20.11Management Defenses

Incumbent managers have come up with a number of defensive strategies to fight off

unwanted takeover attempts. These include the following:

•	Paying greenmail, or buying back the bidder’s stock at a substantial premiumover its market price on condition that the bidder suspend his or her bid.
•	Creating staggered board termsand supermajority rules, which can keep a bidder from taking over the firm even if he or she accumulates more than 50 percent of the target firm’s shares.
•	Introducing poison pills, which provide valuable rights to target shareholderswho choose not to tender their shares.
•	Lobbying for antitakeover legislation.

Greenmail

Stock prices generally drop when firms pay greenmail to large shareholders who are try-

ing to take over the firm. In 1984, for example, David Murdoch, who owned about 5

percent of Occidental Petroleum’s stock, put pressure on Occidental’s management to

take actions to improve the value of its stock. Rather than change its policies, the firm

bought Murdoch’s shares at a substantial premium over their market price. They paid

$40.10 for shares that had a market price of $28.75 just before the announcement of the

purchase. In other words, they paid a premium of 42 percent over the market price for

Murdoch’s shares, giving him a gain of over $56 million. On the announcement of the

repurchase, the share price of Occidental dropped $0.875, indicating a reduction in the

market value of the firm of more than $80 million. This $80 million loss underestimates

the true drop in the firm’s market value created by this buyout since the price of Occi-

dental’s stock declined prior to the announcement of the buyback once shareholders

began to anticipate—not only that Murdoch might receive a $56 million gift—but, more

importantly, that he would be unsuccessful in getting the firm to change its policies.

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728Part VIncentives, Information, and Corporate Control

Staggered Boards and Supermajority Rules

An acquirer does not necessarily gain control of a target firm after acquiring more than

50 percent of its stock. Many corporations have supermajority rules that require share-

holder approval by at least a two-thirds vote and sometimes as much as 90 percent of

the shares before a change in control can be implemented. In most cases, the board of

directors can override the supermajority provision, but gaining control of the board can

be difficult. Board members are often elected to three-year terms which are generally

staggered, so that in any given year, only one-third of the board members are elected.

Poison Pills

Poison pills, first introduced in the mid-1980s, are the most effective takeover defense

and thus warrant the most discussion. Poison pills are rights or securities that a firm

issues to its shareholders, giving them valuable benefits in the event that a significant

number of its shares are acquired. There are many varieties of poison pills, but all share

the basic attribute that they involve a transfer from the bidder to shareholders who do

not tender their shares, thereby increasing the cost of the acquisition and decreasing the

incentives for target shareholders to tender at any given price.

FlipoverRights Plans.The most popular poison pill defense is generally referred to

as the flipoverrights plan.¹⁹

Under this plan, target shareholders receive the right to

purchase the acquiring firm’s stock at a substantial discount in the event of a merger.

For example, if Alpha Corporation acquires Beta shares and then proceeds with a merger,

existing Beta shareholders will receive rights to purchase Alpha stock at 50percent of

its value in the event the merger is consumated. This would make the merger

prohibitively expensive for Alpha, which would be reluctant to proceed with the merger

unless the poison pill was rescinded. In most cases, poison pills can be rescinded by the

board of directors at a trivial cost to allow mergers which they believe are in the

shareholders’interest to be implemented.

How Effective Are Poison Pills?Poison pills have been effective in allowing man-

agers to delay unwanted takeovers and to bargain more effectively with potential acquir-

ers. However, they do not always make managers completely immune to unwanted

takeovers. In many cases, bidders have taken target managers to court and have forced

them to remove a poison pill. Comment and Schwert (1995) concluded that although

poison pills have undoubtedly deterred some takeovers, these cases are relatively rare.

Their evidence suggests that the decline in takeovers in the late 1980s and early 1990s

was not due to poison pills and antitakeover laws but to the demise of the junk bond

market and the credit crunch at commercial banks that occurred at about the same time.

The boom in the takeover market in the 1990s, when credit markets recovered, pro-

vides further support for this claim. However, as we mentioned earlier, almost all of

the takeovers in this period were friendly.

Antitakeover Laws

Afurther deterrent to hostile takeovers were the antitakeover laws passed by various

states in the late 1980s. Many of these laws prevent an investor who obtains a large

¹⁹For

more information on poison pill defenses, see Weston, Chung, and Hoag (1990).

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Strategy, Second Edition

Chapter 20

Mergers and Acquisitions

729

proportion of the target’s outstanding shares (for example, 20 percent), from voting

those shares. Other laws allow directors to consider the interests of nonfinancial stake-

holders like employees and the community when considering a takeover offer. Direc-

tors are thus free to turn down an offer that provides a substantial premium over the

current share price if they believe, for example, that the takeover will result in layoffs.

Are Takeover Defenses Good for Shareholders?

There has been an active debate about how good or bad these defensive actions are for

shareholders. On the one hand, it is argued that takeover defenses do no more than

keep entrenched managers in power. Adefensive action that prevents the success of an

offer of $50 per share cannot be in the interests of shareholders if it results in the firm

staying independent with a share price of $40. On the other hand, defensive actions

sometimes result in the bidder making a higher offer which, of course, benefits target

shareholders. For example, a bidder who would otherwise bid $50 per share may be

willing to raise his bid to $55 to prevent management resistance.

Evidence on the reaction of stock prices to management defensive actions has been

mixed. In some cases, share prices increase following the announcement of a defen-

sive action while in others the price decreases. Jarrell and Poulsen (1987) documented

that antitakeover amendments, on average, lead to negative changes in the price of the

target’s stock. However, the stock price reaction is not always negative and is, on aver-

age, positive when a large percentage of the firm is held by institutional investors who

presumably are better able to block a proposed amendment that hurts shareholder value.

This evidence is consistent with the hypothesis that the majority of antitakeover amend-

ments hurt target shareholders, but on occasion their implementation may be in the

shareholders’interests.