Key Stages of Privatisation

3. Methods of Sale

c) Auction

i) What type of situation it is suitable for

Auctions are also a relatively rare method of privatisation, because often enterprises which are being privatized are too large, too complex and too important simply to be sold off to whoever offers the most money.

However, there are situations in which this method has been used, and with some success. It was used in many countries which formerly had planned economies in which even the smallest enterprises were owned by the state. After these countries abandoned this system and wanted to transfer much state property to private hands, auction was used to sell many small shops, businesses and services.

Auction has also occasionally been used in countries with mixed economies or predominantly market economies, for instance to sell the rights to a radio frequency.

It can be noted that auction has in general only been used for small enterprises or assets which do not carry a large social responsibility, such as a large workforce whose jobs depend on it or a naturally monopolistic public service or utility. In such cases where there are important political and social implications to selling the enterprise or assets, it is unwise for the vendor to consider selling them with regard only to the sale price and no regard to other considerations.

ii) Process and methods of auction

The process of an auction begins, as does a trade sale, with calculating a valuation and sale price for the entity to be privatized. This should naturally be conducted by an independent external advisor. From this the vendor will decide on a floor price and also on a starting price, which is the price at which the bids will start in an auction. Obviously the vendor will not want to set the starting price too low, but they should also be careful not to set it too high, as this will discourage potential bidders from participating, and increase the possibility of collusion between bidders.

The next step will be the public announcement of the auction. Public knowledge and support of the auction process are very important, and so the auction and its rules should be announced well in advance of the auction date and widely publicized.

An appropriate level of information about the enterprise/assets should be available to all interested parties. The most detailed information will be available through direct contact with the privatisation authority, but wide public information campaigns are likely to encourage more participation from the general public. The auction should be open to all members of the public.

Auction organizers should state clearly who can participate in the auctions. For example, definitions of natural persons and legal entities, and rules on foreign participation should be made known. All bidders should be registered and qualified (that is, they should be made to prove their legitimacy and their ability to pay). The same amount of information about the enterprise/assets should be available to all bidders.

In order to ensure transparency and impartiality it may be advisable to appoint an independent auction commission to oversee proceedings. The members of this commission should be independent of the vendors and of any of the bidders in order to avoid any conflicts of interest.

At registration the bidders should sign an agreement which commits them to abide by the regulations of the auction and which establishes penalties for not complying with these regulations. Guidelines for transfer of ownership need to be clear to both buyer and sponsoring body (if applicable) and be supported by laws. All laws which have bearing on the process, including new legislation, should be clear, consistent and universally enforced.

There are several issues which need to be addressed in transferring the state property to the buyer after the auction, including the creation of a fund (or a specific bank account) to collect the proceeds of the auction and determining how and to which state organizations the proceeds will be allocated. All these matters must be made transparent to the public.

In the auction the highest bidder for an enterprise/asset will naturally win the right to take ownership of it, and will subsequently assume ownership, including legal rights, for it on full payment to the vendor. The re-sale rights of the new owners should be clearly defined in order to increase investor confidence.

It seems helpful for the vendor to provide some support to buyers after the sale, in order to help address any initial problems experienced by the buyer in the enterprise’s running, particularly any conflicts arising between new owners and previous managers. 

iii) Safeguards and regulation

The process of an auction presents a few difficulties that need to be considered in order to ensure that it is successful. Firstly, the importance of having a transparent sale process and a strong, respected legal framework to support the process cannot be overemphasized. Without these most basic safeguards of procedure, the public is likely to lose confidence in the integrity of the process.

There have also been numerous instances in the past in which the highest bidder has pushed the sale price of an enterprise/asset to higher than the market value without intending to follow through with the payment. While this is more of an annoyance than a serious threat to the integrity of the process, it is a good idea to make some arrangements to guard against this risk.

The vendor may require the bidder to deposit a certain amount as a guarantee, but demanding deposits may limit competition if a number of enterprises/assets are being sold at the same time. Alternatively the auction organizers could include a rule that if a bidder defaults, they should lose the registration fee and the next highest bidder should have the right to obtain the enterprise/asset at that price. Any such rules and procedures should be announced before the auction takes place.

As enterprises/assets which are sold by auction will generally be quite small, there is not such a need for government regulation of their subsequent performance as with sales of public services or large employers etc.

The vendor should adhere to the floor price set for any enterprise/asset by external valuation, and so if no bids offer an acceptable price it will not be sold. However, in a situation where there is a very weak investment market at the time of the auction but which is expected to improve significantly some time after, the Government may wish to increase investor confidence by accepting somewhat low prices for enterprises/assets which are being auctioned. In such a situation it may be appropriate to consider inserting a clawback clause into the contract of sale in order to secure their just returns if the investment market rapidly improves in the years following the auction, which may indeed come partly as a result of the auctions.

Next: Flotation and Public offering

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