The Allocation of Residual Rights

Abstract

In this paper we examine the value of the right to design the method of sale of corporate assets. The question we ask is simple - who should have the right to decide how the assets of the firm should be sold? We show that this right is a valuable one and its value comes from recognizing the conflicting incentives of claimants at the time of sale. We characterize the choices of the senior and junior claimants and show that they have distinct preferences on a set of common auction procedures. More importantly, we show that the optimal allocation of the right cannot be independent of the realized values of information at the time of sale. We also show that the firm-value maximization is aided when the law mandates an ascending-bid selling mechanism for sale of indentured corporate assets. Our analysis points out that when the process of disposition of a firm's assets in bankruptcy is disassociated with that of the distribution of cash flows accruing from the sale, the incentive problems that are commonly analyzed in the bankruptcy literature show up in the choice of the selling mechanism. In particular, the choice of a selling mechanism is formally identical to the choice of a risky project.