This article is written by Aditya Kasiraman who is pursuing a Diploma in M&A, Institutional Finance and Investment Laws (PE and VC transactions) from LawSikho.
Much has been written, often in a horrible and intimidating language, about taking aggressive action and the various steps companies take to prevent it. While many articles and books cover such events from the perspective of investment banks and corporate executives, little has been written about the impact of shareholding on targeted companies. However, these shareholders may experience serious financial consequences when the target company’s board uses a defense or signals its intention to do so by adding defensive measures to the corporate constitution following the news of when it will be taken over.
To test the balance of withdrawals, shareholders need to identify and understand the various security strategies companies use to avoid one. These shark repellent methods can both work to prevent hostile takeovers and to damage stock prices. This article will discuss the effects of some of the more common methods of expelling shark repellents and poison pills.
Martin Lipton is an American attorney known in 1982 for creating a dividend scheme, best known as a shareholder rights program. At the time, the companies facing a hostile takeover had a few defensive tactics against corporate attackers, men like Carl Icahn and T. Boone Pickens, who would buy large stakes from companies in an effort to gain control.
The shareholder rights program comes into effect immediately after the potential acquirer reveals their takeover plan. These programs offer existing shareholders the opportunity to purchase additional company stock at a discounted price. Shareholders are tempted by the low price of buying more stock, thus reducing the percentage of ownership of the acquirer. This makes the acquisition more expensive for the acquirer and may interfere with the full acquisition. At the very least, it gives the company’s board of directors time to evaluate other offers.
Shareholder rights program is a form of “poison pill” strategy because it makes the identified company harder to swallow. For shareholders, however, a poison pill can have side effects.
This came in July 2018 when the board of directors of Papa John’s International Inc.’s (PZZA) voted to add a shareholder rights program to its agreement to prevent fired founder John Schnatter from gaining control of the company. The move has led to an increase in the company’s general stock price, making it more expensive for Schnatter’s takeover plan.
While the poison pill prevented Papa John’s hostile takeover, its positive shareholder results were short-lived. The peak of stocks declined sharply after the threat of a cashback, declined by more than 25% within a few weeks.
In addition to causing a temporary increase in stock prices, shareholder rights programs can have a detrimental effect on preventing shareholders from reaping any potential benefits if the cash flow is successful.
The voting rights system is the section which a company’s board of directors adds to its constitution in an effort to regulate voting rights for pre-determined shareholders of a company. For example, shareholders may be barred from voting on certain issues if their ownership is more than 20% of the remaining shares. Administrators may use voting rights programs as a precautionary measure to prevent potential voters from accepting or rejecting a bid to be taken.
Administrators can also use the voting rights system to require a larger vote to agree to a meeting. Instead of obtaining a 51% stakeholder approval, the voting rights system would mean that 80% of shareholders would have to agree to a merger. With such a strong clause, many corporate attackers may find it impossible to control the company.
Companies often find it difficult to convince shareholders that such phrases are helpful, especially since they may prevent shareholders from making a profit. In fact, the adoption of voting rights clauses often follows a decline in the price of a company’s stock.
This defense strategy is based on making it time consuming to vote for the entire board of directors, thus enabling the representative to challenge the challenger. Instead of having the entire board come to the election at the same time, the staggered board of directors means that the directors are elected at different times for many terms.
As the raider aspires to fill the company board with friendly directors in the capture systems, having a non-stop board means it will take time for the raider to be able to control the company with a proxy fight. The target company hopes that the attacker will lose interest rather than take part in a long battle. While hiring a staggered board of directors can help company executives, there is no direct benefit to shareholders.
Greenmail is where the target company agrees to buy back its shares from the prospective attacker at a higher price to prevent hostile takeover. This name is derived from a combination of “blackmail” and “greenbacks” (dollars). Instead of receiving a premium, the attacker will agree to stop hostility attempts.
Example of Greenmail
Activist Carl Icahn is best known for his use of greenmail to force companies to repurchase their shares from him or risk their chances of a hostile takeover. In the 1980s, Icahn used the greenmail strategy when he threatened to control Marshall Field, Phillips Petroleum, and Saxon Industries. In the case of Saxon Industries, a New York specialty paper distributor, Icahn bought 9.5% of the company’s standard stock. To get Icahn to agree not to fight, Saxon paid $ 10.50 per share to buy back its shares from Icahn. This represented a 45.6% profit on Icahn, who initially paid an estimated $ 7.21 per share.
