The Winner's Curse and Bidder Competition in Acquisitions: Evidence from Failed Bank Auctions

This study examines the effect of bidder competition in acquisitions. We use predictions from auction theory to test whether acquirers of failed banks overpay (the “winner's curse”) when bidding in FDIC sealed-bid purchase and assumption (P&A) transactions (auctions). The empirical results indicate that winning bids tend to increase as the number of competitors increases, as predicted by theory. We also find that bid levels of all bidders increase with increased competition, which is consistent with bidders' failing to adjust for the winner's curse in a common value auction setting. However, additional tests using winning bids only are consistent with both a common value and a private values model, so this result should be interpreted with caution.     

The overconfidence of investors in the primary market

We analyze the investment performance of 6993 investors bidding in 77 discriminatory IPO auctions in the Taiwan stock market between January 1996 and April 2000, and find that frequent bidders in these auctions have lower returns than infrequent bidders. The frequent bidders bid too aggressively and evaluate the IPO firms too optimistically, resulting in inferior performance. Despite being quite successful in their first few auction bids, the returns for frequent investors are gradually reduced in subsequent auctions. The multivariate model and the analysis of the possibility of perverse incentives of brokerage firms suggest that our findings cannot be explained by rational hypotheses, whereas in contrast, the theories on overconfidence and self-attribution bias can explain the increase in bidding frequency and the deterioration in return performance for bidders in IPO auctions.     

THE VALUE OF A REGULATORY SEAL OF APPROVAL

I investigate whether obtaining a regulatory seal of approval adds to firm value. For a sample of thirty-four firms that acquired the insured deposits of failed banks, I find a significantly greater price response for firms that could benefit from obtaining a regulatory seal of approval than for firms that had recently obtained a similar form of approval. Further, abnormal returns to winning bidders are significantly larger when a regulatory seal of approval is likely to be more valuable, i.e., when the industry faces severe economic problems. In addition, bidder gains are significant only in markets where regulatory certification of a firm's health is important—markets that have recently experienced several bank failures. Finally, wealth transfers from the FDIC insurance fund may contribute to bidder gains. The evidence suggests that obtaining a regulatory seal of approval can positively affect firm value.     

Does Joint Bidding Reduce Competition? Evidence from Hong Kong Land Auctions

This paper analyses firms’ bidding behavior in auctions for development land in Hong Kong. The real estate market in Hong Kong is considered to be oligopolistic as it is dominated by a few top real estate firms, which have strong financial strength/development capacity and large land banks. Joint bidding is used by other real estate firms (“large” firms) to pool resources/capital in order to compete with the top firms. We test whether joint bidding increases or decreases the level of competition in land auctions, using land auction data in Hong Kong from 1991 to 2011. We find that large real estate firms are more likely to be successful than top firms at auctions when bidding jointly. However, joint bidding/winning does not harm competition as reflected by the number of bids, bids per bidder and number of bidders. Land prices also increase significantly in auctions won by joint bidders or alliances of large developers. Our results suggest that joint bidding enhances competition by allowing large firms to act strategically by pooling their resources and act aggressively to compete with the top firms.

     

RULE CHANGES AND UNCERTAINTY IN DISCRIMINATORY AND UNIFORM PRICE AUCTIONS

The auction literature indicates that uncertainty about the value of auctioned goods increases underpricing in discriminatory price auctions. Such uncertainty has a smaller effect on uniform price auctions because the pricing rule aggregates bidders' information. We find that uncertainty resulting from inexperience with an auction mechanism has similar effects. Using initial public offering (IPO) data from Japan and Israel, we find that average underpricing increases temporarily in Japan's discriminatory price auctions after changes in the auction rules, which suggests that bidders reduce their bids in response to uncertainty. Underpricing in Israel's uniform price auctions is not affected by rule changes.     

An Analysis of Bidding in the Japanese Government Bond Auctions

We examine the bidding patterns and auction profits in the Japanese Government Bond (JGB) auctions and empirically test the predictions of auction theory. We find that the average profit in JGB auctions is not reliably different from zero, and the degree of competition and the level of uncertainty are insignificant in determining auction profits. The winning shares of the U.S. dealers are positively related to auction profits, whereas the winning shares of their Japanese counterparts show a negative association. We also find that the share of winnings of Japanese dealers tends to be correlated with the share of winnings of their compatriot dealers but a similar relation is not found for U.S. dealers.     

Estimation in English auctions with unobserved heterogeneity

We propose a framework for identification and estimation of a private values model with unobserved heterogeneity from bid data in English auctions, using variation in the number of bidders across auctions, and extend the framework to settings where the number of bidders is not cleanly observed in each auction. We illustrate our method on data from eBay Motors auctions. We find that unobserved heterogeneity is important, accounting for two thirds of price variation after controlling for observables, and that welfare measures would be dramatically misestimated if unobserved heterogeneity were ignored.     

