Shareholder rights plan
A shareholder rights plan, colloquially known as a "poison pill", is a type of defensive tactic used by a corporation's board of directors against a takeover. In the field of mergers and acquisitions, shareholder rights plans were devised in the early 1980s as a way for directors to prevent takeover bidders from negotiating a price for sale of shares directly with shareholders, and instead forcing the bidder to negotiate with the board. Shareholder rights plans are unlawful without shareholder approval in many jurisdictions such as the United Kingdom, frowned upon in others such as throughout the European Union, and lawful if used "proportionately" in others, including Delaware in the United States.
The typical shareholder rights plan involves a scheme whereby shareholders will have the right to buy more shares at a discount if one shareholder buys a certain percentage of the company's shares. The plan could be triggered, for instance, when any one shareholder buys 20% of the company's shares, at which point every shareholder (except the one who possesses 20%) will have the right to buy a new issue of shares at a discount. The plan can be issued by the board as an "option" or a "warrant" attached to existing shares, and only be revoked at the discretion of the board of directors. A shareholder who can reach a 20% threshold will potentially be a takeover bidder. If every other shareholder will be able to buy more shares at a discount, such purchases will dilute the bidder's interest, and the cost of the bid will rise substantially. Knowing that such a plan could be called on, the bidder could be disinclined to the takeover of the corporation without the board's approval, and will first negotiate with the board so that the plan is revoked.
Shareholder rights plans, or poison pills, are controversial because they hinder an active market for corporate control. Further, giving directors the power to deter takeovers puts directors in a position to enrich themselves, as they may effectively ask to be compensated for the price of consenting to a takeover.
The poison pill was invented by mergers and acquisitions lawyer Martin Lipton of Wachtell, Lipton, Rosen & Katz in 1982, as a response to tender-based hostile takeovers. Poison pills became popular during the early 1980s in response to the wave of takeovers by corporate raiders such as Carl Icahn. The term "poison pill" derives its original meaning from a poison pill physically carried by various spies throughout history, a pill which was taken by the spies when they were discovered to eliminate the possibility of being interrogated by an enemy.
It was reported in 2001 that since 1997, for every company with a poison pill which successfully resisted a hostile takeover, there were 20 companies with poison pills that accepted takeover offers. The trend since the early 2000s has been for shareholders to vote against poison pill authorization, since poison pills are designed to resist takeovers, whereas from the point of view of a shareholder, takeovers can be financially rewarding.
Some have argued that poison pills are detrimental to shareholder interests because they perpetuate existing management. For instance, Microsoft originally made an unsolicited bid for Yahoo!, but subsequently dropped the bid after Yahoo! CEO Jerry Yang threatened to make the takeover as difficult as possible unless Microsoft raised the price to US$37 per share. One Microsoft executive commented, "They are going to burn the furniture if we go hostile. They are going to destroy the place." Yahoo has had a shareholders rights plan in place since 2001. Analysts suggested that Microsoft's raised offer of $33 per share was already too expensive, and that Yang was not bargaining in good faith, which later led to several shareholder lawsuits and an aborted proxy fight from Carl Icahn. Yahoo's stock price plunged after Microsoft withdrew the bid, and Jerry Yang faced a backlash from stockholders that eventually led to his resignation.
In publicly held companies, "poison pills" refer to various methods to deter takeover bids. Takeover bids are attempts by a bidder to obtain control of a target company, either by soliciting proxies to get elected to the board or by acquiring a controlling block of shares and using the associated votes to get elected to the board. Once in control of the board, the bidder can manage the target. As discussed below, targets have various takeover defenses available, and several types of defense have been called "poison pills" because they harm not only the bidder, but the target (or its shareholders) as well. Currently, the most common type of takeover defense is a shareholder rights plan.
Because the board of directors of the company can redeem or otherwise eliminate a standard poison pill, it does not typically preclude a proxy fight or other takeover attempts not accompanied by an acquisition of a significant block of the company's stock. It can, however, prevent shareholders from entering into certain agreements that can assist in a proxy fight, such as an agreement to pay another shareholder's expenses. In combination with a staggered board of directors, however, a shareholder rights plan can be a defense.
