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

Bankruptcy auctions have become a preferred practice in bankruptcy, frequently used to maximize the value of the distressed assets for the claimants’ benefit. Still, what is the optimal design of a bankruptcy auction? Does the method used to execute a bankruptcy auction matter at all? Does one auction method fit all bankrupt firms? Surprisingly, these questions have not been answered yet, as auction design in the specific context of bankruptcy has barely been studied. This paper contributes to this scarce literature by shedding light on the possible interaction of bankruptcy auctions with Auction Theory. To demonstrate its potential contribution, we employ Auction Theory to analyze current auction practices, including the question of “credit bidding” (i.e., the practice of allowing a secured creditor to bid while using its claim as currency rather than cash). The application of Auction Theory to the bankruptcy context educes three important contributions. First, we suggest a novel design of a bankruptcy auction that differs markedly from the current prevailing practice. The bankruptcy auctions of large firms should be executed according to a design that we call “Anglo-Dutch Veto Auction” (“ADVA”). An ADVA consists of an Anglo-Dutch auction with a veto right accorded to the secured creditor. The creditor can evoke this right under several defined conditions. Second, we find that “credit bidding” should not necessarily be encouraged. Third, because of the absence of a “bankruptcy auctions” regulator who could implement a process of trial-and-error, lawmakers should consider, as an institutional reform, to have the bankruptcy court assume this role