Why you can’t always trust auction results

By Felix Salmon
November 21, 2011
Sarah Thornton started worrying about the system of third-party guarantees and irrevocable bids at high-profile auction houses.

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Back in May, Sarah Thornton started worrying about the system of third-party guarantees and irrevocable bids at high-profile auction houses. I struggled to see what the fuss was about:

What’s Thornton’s beef with private sales, especially when the final price is public? A $50 million Warhol is a $50 million Warhol, whether the sale takes place in public, in private, or somewhere in between — and whether the sale is deliberate and orchestrated or whether it’s chaotic and unpredictable.

Now, however, Thornton has answered my question, in a new post. It turns out, according to her, that a $50 million Warhol — or, more to the point, a $43,202,500 Lichtenstein — might not be quite what it seems after all.

It is strongly believed, for example, that Guy Bennett, an art advisor acting on behalf of the Qataris, negotiated third-party guarantees on the top lots at both Christie’s and Sotheby’s recent contemporary auctions in New York. During the prestigious evening sale at Christie’s on November 8th, Mr Bennett was seen to make the winning bid of $38.5m for Roy Lichtenstein’s 1961 painting, “I can see the whole room!… and There’s Nobody in it!”. Christie’s normal buyer’s premium (or commission) on this would bring the final price up to $43.2m, which was the price reported by Christie’s. However, high-powered guarantors often negotiate a 50-50 split with the auction house of as much as 30% of the overage (the amount generated above the guaranteed price) and an additional 50% of the buyer’s premium. The market believes the Lichtenstein was guaranteed at $35m. If Mr Bennett, who bought the picture, had negotiated such a deal, the real price he paid would have been $40.3m.

This is more complicated than it needs to be, and of course it’s all based on what “the market believes”, which might not be fully accurate. But in principle, there’s definitely the possibility that something fishy might be going on whenever a guarantor buys a painting at auction for more than its low estimate.

There’s a lot of opacity when it comes to fine-art auctions, but the one thing which is always fully transparent is the final sale price. Sellers can negotiate deals when it comes to the commission they pay the auction house; buyers can’t. The buyer’s premium is set, and is public, and can always be used to find out the total amount of money which was spent by the buyer on the work of art in question. That’s why art-price databases use auction results: they know exactly how much was spent, even if they don’t know who the buyer was.

But now, with the system of third-party guarantees, we no longer know for sure that the reported price was in fact the price actually paid by the buyer.

The reason is this: in return for providing an irrevocable bid for a certain artwork (normally, but not always, at the low estimate), the auction house agrees to split some of the upside with the guarantor. Take that Lichtenstein. Its low estimate was $35 million; let’s say that someone called Guy Guarantor provides an irrevocable bid at that price. In return, he gets a deal from Christie’s. If the painting sells for more than $35 million, he’ll get 15% of the increase in the hammer price over and above $35 million, and he’ll also get 50% of the total buyer’s premium.

As it happened, the Lichtenstein was hammered down for $38.5 million — that’s $3.5 million more than the low estimate at which Guy Guarantor was providing the irrevocable bid. The total reported price for the painting was $43,202,500, including a buyer’s premium of $4,702,500. So Christie’s takes 15% of $3.5 million, or $525,000, and adds it to 50% of $4,702,500, which is $2,351,250. The total — $2,876,250 — is the amount that’s owed to Guy Guarantor under the terms of their deal.

That’s all fine, as far as I’m concerned. The buyer pays a total of $43,202,500, and that money gets divvied up between various parties. Christie’s gets some, Guy Guarantor gets some, and the seller, of course, gets most of it. As long as we know the amount the buyer is willing to spend on the painting, the auction market remains as transparent as it’s ever been.

But what happens if Guy Guarantor is the buyer? According to Thornton, the agreement is still in effect — which means that as he’s handing over a check for $43,202,500 with one hand, he’s simultaneously receiving a check for $2,876,250 with the other. The total amount the buyer pays, in this instance, is not $43,202,500, but rather $40,326,250.