WHO WINS IN LARGE STOCK BUYBACKS – THOSE WHO SELL OR THOSE WHO HOLD?

Both fixed-price and dutch auction repurchases offer large premiums over current values to tendering shareholders. And, because announcements of such offers are generally accompanied by significant increases in stock prices, economists view selftender offers as mechanisms for signaling undervaluation. Using samples of fixed-price and dutch auction self-tender offers from the 1980s, this study attempts to answer the following questions: Are non-tendering shareholders fully compensated for the premium wealth transfer by the increase in the intrinsic value of their shares? Since fixed-price offers feature larger premiums, are they accompanied by larger increases in intrinsic value (or do insiders have a tendency to “overpay” in fixed-price offers)? Is the premium wealth transfer a big component of the returns to the two shareholder groups—and what percentage of firm value does the transfer represent? The findings of this study, unlike those reported by earlier research, suggest that the two types of offers generate roughly the same total returns (about 10–11%, on average, during the offering period) to shareholders who do not tender. Fixed-price offers involve considerably larger premiums (over the new, “full-information” price) and wealth transfers than dutch auctions. Reflecting the higher premiums, shareholders tendering into fixed-price offers receive higher returns than those tendering into dutch auctions (13.8% vs. 11.3% during the announcement period). But while fixed-price offers involve a considerably larger wealth transfer from non-tendering to tendering shareholders, fixed-price repurchases compensate the non-tendering shareholders for the larger wealth transfer with larger increases in “intrinsic value,” thus generating the same total return as dutch auctions. Moreover, despite the large premiums offered in both types of offers, the wealth transfer implicit in the premium represents a small cost (less than 1% in fixed-price offers, and less than 0.1% in dutch auctions) to non-tendering shareholders.     

Do auctions induce a winner's curse? New evidence from the corporate takeover market

We contrast the winner's curse hypothesis and the competitive market hypothesis as potential explanations for the observed returns to bidders in corporate takeovers. The winner's curse hypothesis posits suboptimal behavior in which winning bidders fail to adapt their strategies to the level of competition and the amount of uncertainty in the takeover environment and predicts that bidder returns are inversely related to the level of competition in a given deal and to the uncertainty in the value of the target. Our measure of takeover competition comes from a unique data set on the auction process that occurs prior to the announcement of a takeover. In our empirical estimation, we control for the endogeneity between bidder returns and the level of competition in takeover deals. Controlling for endogeneity, we find that the returns to bidders are not significantly related to takeover competition. We also find that uncertainty in the value of the target does not reduce bidder returns. Related analysis indicates that prestigious investment banks do not promote overbidding. Analysis of post-takeover operating performance also fails to find any negative effects of takeover competition. As a whole, the results indicate that the breakeven returns to bidders in corporate takeovers stem not from the winner's curse but from the competitive market for targets that occurs predominantly prior to the public announcement of bids.     

The Impact of Capacity Costs on Bidding Strategies in Procurement Auctions

This paper analyzes the impact of capacity costs on bidding strategies of firms participating in procurement auctions. More efficient firms will invest in advance due to their high probability of winning the auction while less efficient bidders prefer to wait with their investments until the outcome of the auction is known. However, in equilibrium both types of firms include a coverage for their investment costs in their bids and therefore adopt a full cost pricing policy. This revised version was published online in November 2006 with corrections to the Cover Date.     

Selling Failed Banks

The average FDIC loss from selling a failed bank is 28% of assets. We document that failed banks are predominantly sold to bidders within the same county, with similar assets business lines, when these bidders are well capitalized. Otherwise, they are acquired by less similar banks located further away. We interpret these facts within a model of auctions with budget constraints, in which poor capitalization of some potential acquirers drives a wedge between their willingness and ability to pay for failed banks. We document that this wedge drives misallocation, and partially explains the FDIC losses from failed bank sales.     

Capital and resolution policies: The US interbank market

We develop an empirically based simulation study to test two types of policies designed to control systemic risk: preventive policies targeting capital requirements and mitigation policies targeting default resolution. We find that capital buffers reduce both the number of defaults and the resulting losses. The loss reduction benefit increases as the magnitude of adverse shocks becomes higher. We find that a simple branch-breakup resolution strategy reduces the loss borne by the Federal Deposit Insurance Corporation (FDIC). The mitigation effect becomes higher as the fraction of assets resolved through auctions and auction competitiveness increase.     

Strategic bidding in multi‐unit auctions with capacity constrained bidders: the New York capacity market

This article employs a simple model to describe bidding behavior in multi‐unit uniform price procurement auctions when firms are capacity constrained. Using data from the New York City procurement auctions for power generating capacity, I find that firms use simple bidding strategies to coordinate on an equilibrium that extracts high rents for all bidders. I show theoretically and empirically that the largest bidder submits the auction clearing bid. All other bidders submit inframarginal bids that are low enough to not be profitably undercut. Inframarginal bidders decrease their bids as the pivotal firm's capacities and its profits of undercutting increase.     