Following the announcement that the executives were defeated by the payment strategy, Saxon’s stock prices dropped to $ 6.50 per share, providing a clear example of how shareholders could lose out even if they avoid being forcibly taken over.
The white knight’s plan enables the company’s management to prevent the hostile buyer by selling the company’s assets to a customer whom they find to be very friendly. The company sees the friendly buyer as a working partner, who is likely to keep the current management in place and who will give shareholders a better value for their shares.
In general, the protection of white knight is considered to be beneficial to shareholders, especially when managers are tired of all other means of avoiding hostile takeovers. However, this strategy won’t work when the merger price is low or when the combined value of the two companies fails to meet the expected financial returns.
Example of a White Knight Strategy
In 2008, international investment bank Bear Stearns demanded a white knight after suffering catastrophic losses during a global credit crisis. Investment in the company’s stock market had dropped by 92%, making it a victim of a hostile takeover and at risk of a collapse. White knight JPMorgan Chase & Co (JPM) agreed to buy Bear Stearns for $ 10 per share. While this was far from the $ 170 per share the company traded a year earlier, the offer rose from the $ 2 per share JPMorgan Chase originally offered to shareholders.
Corporate executives may deliberately increase their debt as a precautionary measure against a hostile takeover. The purpose is to create concern about the company’s ability to make repayment after the acquisition is completed. The risk, of course, is that any major debt liability may adversely affect the company’s financial statements. If this happens, then shareholders may be left with a heavy burden of this strategy as stock prices fall. For this reason, an increase in debt is often seen as a strategy that in the short term helps the company to avoid a hostile takeover, but over time it can hurt shareholders.
Compared with the increase in debt, making strategic acquisitions can be beneficial to shareholders and can represent a more effective option to avoid hostile takeovers. Company executives may acquire another company with a combination of stock, credit, or stock swaps. This would make corporate invaders’ attempts to a takeover more expensive by reducing the percentage of their ownership. Another benefit for shareholders is that if the management of the company works diligently in selecting the right company for them, the shareholders will benefit from long-term partnerships and earnings.
This defense is often referred to as the Pac-Man defense, named after the popular video game. The target company captures the unwanted development of the acquiring company by making its own bid to control the acquiring company. This approach is rarely effective and puts the company at risk of becoming heavily indebted. Shareholders may end up paying for this expensive strategy with lower share prices or lower dividend payments.
The triggered stock option vesting results from a clause by the board of directors to the company’s constitution applicable only in the event of a company acquisition. The clause states that in the event of a change in management of a company, all unvested stock options are automatically opened and must be paid to employees by the acquiring company.
This strategy avoids hostile investors because of the high costs involved and because it can lead to skilled employees selling their stock and leaving the company. Shareholders often do not benefit from the inclusion of this clause because it often leads to a decline in stock prices.
Poison Pills and Shark Repellents have declined, and the percentage of Standard & Poor’s 1500 Index companies with a poison pill clause dropped to 4% at the end of 2017, according to 2018 data from the ISS Governance US Board Study. In contrast, 54% of companies had one in 2005. The S&P 1500 index includes Standard & Poor’s 500 (S&P 500), Standard & Poor’s MidCap 400 (S&P 400), and Standard & Poor’s SmallCap 600 (S&P 600).
The decline in popularity is due to a number of factors, including the growing advocacy for hedge funds, shareholders’ desire for acquisition, stopping the board of directors from an action to add defensive strategies, and the elimination of these clauses over time.
The effect of anti-takeover strategies by shareholders often depends on the management’s recommendations. If the management feels that taking the money will lead to a decline in the company’s ability to grow and make a profit, the right course of action would be to use all available strategies to prevent such a takeover. If executives do their due diligence and see that the acquisition can benefit the company and in addition its shareholders, managers can carefully use certain strategies as a way to increase the purchase price without compromising on the agreement. However, if managers are only encouraged to protect their interests, then they may be tempted to use any defensive strategies they may deem necessary, regardless of the impact on the shareholders.
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