That makes a difference. For one thing, if the work actually sold for $40,326,250 rather than $43,202,500, it would no longer be an auction record for the artist: “Ohhh… Alright…”, a 1964 canvas, sold in the same sale last year for $42,642,500. Is “I can see the whole room” the most expensive Lichtenstein ever sold at auction? According to Christie’s it is. But given Thornton’s reporting, there has to be some doubt about this.

I’ve got a call in to Christie’s about this, and we’ll see what they say, but I’ll only really be happy with one thing: a clear statement that a guarantor — or any other buyer, for that matter — cannot get any kind of rebate when he ends up being the high bidder. In order for published auction prices to mean anything, we need to know that the buyer actually paid the sum reported. Right now, we don’t know that — and in the case of the $43,202,500 Lichtenstein, there’s solid reason to believe that the price as reported by Christies, and embedded in places like the Artnet auction database, could actually be a lie.

(Incidentally, the Lichtenstein is a great poster child not only for auction-house opacity, but also for contemporary-art price appreciation. It was last sold for $2,090,000 in 1988 — and before that was sold for $450 in 1961. That’s a 50-year CAGR of somewhere over 25%.)

Update: Christie’s gets back to me, with this statement. The emphasis is mine:

When a third party agrees to finance all or part of Christie’s interest in a lot, it takes on all or part of the risk of the lot not being sold, and will be remunerated in exchange for accepting this risk. The third party may also bid for the lot. Where it does so, and is the successful bidder, the remuneration may be netted against the final purchase price. If the lot is not sold, the third party may incur a loss.

This seems to me an admission that the recorded final purchase price may indeed not be the actual price of the artwork to the buyer. And that therefore we can not trust that, to take just this example, a new artist record has just been set for Roy Lichtenstein. And, I can’t see how the third party will ever incur a loss, unless they never wanted the artwork in the first place. The worst-case scenario, for the guarantor, is that they end up buying the artwork for the amount they said they were willing to buy it for.

Update 2: TGDC and Auros, in the comments, make the case that Guy Guarantor really did pay the full $43,202,500:

He paid in in the form of the $40.3mm in net cash paid PLUS forgoing the $2.9mm he would have otherwise gotten had he not won. The guarantee is a sunk cost/gain since it happens in advance and is irrevocable. At the margin, he decided he’d rather have the painting than the $43mm in cash he’d have if he didn’t make that final bid. That is the market price.

If Guy had decided not to make a further bid above his original irrevocable $35M, he would’ve gone home with a paycheck. The service he provided, for that paycheck, has been renedered, whether he bids or not. The paycheck has to be considered separately from the cost of the art.

I think that TGDC is wrong that Guy Guarantor would have had $43 million in cash if he hadn’t made that final bid. In fact, to make that bid he needed only $40.3 million in cash. But the case here is definitely colorable. It just doesn’t change the fact that the buyer didn’t actually pay the amount he’s reported to have paid.

Update 3: I feel like I’m disappearing down a rabbit hole here, but I’m going to make one more stab at the question of Guy Guarantor’s cash situation. We can basically bring it down to two choices: either he buys the painting, or he doesn’t. (We’ll assume it’s hammered down for $38.5 million either way.) If he buys the painting, he’s down $40.3m in cash, and up one painting. If he doesn’t buy the painting, he’s up $2.9m in cash. So it’s reasonable to say that, in cash terms, the difference between buying and not buying is the difference between -$40.3m and +$2.9m, which is the headline $43.2m figure.

So here’s the question. When you make a purchase, is the amount you spend on that purchase the amount you spend on that purchase? Or does it make more sense to think of it as the difference between the amount of money you have after the transaction, on the one hand, and the amount of money you would have spent if you hadn’t made the transaction, on the other?

In the case of art, there’s a case to be made for looking at it either way. But by convention, sale prices never include sales tax. If I buy a painting at auction in New York and hang it in my New York apartment, I have to pay sales tax on that. But the price of the painting is not the full amount I pay; it’s just the price of the painting, sans tax. If auction results exclude sales tax for those people who pay it, they should also exclude the opportunity cost of guarantors’ foregone profit, I think.

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