The Bankruptcy Auction as a Game - Designing an Optimal Auction in Bankruptcy

Article excerpt

I. BANKRUPTCY AUCTIONS-LEGAL AND ECONOMIC PERSPECTIVES 330

A. Legal Background 330

1. Τypical Scenarios 330

2. The Question of Credit Bidding 333

B. Economic Environment 336

1. Why an Auction? 336

2. Challenges for Bankruptcy Auctions 345

II. AUCTION THEORY-A PRIMER 352

A. General 353

?. A Typology of Auctions 354

C. Choosing an Auction Method 358

1. Sealed-Bid Auction and Dutch Auction 358

2. English Auction and Second-Price Auction 359

3. Why Are Second-Price Auctions So Rare? 361

4. Sealed-Bid Auction Versus English Auction 363

a. When Is the English Auction Preferable?.. 363

1. Transaction Costs and Erroneous Strategy 363

2. Incomplete Information and the "Winner's Curse" 364

b. When Is the Sealed-Bid Auction Preferable?.. 366

D. Additional Aspects 370

1. Information on the Asset 370

2. Reserve Price 371

E. Auction Theory in Action-The FCC Spectrum Licenses Auctions 373

F. The Lesson Learned 379

III. DESIGNING AN OPTIMAL BANKRUPTCY AUCTION 380

A. General Guidelines 381

1. Utilizing Auction Theory 381

2. The Suggested ADVA Design 382

a. The Anglo-Dutch Feature 384

b. The Veto Feature 385

c. Other Features 387

B. Credit Bidding-A Critical Analysis 388

C. The Absence of a Regulator 391

IV. CONCLUSION 393

Whether in a bankruptcy case of a fraudulently operated firm such as Enron1 or that of the temporarily distressed Los Angeles Dodgers baseball team;2 in a routine and small-scale bankruptcy case of a neighborhood restaurant3 or in the unique multi-billion dollar bailouts of Chrysler and General Motors;4 in a bankruptcy of a traditional manufacturing firm5 or of a high-tech business;6 in the United States or in Europe;7 bankruptcy auctions have become "no longer a last resort but an option to be exercised at any time if it is in the creditors' interest."8 Indeed, recent studies show that over half of the firms entering corporate bankruptcy proceedings9 are auctioned10-either piecemeal or as a going concern-instead of reorganized" and restructured.12 Auctions seem to create value for financially distressed firms.13 However, what is the optimal design of a bankruptcy auction? Does the method by which a bankruptcy auction is executed matter at all? Is there a difference, for example, between the impact of an "English auction" and that of a "sealedbid" auction? Does it matter whether a reserve price is set in advance or whether that price is hidden from potential bidders? More generally, does one auction method fit all bankrupt firms?

Surprisingly, although bankruptcy auctions are ubiquitous, these questions have not yet been answered, as auction design in the specific context of bankruptcy has barely been studied.14 Thus, the optimal design of a bankruptcy auction remains a "black box" to lawmakers and practitioners.15 Bankruptcy scholars have argued vigorously about whether bankruptcy auctions should be employed as the preferred method for redeploying the bankrupt firm's assets.16 Additionally, they have also utilized empirical data gathered on bankruptcy auctions worldwide to argue over the relative efficacy of auctions in bankruptcy cases.17 However, little attention has been given to the art of designing an optimal bankruptcy auction. Even more importantly, much of the work performed by scientists in the context of general auctions-many of the valuable insights generated and findings gathered during decades of research-has failed to reach and influence the setting of bankruptcy auctions.

This Article contributes to this scarce literature by shedding light on the possible interaction of bankruptcy auctions with a field of study that has strongly influenced the design of auctions in general: game theory. Our main theme concerns the need to consider the insights offered by the field of "auction theory" when planning the manner in which the assets of financially distressed firms are to be auctioned within a bankruptcy proceeding. …