Liquidation, fire sales, and acquirers' private information

We develop a dynamic model in which a distressed firm optimizes an exit choice be- tween sell-out and default as well as its timing. We assume that the distressed firm is not informed about the acquirer's asset valuation. We show that the firm delays liquidation to decrease the acquirer's information rent. Notably, the firm can change the exit choice from sell-out to default when the screening cost is high. In this case, shareholders declare default regardless of the acquirer's valuation, which provides the acquirer the maximum information rent. Together with bankruptcy costs, the maximal information rent lowers the sales price and debt recovery. This mechanism can explain many empirical findings about fire sales and acquirers' excess gains. Higher volatility, leverage, and asymmetric information increase the likelihood of a fire sale, but higher bankruptcy costs could play a positive role in preventing a fire sale. With asymmetric information, the firm can reduce debt issuance to avoid the risk of a fire sale.