The Controversial ‘Poison Pil’ Takeover Defense: How valid are the Arguments in Support of it?

Abstract

In today’s world of business, Mergers and Acquisitions (M&A) are an indispensable part of corporate strategy. However, not all mergers and acquisitions are friendly and the threat of hostile takeovers has led to the development of a wide range of anti-takeover defenses. This paper looks at one of the most controversial takeover defenses, the ‘poison pill’. This assumes significance in light of the fact that M&As, including hostile takeovers, are not merely a North American phenomena and defensive tactics used in this region are spreading to other regions. This paper examines the merits of various arguments used in support of the poison pill taking into consideration previous research on takeover defenses. It finds that poison pills have a strong deterrent effect on takeovers and the bargaining power argument does not provide sufficient economic rationale for shareholders to leave the decision to the board. The paper concludes that the use of a poison pill without a provision for shareholders review, particularly when combined with an effective staggered board, strongly suggests that management entrenchment and shareholder activism in this direction is a natural consequence. The paper recommends design of takeover defenses that align the interests of both shareholders and management

Introduction:

In 2007, the value of announced Mergers and Acquisitions (M&A) crossed the $ 4 trillion mark (Capaldo, Dobbs and Suonio, 2008). This is higher than the GDP of many countries and highlights the importance of M&A in today’s world of business. Many companies consider M&A an indispensable part of their corporate strategy (Harding, Shankar and Jackson, 2013; Singh, 2012) and according to Lovallo, Viguerie, Uhlaner and Horn (2007), 30% of the growth of large corporations come from M&A. As more and more companies turn to M&A in their quest for growth, the worldwide number and value of M&A will continue to rise. Earlier, M&A were seen as a North American phenomenon; however, the trend changed in the 90’s with other regions like Europe and Asia Pacific contributing significantly to worldwide M&A statistics (Black, 2000, Gaughan, 2011). With a number of high value M&A deals being reported from emerging economies (Anandan, Kumar, Kumra and Padhi, 1998; Chakravarti, 2013; Kumar, 2009), one can now safely label M&A as a worldwide phenomenon.

Most M&A are friendly, which means that the directors of the acquirer and the target negotiate and finalize a mutually acceptable deal. However, when the negotiations fail, the acquirer is left with the option of either backing off or mounting a hostile takeover. In case of a hostile takeover, the acquirer makes a direct tender offer to the shareholders of the firm to buy the required number of shares. When a hostile bid is made (or anticipated), the board of the target can either remain passive letting the shareholders decide, or mount defenses to protect the company from being taken over. Some of the defenses available to the target are given in appendix -1. Of the various defenses listed, the poison pill is considered extremely effective in preventing or delaying takeovers (Barry and Hatfield, 2012; Mallette and Fowler, 1992; Subramanian, 2003). At the same time, it is also one of the most controversial of defenses and its use is questioned by a number of researchers (Bebchuk & Farrell, 2001; Gruener, 2005; Macey, 1998).

This paper looks at various arguments made by the proponents of the poison pill and examines the validity of these arguments from a shareholders perspective. Using the findings reported by various researchers on the deterrent value of the poison pill and increase in takeover premiums, the paper uses a simple decision tree analysis to examine the validity of the bargaining power argument used in support of the pill. Other arguments favouring the use of the poison pill are also examined to see if the pill is beneficial to the shareholders. In the following section, a brief overview of the poison pill is provided. It is followed by a section that explores the controversy surrounding the poison pill by looking at the arguments for and against it. The subsequent section examines the arguments in favour of the pill from the perspective of the shareholder and in the final section, conclusions are drawn and recommendations made.

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