Corporate reorganization rules is to be judged and the fundamental problem of valuation: THE AUCTIONS ALTERNATIVE TO EXISTING RULES

Corporate reorganization rules is to be judged and the fundamental problem of valuation: THE AUCTIONS ALTERNATIVE TO EXISTING RULESThe structural problems of the prevailing bargaining-based approach have led to much research work on alternative arrangements. One approach that has been natural for researchers to explore is relying on the market to address the problem of valuation.

Roe suggested selling a sample of 10% of the reorganized company’s tickets on the market to get the market’s estimate of the value of these tickets — and then to distribute the remainder of the tickets on the basis of this estimate. In Roe’s proposal, the market was just used to get an estimate of the reorganization value by extrapolating from a 10% sale. Subsequent work, however, did not see a reason to stop at 10% rather than sell the full 100% and developed the “auctions approach.”

Under the auctions approach, which was put forward by Baird and Jackson and subsequently advocated also by Jensen, the assets of the insolvent company will be always put on the block and auctioned off. The auction procedure will be designed with the aim of getting the highest value, and accordingly the assets will be sold piecemeal or as a going concern depending on which way will be judged to generate the largest revenue. The auctions approach can be regarded as suggesting a drastic change in the rules of Chapter 11 or as a suggestion for eliminating Chapter 11 altogether and effecting sales through the rules of Chapter 7; for our purposes here, it matters very little which characterization is chosen.

The argument for the auctions approach is that it provides a neat separation between two issues: what should be done with the assets of the company, and how to divide the reorganization value among the participants. The existing rules of Chapter 11 leave the answer to both questions for the bargaining process. And because the existing rules tie together these two issues, distortions arise. As we have seen, the haggling under the bargaining-based approach might fail both to maximize the assets’ value and to divide this total value in accordance with contractual priorities.