Systemic Financial Distress and Auction-Based Bankruptcy Reorganization

Financial reorganization under bankruptcy reduces a firm's debts to a serviceable level through negotiations overseen by courts. Markets have been suggested as an alternative to such negotiations, recognizing that equity holders and junior claimants have call options to buy the firm back from senior creditors. This paper further develops this market-based approach when claimants are severely cash-constrained and there is merit in having existing owners-managers remain in control. The scheme arranges creditors in a queue to be serviced in sequence from the firm's operating cash flows. Creditors bid for their position in this queue, and those accepting a greater proportionate reduction in the face value of their claims (perhaps those most pessimistic about the firm's prospects) are placed ahead of the others. A pre-existing hierarchy of claims is honored by having claimants bid for their positions within the relevant segment of the queue. No one in the queue (including owners who are last) is paid anything until the (reduced) debts of the first in line are fully discharged using the firm's operating cash surpluses. The queue then moves up and the next claimant in line is serviced. The paper shows that, in equilibrium, the aggregate debts of the firm are reduced to a level that is more serviceable and that provides the owner-manager with a positive expected residual return. We discuss the appropriateness of this scheme to situations of systemic financial distress, including the East Asian crisis.

Bankruptcy reorganization through markets : Auction-based Creditor Ordering by Reducing Debts (ACCORD)

The authors further develop such a market-based approach for situations in which claimants are severely cash-constrained and there is good reason for existing owner-managers to remain in control. Under the ACCORD scheme-Auction-based Creditor Ordering by Reducing Debts-creditors remain creditors but form a queue, to be serviced in sequence from the firm's operating cash flows. Creditors bid for their position in this queue. Those accepting greater proportionate reductions in the face value of their claims (perhaps most pessimistic about the firm's prospects) are placed ahead of theothers. A preexisting hierarchy of claims is honored by having claimants bid for their positions within the relevant segment of the queue. No one in the queue, including owners (whoa re last), is paid anything until the (reduced) debts of the first in line are fully discharged. The queue then moves up and the next claimant in line is serviced. Deferred creditors, who must wait their turn for the firm's operating cash surpluses, are not junior creditors in the conventional sense. The authors determine equilibrium bidding strategies, showing that the firm's aggregate debts would be reduced to a more serviceable level. This would improve the incentives of the firm's owner-managers, who remain in control, to operate the firm efficiently. Economic resources would thus be better used, and losses already incurred would be efficiently and quickly allocated among creditors. The authors suggest that ACCORD would be appropriate for East Asia, where, despite new bankruptcy laws, inexperienced courts are unlikely to nudge creditors into a quick negotiated agreement nor to be able to cope with systemic bankruptcy. Moreover, when the government is a major unsatisfied creditor, whose agents may not act in the taxpayers'best interests, market-based solutions might remove political interference from restructuring decisions. Neither owners nor creditors would be worse off than they are now.Strategic Debt Management,Banks&Banking Reform,Payment Systems&Infrastructure,International Terrorism&Counterterrorism,Economic Theory&Research,International Terrorism&Counterterrorism,Strategic Debt Management,Banks&Banking Reform,Economic Theory&Research,Housing Finance

An Asymmetric Common-Value Auction Model

This article develops a model allowing asymmetric information between two bidders in an auction for a common-value object. It supposes that there is a common prior distribution on the object's value and that each bidder receives a private signal conditional on the object's unknown true value. Asymmetry comes about through a difference in the precision of the bidder's signals. Placing a restriction on the nature of this difference, I determine the equilibrium bidding strategies for the first-price and second-price auctions. The strategies are symmetric, and the second-price auction generates a higher seller's expected revenue, a result that extends the well-known revenue-ordering result of symmetric-information auctions. I do, however, provide an example to show that this ordering is not necessarily maintained in a less restricted asymmetric setting. Finally, another example illustrates that the seller may prefer that bidders be asymmetrically informed to releasing information that would reduce the asymmetry.

Multi-Object Auctions: Sequential vs. Simultaneous Sales

Would a seller prefer to sell multiple objects through sequential or simultaneous auctions? Sequential auctions with bids announced between sales seem preferable because the bids may convey information about the value of objects to be sold later. The auction literature shows that this information effect increases the seller's expected revenue. However, there is also a deception effect which develops in the sequential sales. If a bidder knows that his current bid will reveal information about later objects then he has an incentive to underbid. These two opposing effects are studied in a two-signal model. The results show that either effect may dominate the other, leading the seller to sometimes prefer simultaneous sales and to sometimes prefer sequential sales. The winner's curse can explain this ordering.bidding, auctions, sequential bidding, winner's curse

Systemic financial distress and auction-based bankruptcy reorganization

Most bankruptcy procedures try to reorganize a financially-distressed firm's debts to a serviceable level through negotiations overseen by courts. Markets are an alternative to such negotiations. This paper develops a market-based approach that is appropriate if claimants are severely cash-constrained and there is merit in having existing owners-managers remain in control. This approach was developed in response to the 1997 Asian Crisis, where the sheer numbers of over-indebted firms, creditors with poor incentives, and inexperienced courts stymied negotiated resolution. The scheme, however, can be applied to other crisis settings that exhibit particular characteristics. One such setting could be the resolution of external sovereign debts, a situation where creditors obviously cannot take possession of a country. The scheme arranges creditors in a queue to be serviced in sequence from the firm's operating cash flows. Creditors bid for their position in this queue, and those accepting a greater proportionate reduction in the face value of their claims are placed ahead of the others. Any existing hierarchy of claims is honored by having claimants bid for their positions within the relevant segment of the queue. No one in the queue (including owners who are last) is paid anything until the (reduced) debts of the first in line are fully discharged using the firm's operating cash surpluses. The queue then moves up and the next claimant in line is serviced. The paper shows that, in equilibrium, the aggregate debts of the firm are reduced enough to provide a positive expected residual return to the owner-managers, which improves their incentives to efficiently operate the firm and can result in an outcome that is Pareto superior to other bankruptcy procedures. We discuss the efficiency properties of this scheme and its appropriateness to situations of systemic financial distress.Bankruptcy reorganization Systemic financial distress Auctions