Matthew Rhodes-Kropf
Columbia University, New York, NY
S. Viswanathan
Duke University, Durham, NC
ABSTRACT
Selling a bankrupt firm using a cash auction insures an ex-post efficient allocation as long as bidders axe not cash constrained. A non-cash auction allows cash constrained bidders to participate and thereby increases the competition. As a consequence, Aghion, Hart and Moore (1992) suggest non-cash auctions as an alternative to cash auctions in their proposed bankruptcy scheme. This allows cash constrained management teams to submit reorganization plans. However, bids of securities create a valuation problem for the seller: the value of the bid depends on the bidder. Thus, the usual auction has attached to it a signaling aspect since the bid signals the unknown type of the bidder. Our main contribution is to analyze the theory of auctions with securities bids. We show that with securities, signaling bidders raise their bids and increase the seller's revenue. We present a theorem to rank efficient auctions that involve different kinds of securities. However, without cash, we find an auction may not separate, and hence efficiency may be lost. We show that an all equity auction is never efficient, although in some situations separability can be restored if bids contain a minimum debt requirement. For other examples even this is not enough, and significant cash bids or a dead weight loss associated with bankruptcy are necessary to attain efficiency. Our analysis indicates that any reorganization must involve securities like debt and convertibles and an all equity outcome is unlikely. A non-cash auction may also be inefficient because it not only separates the managers but determines the managers incentive contract and the capital structure for the firm. The auction is unlikely to efficiently complete all three. In light of this, we recommend a new cash auction (for an optimally designed incentive contract) which addresses the problems discussed in AHM's proposal and those we find.