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Treasury has had mixed results in selling the investments it holds in banks it rescued amid the financial crisis.
The agency notched a $1.1 billion profit after privately negotiating a price for warrant in Goldman Sachs Group, which received $10 billion in bailout funds. That compares with the $950 million profit from an auction of warrants from J.P. Morgan Chase ($25 billion in rescue funds). The winning bid was higher than the minimum, but lower than traders expected. And last week, the Treasury delayed plans to sell Citigroup shares because of weak bids.
So, what is the best way for the Treasury to sell the warrants in the roughly 200 banks the agency still owns a stake in: auctions or direct negotiated sales?
For insight, Deal Journal talked with Adam Galinsky, an ethics and management professor at Northwestern's Kellogg School of Management who analyzed the outcomes of auctions versus negotiated deals for a recent study he co-wrote.
Deal Journal: When is it better to auction something off instead of negotiating its sale? Galinsky: The key determining factor is figuring out what the market is like. When there is a huge market for something, an auction will make the seller better off by creating a bidding frenzy. But if there is not sufficient market, there is going to be no one bidding and you end up with a low price.
DJ: What about starting prices? Galinsky: We found that the auctions that started with a low price ended up with higher final prices. Whenever you are selling something, you want to reduce barriers to entry to get access to your goods. That is why you start with a low price. I had a friend who sold a baby Bjorn (baby carrier) on eBay for 85 euros when you can get one new for 75 euros. It tells you there was a lot of demand, but also how irrational auctions can be. Another friend tried to sell his Indie record collection, and he only got one bid because there weren't a lot of people who shared his tastes.
DJ: What are some other auction strategies? Galinsky: The one thing people do is to make the auction too short. The longer it goes, the the more bidders have invested in it. The other mistake is that sellers don't think about the competition. On eBay, too many people end their auction at the same time, between 5 and 7 p.m., when there is a flood of sellers. It may be better to end it at 2 a.m. If there are other investments that people are making at the same time it could be distracting.
DJ: What about pricing strategy in negotiations? Galinsky: It is typically better to start with a higher price if you are the seller. It is called the anchoring effect. You walk into a suit store and the salesman is going to start with the $1,000 suit and move down. It gives the seller room to make concessions and make the buyer think they are getting a good deal. Also, if you start with a high price when you are selling a car it sticks in people's minds. Their mind tends to focus on the good things about the car. The essence of the thing comes out in the price.
DJ: Do all these tactics work for skilled sellers and buyers and not just casual eBay users? Galinsky: There is data to suggest that experts are less likely to jump in when they see a large number of bidders. Experts see bidders as a barrier to entry. Novices see them as truly high value.
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A 5th grader could teach those turnips…..
Deal Journal is an up-to-the-minute take on the deals and deal makers that shape the landscape of Wall Street, including mergers and acquisitions, capital-raising, private equity and bankruptcy. In short, wherever money changes hands. Deal Journal is updated throughout each trading day with exclusive commentary, analysis, data, news flashes and profiles. The Wall Street Journal's Michael Corkery is the lead writer, with contributions from other Journal reporters and editors. Send news items, comments and questions to deals@wsj.com.
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