Auction Price Formation with Costly Occupants: Evidence Using Data from the Osaka District Court

Foreclosure properties sold at Japanese judicial auctions are delivered to buyers with an unclear title when occupants exist, because the foreclosure laws protect occupants from compulsory execution of auctions. The existence of occupants theoretically affects the auction price through two channels. First, it affects the reserve price, and this changes in auction price. Second, the number of bidders changes in response to changes in the reserve price that is controlled by occupants, and this changes the auction price. Using data from the Osaka District Court, we empirically find that the existence of occupants in properties reduces the auction price through two channels.     

Multiple Unit Auctions and Short Squeezes

This article develops a theory of multiunit auctions where shortsqueezes can occur in the secondary market. Both uniform anddiscriminatory auctions are studied and bidders can submit multiplebids. We show that bidders with short and long preauction positionshave different valuations in an otherwise common value setting.Discriminatory auctions lead to more short squeezing and higherrevenue than uniform auctions, ceteris paribus. Asymptotically,as the auction size approaches infinity, the two formats leadto equivalent outcomes. Shorts employ more aggressive equilibriumbidding strategies. Most longs strategically choose to be passive.Free riding on a squeeze by small, long players has no impacton these results, but affects revenue in discriminatory auctions.     

Repeated acquirers in FDIC assisted acquisitions

We studied repeated acquirers in Federal Deposit Insurance Corporation (FDIC) assisted acquisitions. Using a sample of 128 FDIC assisted acquisitions and 387 non-assisted acquisitions, we found that FDIC assisted acquirers, on average, produced positive abnormal returns. This result was driven by repeated acquirers. First-time acquirers did not profit in these assisted acquisitions. In a logit analysis, we found that the FDIC repeated acquirer improved its profiting chances by reducing the winning bid and the number of bids. This evidence is consistent with the suggested experience/information effect based on theory and FDIC practices.     

Timing of bids at pooled real estate auctions

When many similar properties are being auctioned, auctioneers often resort to the pooled design. The winning bidder of a given round is given a choice among all the unclaimed (pooled) properties. Bidding strategy depends on expectations of rival bidders' behavior as well as personal valuation. Anecdotal evidence from condominium auctions suggests that bidding decisions can produce price anomalies. This study develops a simple theoretical model with three active bidders and three units for sale to show how such anomalies may emerge. Estimation is then made of a hedonic price model using data from a condominium auction of 53 units on three separate dates. The empirical results support the view that the best buys are found in the middle of the auction with overpayments at the beginning and end.     

Bounds on revenue distributions in counterfactual auctions with reserve prices

Measuring auction revenues under counterfactual reserve prices or formats requires knowledge of distributions of bidders' values and private signals. This poses a challenge when bids are observed from first‐price, common‐value auctions. I bound counterfactual revenue distributions without imposing parametric restrictions on the model structure. Using data from U.S. municipal bond auctions, I find first‐price and second‐price auctions under optimal reserve prices lead to little improvement in revenues over existing first‐price formats. The number of bidders has a more significant impact on revenues in optimal auctions. I also find invoking an incorrect assumption of private values in counterfactual analyses results in small errors in predicting revenues from optimal second‐price auctions.     

Not knowing the competition: evidence and implications for auction design

In a government auction program where first-price auctions generate significantly higher revenue than English auctions, I document evidence that bidders are uncertain about the number of auction entrants. Motivated by additional data evidence, I estimate a structural model of auctions in which rivals' participation is stochastic, allowing for bidders' risk aversion and asymmetry. Counterfactual simulations reveal that bidders' uncertainty about the number of entrants, combined with risk aversion, substantially softens the revenue impact of low competition in first-price auctions. This explains the observed revenue patterns and uncovers an empirically important reason for sellers to favor first-price auctions over English auctions.     

Creditor financing and overbidding in bankruptcy auctions: Theory and tests

We present unique empirical tests for auction overbidding using data from Sweden's auction bankruptcy system. The main creditor (a bank) can neither bid in the auction nor refuse to sell in order to support a minimum price. However, we argue that the bank may increase its expected revenue by financing a bidder in return for a joint bid strategy, and we show that the optimal coalition bid exceeds the bidder's private valuation (overbidding) by an amount that is increasing in the bank's ex ante debt impairment. We find that bank–bidder financing arrangements are common, and our cross-sectional regressions show that winning bids are increasing in the bank-debt impairment as predicted. While, in theory, overbidding may result in the coalition winning against a more efficient rival bidder, our evidence on post-bankruptcy operating performance fails to support such allocative inefficiency effects. We also find that restructurings by bank-financed bidders are relatively risky as they have greater bankruptcy refiling rates, irrespective of the coalition's overbidding incentive.