Ch. 3: Auctions in Corporate Finance 139
While auction theory deserves much credit for its inroads into corporate finance, two
areas of concern do emerge. First, there are some phenomena in corporate finance for
which we still lack sufficient understanding, and where one might have expected auction
theory to lead the way. Yes, we have increased our understanding of returns to bidders
and targets in the market for corporate control, but why are acquirers’ returns so small?
Any auction with heterogeneity of valuations or information leads to strategic behavior
and expected profits for inframarginal bidders. And why do acquirers seem to do better
when acquiring private companies? There is still a huge question as to whether auctions
in bankruptcy are better than a court-supervised valuation and division of assets. Why
are toeholds so seldom taken, if they lead to a bidding advantage? If auctions really are
so good, why are they used so infrequently in the initial public offering market, and why
do some sellers of companies bypass an auction in favor of a one-on-one negotiation?
The second unsatisfactory aspect of auctions in corporate finance is simply that no
new fundamental insights have emerged. We do understand better how information,
values, and strategic behavior combine to yield prices and allocations of assets in real
financial markets. There has been no quantum leap forward, just incremental learning at
the margin. This should, we suppose, actually be gratifying, for it shows the robustness
of our primitive and most cherished assumptions. Unfortunately, at times the models
that are developed and that are pushing back the frontier only marginally are incredi-
bly complicated, and one has to wonder if the complexity is worth it. One doubts that
quantum leaps in knowledge are going to come from models that need a myriad of
questionable assumptions.
Where next for auctions in corporate finance? We would suggest three areas for focus.
First, data will be key for further empirical discovery, and this could in turn lead to new
theoretical developments. We believe that auctions of private companies and auctions
in bankruptcy are two areas that may yield significantly better data in the future and
where the returns to clever empirical work would be large. Second, on the theoretical
side, it is clear that some of the best work to date has been on what might appear as the
second-order institutional practices, such as non-cash bids, toeholds, bidder discrimi-
nation, and reserve prices. Much progress has been made in understanding the role of
these practices, while at the same time reinforcing the importance and validity of the
overall auction-based framework. Third, we would like to see more work done with
non-standard informational and valuation assumptions. The general symmetric model
is extremely powerful, but does it really capture many of the real settings that we ob-
serve? We should expect that heterogeneity of bidders will be manifested in many ways
and will turn out to affect the equilibria quite strongly, especially in regard to bidders’
profits. Efficiency of the allocation will also become inherently more interesting of a
question, and initial work suggests it will be harder to achieve.
We would confidently make the prediction, though, that auctions in corporate finance
will be a much-studied topic for years to come. Our very strong recommendation would
be for all PhD students to get a thorough grounding in auction theory.