The target company issues rights to existing shareholders to acquire a large number of new securities, usually common stock or preferred stock. The new rights typically allow holders (other than a bidder) to convert the right into a large number of common shares if anyone acquires more than a set amount of the target's stock (typically 15%). They dilute the percentage of the target owned by the bidder, and make it more expensive to acquire control of the target. This form of poison pill is sometimes called a shareholder rights plan because it provides shareholders (other than the bidder) with rights to buy more stock in the event of a control acquisition.
The goal of a shareholder rights plan is to force a bidder to negotiate with the target's board and not directly with the shareholders. The effects are twofold:
- It gives management time to find competing offers that maximizes selling price.
- Several studies indicate that companies with poison pills (shareholder rights plans) have received higher takeover premiums than companies without poison pills. This results in increased shareholder value. The theory is that an increase in the negotiating power of the target is reflected in higher acquisition premiums.
Common types of poison pills
A "dead-hand" provision allows only the directors who introduce the poison pill to remove it (for a set period after they have been replaced), so potentially delaying a new board’s decision to sell a company.
Constraints and legal status
The legality of poison pills had been unclear when they were first put to use in the early 1980s. However, the Delaware Supreme Court upheld poison pills as a valid instrument of takeover defense in its 1985 decision in Moran v. Household International, Inc. However, many jurisdictions other than the U.S. have held the poison pill strategy as illegal, or place restraints on their use.
In Canada, almost all shareholders rights plans are "chewable", meaning they contain a permitted bid concept such that a bidder who is willing to conform to the requirements of a permitted bid can acquire the company by take-over bid without triggering a flip-in event. Shareholder rights plans in Canada are also weakened by the ability of a hostile acquirer to petition the provincial securities regulators to have the company's pill overturned. Generally, the courts will overturn the pill to allow shareholders to decide whether they want to tender to a bid for the company. However, the company may be allowed to maintain it for long enough to run an auction to see if a white knight can be found. A notable Canadian case before the securities regulators in 2006 involved the poison pill of Falconbridge Ltd. which at the time was the subject of a friendly bid from Inco and a hostile bid from Xstrata plc, which was a 20% shareholder of Falconbridge. Xstrata applied to have Falconbridge's pill invalidated, citing among other things that the Falconbridge had had its pill in place without shareholder approval for more than nine months and that the pill stood in the way of Falconbridge shareholders accepting Xstrata's all cash offer for Falconbridge shares. Despite similar facts with previous cases in which securities regulators had promptly taken down pills, the Ontario Securities Commission ruled that Falconbridge's pill could remain in place for a further limited period as it had the effect of sustaining the auction for Falconbridge by preventing Xstrata increasing its ownership and potentially obtaining a blocking position that would prevent other bidders from obtaining 100% of the shares.
In the United Kingdom, poison pills are not allowed under the Takeover Panel rules. The rights of public shareholders are protected by the Panel on a case-by-case, principles-based regulatory regime. One disadvantage of the Panel's prohibition of poison pills is that it allows bidding wars to be won by hostile bidders who buy shares of their target in the marketplace during "raids". Raids have helped bidders win targets such as BAA plc and AWG plc when other bidders were considering emerging at higher prices. If these companies had poison pills, they could have prevented the raids by threatening to dilute the positions of their hostile suitors if they exceeded the statutory levels (often 10% of the outstanding shares) in the rights plan. The London Stock Exchange itself is another example of a company that has seen significant stakebuilding by a hostile suitor, in this case the NASDAQ. The LSE's ultimate fate is currently up in the air, but NASDAQ's stake is sufficiently large that it is essentially impossible for a third party bidder to make a successful offer to acquire the LSE.
Takeover law is still evolving in continental Europe, as individual countries slowly fall in line with requirements mandated by the European Commission. Stakebuilding is commonplace in many continental takeover battles such as Scania AB. Formal poison pills are quite rare in continental Europe, but national governments hold golden shares in many "strategic" companies such as telecom monopolies and energy companies. Governments have also served as "poison pills" by threatening potential suitors with negative regulatory developments if they pursue the takeover. Examples of this include Spain's adoption of new rules for the ownership of energy companies after E.ON of Germany made a hostile bid for Endesa and France's threats to punish any potential acquiror of Groupe Danone.
