (2000)has exploited the Swedish bankruptcy ex-
perience to draw important conclusions on the relative efficiency of cash auctions of
bankrupt firms. In Sweden, the typical procedure has been for a bankrupt firm to be
taken over by a court-appointed trustee who supervises a cash auction of the firm, either
piecemeal or as an ongoing combination. These data therefore allow for direct exam-
ination of how auctions work in bankruptcy.Thorburn (2000)finds that three-quarters
of the 263 bankrupt firms are auctioned as going-concerns, which compares favorably
to Chapter 11 survival rates. As to cost, direct costs average 6.4% of pre-filing assets,
with the one-third largest firms experiencing costs of only 3.7% of assets. As to debt re-
covery, the recovery rates are comparable to Chapter 11 reorganizations of much larger
(^41) SeeEckbo and Thorburn (2003, 2005).