Booms, Busts, and Fraud

Firms sometimes commit fraud by altering publicly reported informationto be more favorable, and investors can monitor firms to obtainmore accurate information. We study equilibrium fraud and monitoringdecisions. Fraud is most likely to occur in relatively goodtimes, and the link between fraud and good times becomes strongeras monitoring costs decrease. Nevertheless, improving businessconditions may sometimes diminish fraud. We provide an explanationfor why fraud peaks towards the end of a boom and is then revealedin the ensuing bust. We also show that fraud can increase iffirms make more information available to the public.     

Sale-Backs in Bankruptcy

When bankrupt firms are sold, they are often repurchased bytheir former owner or manager. These insiders are by defaultbetter informed than outsiders about the true value of the firmor its assets, so other potential buyers must worry about overpayingif they win. The presence of insiders may thus have a chillingeffect on the bidding. We ask how insiders should be treatedin bankruptcy sales: Should they be allowed to submit bids?If so, under what conditions? We derive properties of an optimalsale procedure and show that it must be biased against insiders.Specifically, it should be harder for insiders to win with lowbids than for outsiders. We show that the "market tests" thatare routinely required in bankruptcy sales are suboptimal sincethey treat all potential buyers alike and forgo the benefitsof biasing the procedure against insiders.     

Optimal 'soft' or 'tough' bankruptcy procedures

This article describes optimal bankruptcy laws in a frameworkwith asymmetric information. The key idea is that the financialdistress of a firm is not observed by its lenders for quitea while. As early rescues are much cheaper than late rescues,it may pay if the creditors are forgiving in bankruptcy, therebyinducing the revelation of difficulties as early as possible.Either 'tough' or 'soft' bankruptcy laws can be optimal, dependingon the parameters. This implies that mandatory one-size-fits-allbankruptcy procedures cannot be optimal. 'Hybrid' procedures,which try to combine elements of soft and tough procedures,are found to be redundant, and possibly harmful. Absolute priorityrules may be helpful as a part of tough procedures, but theirintroduction is (partly) inconsistent with the design of softprocedures. The article also reinterprets much of the evidenceon the performance of Chapter 11, the 'rather soft' U.S. reorganizationprocedure, questioning many negative conclusions.     

Takeover Contests with Asymmetric Bidders

Target firms often face bidders that are not equally well informed,which reduces competition, because bidders with less informationfear the winner’s curse more. We analyze how targets shouldbe sold in this situation. We show that a sequential procedurecan extract the highest possible transaction price. The targetfirst offers an exclusive deal to a better-informed bidder,without considering a less well-informed bidder. If rejected,the target offers either an exclusive deal to the less well-informedbidder, or a modified first-price auction. Deal protection devicescan be used to enhance a target’s commitment to the procedure.(JEL G34, K22, D44)