Other takeover defenses
Poison pill is sometimes used more broadly to describe other types of takeover defenses that involve the target taking some action. Although the broad category of takeover defenses (more commonly known as "shark repellents") includes the traditional shareholder rights plan poison pill. Other anti-takeover protections include:
- Limitations on the ability to call special meetings or take action by written consent.
- Supermajority vote requirements to approve mergers.
- Supermajority vote requirements to remove directors.
- The target adds to its charter a provision which gives the current shareholders the right to sell their shares to the acquirer at an increased price (usually 100% above recent average share price), if the acquirer's share of the company reaches a critical limit (usually one third). This kind of poison pill cannot stop a determined acquirer, but ensures a high price for the company.
- The target takes on large debts in an effort to make the debt load too high to be attractive—the acquirer would eventually have to pay the debts.
- The company buys a number of smaller companies using a stock swap, diluting the value of the target's stock.
- The target grants its employees stock options that immediately vest if the company is taken over. This is intended to give employees an incentive to continue working for the target company at least until a merger is completed instead of looking for a new job as soon as takeover discussions begin. However, with the release of the "golden handcuffs", many discontented employees may quit immediately after they've cashed in their stock options. This poison pill may create an exodus of talented employees. In many high-tech businesses, attrition of talented human resources often means an empty shell is left behind for the new owner.
- Peoplesoft guaranteed its customers in June 2003 that if it were acquired within two years, presumably by its rival Oracle Corporation, and product support were reduced within four years, its customers would receive a refund of between two and five times the fees they had paid for their Peoplesoft software licenses. The hypothetical cost to Oracle was valued at as much as US$1.5 billion. Peoplesoft allowed the guarantee to expire in April 2004. If PeopleSoft had not prepared itself by adopting effective takeover defenses, it is unclear if Oracle would have significantly raised its original bid of $16 per share. The increased bid provided an additional $4.1 billion for PeopleSoft's shareholders.
- Classified boards with staggered elections for the board of directors. For example, if a company had nine directors, then three directors would be up for re-election each year, with a three-year term. This would present a potential acquirer with the position of having a hostile board for at least a year after the first election. In some companies, certain percentages of the board (33%) may be enough to block key decisions (such as a full merger agreement or major asset sale), so an acquirer may not be able to close an acquisition for years after having purchased a majority of the target's stock. As of December 31, 2008, 47.05% of the companies in the S&P Super 1500 had a classified board.
More companies are giving shareholders a say on poison pills. According to FactSet SharkRepellent data, so far this year, 21 companies that adopted or extended a poison pill have publicly disclosed they plan to put the poison pill to a shareholder vote within a year. That's already more than 2008's full year total of 18 and in fact is the most in any year since the first poison pill was adopted in the early 1980s.
Other uses of the term poison pill
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In professional sports, a poison pill is a component of a contract, which one team offers a player, that makes it difficult or impossible for another team (which has the right of first refusal) to match. While it can often refer to a salary structure or clause that would affect all teams equally, it has taken on a new specific meaning of a clause that has unbalanced impact. For example, in March 2006, the Minnesota Vikings offered Steve Hutchinson, an offensive guard with the Seattle Seahawks, a seven-year, $49 million contract of which $16 million was guaranteed. This contract offer had two poison pills in it. One was the salary structure, which would require the team to pay $13 million in the first year of the contract. That salary structure would apply to both teams equally, as the Seahawks would also have to pay $13 million in the first contract year, were they to match the offer. The second was a clause that required Hutchinson to be the highest paid player on the offensive line, or else the entire contract would be guaranteed. Since the Seahawks had another offensive lineman, Walter Jones, with a higher salary and the Vikings did not, this clause would have required the Seahawks to guarantee $49 million, and it effectively eliminated the Seahawks' opportunity to match the contract offer.
