Bankruptcy as an Auction Process: Lessons from Sweden

Abstract

The traditional U.S. Chapter 11 bankruptcy process in which financial claims are renegotiated under court protection and the firm continues to operate under existing management has long been criticized by economists as an inefficient way of dealing with financially distressed companies. In this paper, the authors make the case for a mandatory auction bankruptcy system of the kind now used in Sweden—one that requires all companies filing for Chapter 11 to be sold in open auctions soon after the filing.After discussing the notable features of and differences between the U.S. and Swedish bankruptcy systems, the authors summarize recent research (much of it their own) on the benefits and possible drawbacks of the Swedish system. Among the most notable findings of this research, there is no evidence that mandatory bankruptcy auctions in Sweden lead to “fire‐sale” discounts in auction premiums. Moreover, the fact that three‐quarters of the Swedish companies that filed for bankruptcy survived as going concerns should allay concerns that an auction system will produce excessive liquidations. At the same time, the post‐bankruptcy operating profitability of the companies that emerge from Swedish auctions as going concerns tends to be on a par with that of their (non‐bankrupt) industry peers. Such post‐operating performance, when combined with a 75% rate of reorganization (versus liquidation), suggests that allowing auction investors—instead of the bankruptcy court—decide which companies survive and how they get capitalized and restructured has been quite effective in accomplishing the two aims of a bankruptcy system: (1) preserving intact all economically viable enterprises while (2) eliminating the excess capacity that results from prolonging the existence of companies that are never expected to earn high enough returns on capital to attract private investment.Consistent with these findings, the U.S. in recent years has seen a sharp increase in the use of auctions in Chapter 11 bankruptcies, though on a voluntary rather than a mandatory basis. Such a change reflects the growing recognition of the role of auction processes in reducing bankruptcy costs and preserving going‐concern values as U.S. capital market participants push harder for private workouts, “prepackaged” Chapter 11 filings, and auction sales in Chapter 11.