Policy makers should recognise the merits of fire sales

Academic research shows why it’s important to grasp the wider implications of companies offloading assets at heavily discounted prices during a recession

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With the demise of Debenhams and the purchase of its assets at knock-down prices by Boohoo, along with fears about fire sales in parts of the travel, entertainment and football sectors, acquisitions of business assets at heavily reduced prices are hitting the headlines. These are signs of fewer buyers in constrained sectors, resulting from the current severe economic downturn, according to a study on the dynamics of fire sales.

In such times, governments may step in with financial support, going from loan guarantees and furlough schemes to bailouts of distressed companies or industries. Bailouts are often aimed at preventing companies from being sold at fire sales prices. However, research spanning over 30 years of data and more than 21,000 acquisitions by US listed companies highlights the hidden benefits of fire sales and shows how they can present fewer social costs than is generally believed. Policy makers are therefore urged to appreciate the wider implications to society of asset sales at cut rates.

This study, which was recently mentioned in The New York Times, points out how, in financial crises it can be better to let companies sell assets through fire sales rather than propping them up with a bail out.

This research on fire sales was carried out by Henri Servaes, Professor of Finance at London Business School and Jean-Marie Meier, Assistant Professor of Finance at The University of Texas at Dallas. Professor Servaes explains:

“The sale of distressed assets such as property, business units, or entire companies, generate extra returns for buyers compared to regular corporate sales and the higher returns essentially reflect a redistribution of wealth from sellers to buyers, and not a destruction of wealth.

“Ultimately, this represents an important means for society to preserve the value of assets, according to our research. This is particularly important during times of economic stress and is little understood.

“The root cause for this extra value going to buyers is the reduced bargaining power of distressed sellers and this effect is heightened during recessionary years. It’s therefore important for today’s policymakers to look into both the pros and cons of bailouts.

“Very importantly, data show that neither peer companies, customers nor suppliers suffer as a result of fire sales compared to regular deals. And while we did see a fall in employment in companies engaged in a fire sale, this was similar to the effect on jobs at equivalent businesses facing reorganisation because of bankruptcy without associated fire sales.” The research was explained in the context of the current economic crisis in a recent blog in VoxEu.

Professor Servaes added: “If the main aim of government support is to prevent asset sales at fire sale prices, then the government should think twice. It may be more beneficial to provide a larger safety net for individuals who struggle as a result of the restructuring, rather than supporting failing companies and sectors. Major bailouts are extremely costly: they hit taxpayers hard, can distort business, and may incite lobbyists to influence policy decisions. It’s essential for policymakers to be aware of the wider effects of fire sales.”