Fire Sale Discount: Evidence from the Sale of Minority Equity Stakes

Isil Erel is Distinguished Professor of Finance at The Ohio State University Fisher College of Business; Serdar Dinc is Associate Professor of Finance & Economics at Rutgers Business School; and Rose Liao is Associate Professor of Finance at Rutgers Business School. This post is based on their recent paper.

Asset fire sales—namely, the forced sales by distressed sellers at prices lower than what the highest potential bidder could bid if it were not financially constrained as studied by Shleifer and Vishny (1992)—have attracted much attention. They have become important building blocks in much of recent theoretical work in finance and macroeconomics.

Empirical evidence on fire sales falls into two groups. In the first group are studies such as the analysis of aircraft sales by distressed airlines in Pulvino (1998) and that of fire sale discounts in bankruptcy auctions in Eckbo and Thorburn (2008). These studies observe the transaction prices on asset sales, but have to infer the fundamental values of the assets sold without the benefit of prices from a market with frequent trades. The second group includes studies such as Coval and Stafford (2007) who study the price impact of the sales of equity securities by mutual funds facing fund outflows. These studies have the benefit of asset prices from frequent trades, but they do not observe the transaction price received by the distressed sellers. They instead focus on the long run price impacts of the distressed sellers’ act of selling. There have been no empirical studies in a setting that provides both the transaction prices received by the distressed sellers and the pre-transaction prices given by frequent trades in an active market.

In this paper, we study transactions where the selling firm sells minority equity stakes it holds in publicly listed third parties. These particular transactions have several advantages for a study like ours. First, the seller is not selling its own equity. In other words, these transactions are not seasoned equity issues. Instead, the shares in third parties are sold. Hence, the impact of the factors behind the seller’s distress on the value of the asset being sold is reduced. Second, the assets sold are publicly listed shares, which tend to be more frequently traded than debt securities or real assets, so their pre-transaction market prices can serve as a good estimate for their fundamental values. Third, the transaction prices received by the sellers are often included in press releases or press reports and thus can be obtained from commercial data providers. Finally, in addition to providing more precise estimates of fire sale discounts, focusing on equity securities has the benefit of generating insights about fire sales of financial assets that play an important role in financial crises as surveyed in Shleifer and Vishny (2011).

We study 638 minority equity sales with a 3.7% median stake size and find statistically and economically significant discounts in distressed deals. The industry-adjusted discount based on the target’s, i.e., the stock issuer’s stock price four weeks prior to the announcement is about 8%. This discount is higher if the fraction of the target’s equity being sold is large. For example, when the free-float-adjusted stake size sold is 5% or larger, the industry-adjusted distress discount is about 14%.

Notice that the industry-adjusted discount of 8% that we estimate even for the sale of smaller stakes is higher than the discount estimated for equities using mutual fund cash outflows, which is estimated without the benefit of observed transaction prices. For example, Coval and Stafford (2007) estimate a discount of about 4% during their three-month event window. In other words, our more precise data on the timing of the sale—often to the day of sale—as well as data on the transaction price allow us to provide more precise estimates of fire sale discounts, which are not only higher than those in the literature but are also based on price movements over four weeks rather than three months. As a further comparison to fire sale discounts in the literature, the discounts we estimate for the whole sample are somewhat smaller than the 10–20% discount estimated by Pulvino (1998) for aircraft sales but the discount we estimate for larger stakes is at his mid-range. Interestingly, we find no discount in the sale of large stakes in non-distressed deals. Similarly, we also find that a block sale itself does not result in a discount in non-distressed deals.

Sellers of equity stakes may possess preferential information about the firm. To check whether our results are driven by such information, we also study how the prices behave after the sale. If the sales are motivated by information held by the sellers at the time of distress, the price impact of the sale would be expected to last. However, if the price impact is due to fire sale reasons, market prices of the asset sold should recover after the sale. We indeed find a clear pattern of price recovery after distressed sales.

The complete paper is available for download here.

References

Coval, J., Stafford, E., 2007. Asset fire sales (and purchases) in equity markets. Journal of Financial Economics 86, 479–512.

Eckbo, B.E., Thorburn, S.K., 2008. Automatic bankruptcy auctions and fire-sales. Journal of Financial Economics 89, 404–422.

Pulvino, T.C., 1998. Do asset fire sales exist? An empirical investigation of commercial aircraft transactions. The Journal of Finance 53, 939–978.

Shleifer, A., Vishny, R.W., 1992. Liquidation values and debt capacity: a market equilibrium approach. The Journal of Finance 47, 1343–1366.

Shleifer, A., Vishny, R.W., 2011. Fire sales in finance and macroeconomics. Journal of Economic Perspectives 25, 29–48.

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