What it means
When an issuer such as a city, a school district or a company wants to sell bonds, it can choose between two broad routes. In a negotiated sale it works with one chosen underwriter (a firm that buys the bonds and resells them to investors).
In a competitive sale, several underwriters submit sealed bids and the issuer awards the bonds to the bidder offering the best terms. The option is the issuer's right to choose that route.
Many public bodies are encouraged or required to use competitive sales for straightforward issues, while more complex or unusual deals are often negotiated. The decision is typically made on advice from a financial adviser.
How the best bid is chosen depends on the rules set out in the notice of sale. Often the winner is the bidder that produces the lowest overall interest cost for the issuer, which takes into account both the interest rate and the price paid.
Because every bidder sees the same terms, the process is transparent and easy to defend. The same principle appears in everyday procurement.
A company buying equipment or services can invite several suppliers to bid against each other and select on price, quality and delivery. Finance teams value this because the records show why a supplier was chosen, which helps with audit and governance.
Competition is not always the better route. For a large or complicated deal, or in a nervous market, bidders may demand a higher price for taking on risk, and a negotiated sale can sometimes give the issuer more control over timing and structure.
The right choice depends on size, complexity and market conditions. A practical point is timing: the issuer sets a deadline, receives sealed bids and then awards, often within hours.
Because the market can move quickly, deal teams prepare their documents in advance.
In practice
Real-world examples.
Example
A county government plans to issue $15,000,000 of bonds to fund road repairs. Its adviser recommends a competitive sale because the bonds are simple and well understood. Seven underwriters bid, and the winning bid saves the county money compared with the adviser's estimate.
Example
A manufacturer needs to replace ten delivery vans and asks four dealers for sealed quotes. The finance manager compares price, financing terms and delivery dates in a table. The company awards the order to the strongest overall offer and files the comparison for audit.
Example
A hospital group wants to issue bonds for a new wing, but the structure includes several non-standard features. Its advisers advise against a competitive sale. They explain that bidders might add a risk premium that wipes out the saving.
Formula
Calculation
Proceeds to issuer = Face value of bonds x Bid price (as a % of face value)
A city offers $20,000,000 of bonds with the same coupon for every bidder. Three underwriters bid 98.6%, 99.0% and 99.3% of face value. Proceeds under the lowest bid are 20,000,000 x 98.6% = $19,720,000, and under the highest bid they are 20,000,000 x 99.3% = $19,860,000. The city accepts the highest price, which raises 19,860,000 - 19,720,000 = $140,000 more than the weakest bid.Case study
Seen in the real world.
Riverbend Water District is a fictional public utility used as an illustrative example. It needs to borrow $30,000,000 to replace ageing pipes and asks its financial adviser whether to sell the bonds competitively or through a negotiated deal. Because the bonds are plain, the adviser recommends the competitive route.
On the sale date five underwriting firms submit bids, and the best one offers a price about $210,000 higher than the weakest. The district's board approves the award the same afternoon, and its finance team files the bid sheet as evidence of a fair process. The illustrative story shows how open competition can save money and protect an issuer against criticism.
Watch out
Common mistakes.
- Assuming the highest price is always the best bid. The interest rates and other terms must be compared together, and the lowest overall cost to the issuer is what counts.
- Believing competition always beats negotiation. For complex or risky deals, a negotiated sale can produce a better result.
- Starting the process before the documents are ready. Bidders need clear, complete information to price accurately, and gaps lead to cautious, lower bids.
Questions
People also ask.
Who normally uses a competitive sale?
Public bodies such as cities, counties and school districts use it often for simple bond issues, and companies use similar bidding in procurement. Many have policies that set out when it should be used.
What does an underwriter do?
An underwriter buys the new securities from the issuer and sells them on to investors, earning a margin for taking the risk. In a competitive sale, underwriters compete on how much they will pay.
How is the winning bid decided?
The notice of sale sets the test, which is commonly the lowest interest cost to the issuer. All bidders are told the rule beforehand.
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