In the wake of this contract offer, similar clauses have appeared in other contract offers, including a contract offered to Vikings wide receiver Nate Burleson by the Seahawks, which, with irony fully intended, was structured as a seven year, $49 million deal. The contract given to Burleson had two vengeful poison pill clauses in response to the contract offered to Hutchinson. Firstly, it stipulated that if Burleson were to play five or more games in the state of Minnesota during any single season over the life of the contract, the entire $49 million would become guaranteed. Secondly, if Burleson were to earn more per year on average than all of his team's running backs combined, the $49 million would be guaranteed. Since the Vikings play half of their games at home in Minnesota, and their running backs combined earned less per year than the $7 million in Burleson's contract, Minnesota was unable to match it.
In August 2008, Brett Favre was traded from the Green Bay Packers to the New York Jets. The Jets would have had to surrender three first-round draft picks to Green Bay if they were to trade Favre to the Minnesota Vikings, a division rival of the Packers. The deal ultimately backfired on the Packers, as Favre asked for (and was given) a release by the Jets the following year, leaving him free to sign with the archrival Vikings for the 2009 NFL season.
The NFL's collective bargaining agreement has many poison pills, should either the players or owners, or both, allow it to reach its final year, including an increase in the requirement for unrestricted free agency from four seasons to six, the lack of a salary cap, and restrictions on the ability of top teams to sign free agents. Because these terms would theoretically be disagreeable to both sides, it effectively aims to make sure that should the agreement be broken it would be in the best interests of both sides to agree to new terms. Nevertheless, the NFLPA and NFL owners did not reach a new agreement before the end of the 2009–2010 season, and those poison pills went into effect.
A poison pill may also be used in politics, such as attaching an amendment so distasteful to a bill that even the bill's supporters are forced to vote against it. This manipulative tactic may be intended to simply kill the bill, or to create a no-win situation for the bill's supporters, so that the bill's opponents can accuse them of voting for something bad no matter what. This is known as a "wrecking amendment".
In a democratic system, fiscal or budgetary policies that are designed by an incumbent administration to make things more difficult for the next administration have been referred to as fiscal poison pills.
- Harvard Business School, Case Study 9-496-037, page 5
- Poison Pill Popping - CFO Magazine - October 2001 Issue - CFO.com
- "Yahoo weighs up options". Financial Times. Retrieved 2008-02-03.
- "Microsoft Withdraws Proposal to Acquire Yahoo!". Microsoft. Retrieved 2008-05-03.
- Lohr, Steve (2008-05-05). "Microsoft's Failed Yahoo Bid Risks Online Growth". New York Times. Retrieved 2008-05-06.
- See Bebchuk, Lucian; Coates, John C.; Subramanian, Guhan (2002). "The Powerful Antitakeover Force of Staggered Boards: Theory, Evidence, and Policy". Stanford Law Review (Stanford Law Review) 54 (5): 887–951. doi:10.2307/1229689. JSTOR 1229689.
- For a description of a standard rights plan, see Wachtell, Lipton, Rosen & Katz, The Share Purchase Rights Plan in Ronald J. Gilson & Bernard S. Black, The Law and Finance of Corporate Acquisitions (2d ed. Supp. 1999) at 10-18.
- Fundamentals of Corporate Finance (6th ed.), Editions McGraw-Hill Ryerson, §23: Mergers and Acquisitions
- Krugman: Fiscal poison pill - International Herald Tribune
- LA Bebchuk, JC Coates and G Subramanian, 'The Powerful Antitakeover Force of Staggered Boards: Theory, Evidence, and Policy' (2002) 54(5) Stanford Law Review 887–951
- M Kahan, 'How I Learned to Stop Worrying and Love the Pill: Adaptive Responses to Takeover Law' (2002) 69 University of Chicago Law Review 871
- Wachtell, Lipton, Rosen & Katz, The Share Purchase Rights Plan in Ronald J. Gilson & Bernard S. Black, The Law and Finance of Corporate Acquisitions (2d ed. Supp. 1999)
- Ross, Westerfield, Jordan & Roberts, Fundamentals of Corporate Finance (6th ed. McGraw-Hill Ryerson) §23: Mergers and Acquisitions
- SharkRepellent The definitive source for poison pill and takeover defense information.
- Institute of Mergers, Acquisitions and Alliances (MANDA) M&A An academic research institute on mergers & acquisitions, incl. takeover battles & poison pills