Takeover Defenses
Introduction: The
purpose of adopting a takeover defense is to require a prospective purchaser to
submit the necessary information to allow shareholders to make an appropriate
decision and to secure time for the board of directors to consider counter measures
and present alternatives on the premise that it is the shareholders, not the
management, who should make a judgment on a takeover bid.
Meaning: A
welcome takeover is usually referring to a favorable and friendly takeover.
Friendly takeovers generally go smoothly because both companies consider it a
positive situation. In contrast, an unwelcome or hostile takeover can get
downright nasty. So, to escape from the hostile takeover offer, the targeted
company does some activities. These activities are called as Takeover Defenses.
Benefits
from using takeover defenses:
(1) Stall for more time
to find a White Knight, a potential acquirer who is sought out by a target
company's management to take over the company to avoid a hostile takeover by an
undesirable acquirer.
(2) Directly compete with
bidder (LBO, leveraged recap, Pac Man).
(3) Threaten high
transaction costs (litigation, etc.) as part of bargaining strategy.
Disadvantages
of using takeover defenses:
(1) High transaction
costs (lawyers, investment bankers, etc.).
(2) May deter some deals
that would have been profitable with weaker defenses.
Types of Takeover Defenses
The takeover defenses can
be classified as internal and external control measures. The internal measures refer
to actions taken by shareholders to influence corporate policy by exercising
voting rights. The external measures are taken in response to the actions of outside
bidders to gain control through the accumulation of a large block of shares.
(1) Internal Control Defenses: This
category consists of classified boards, special shareholder meetings, shareholder
action by written consent, and supermajority shareholder voting requirements. These
provisions do not directly affect the bidder's cost of accumulating a large
block of stock.
Classified Boards (Staggered Boards): Companies with classified board of directors elect
a portion (usually one-third) of their directors each year, with directors
serving multiyear (usually three-year) terms. A classified board has the effect
of deterring takeovers because a hostile acquirer waging a proxy contest would
have to win two successive elections in order to obtain voting control of the
board. This provides stability and continuity of leadership, but it also makes
it harder for dissidents to win control of a target company since only a third
of the directors are up for election in any one year. Such an endeavor would be
both time-consuming and expensive.
Special Shareholder Meetings: Special shareholder meetings are meetings other than
the annual meeting, when required. The Board of Directors may call a special
shareholder meeting when it has a significant item of corporate business that
requires shareholder approval. Special meetings may be called as designated in
the bylaws or state corporation statute, by the Board of Directors or by a
shareholder who has ownership of a designated percentage of stock of the
corporation. Similar to annual shareholder meetings, notice of special
shareholder meetings is also required.
Shareholder Action by Written Consent: When it is difficult for shareholders to physically
attend required meetings, they may conduct business by written consent without
holding a meeting. The authorization for action by written consent is typically
included in the bylaws. State corporate law generally defines shareholders'
right to act by written consent, a procedure in which written ballots are
executed and tabulated in the same manner as regular proxy cards. Some
companies have adopted charter or bylaw amendments that restrict or prohibit
shareholders from taking action by written consent without holding a meeting.
Supermajority Shareholder Voting Requirements: When shareholder approval is required to authorize
corporate action, the corporate laws of most states require only the approval
of a simple majority of outstanding shares, or 50% plus one for most actions.
However, the state laws may be default rules in the absence of a contrary
requirement in a company's charter or bylaws. Some companies, in their charter
or bylaws, provide that a higher vote than the one set by statute — usually
two-thirds, 75% or 80% of outstanding shares — is required to approve a
particular corporate action. Supermajority voting requirements make it more
difficult for an unsolicited takeover offer to be successful.
(2) External Control Defenses
External control measures
are those that directly impede or may be used to impede hostile acquisitions
and therefore work primarily through their effects on the external market for
control. This category consists of poison pills and blank check preferred stock,
which increases the bidder’s cost of acquisition.
Poison Pills (Shareholder Rights Plans): Poison pills are adopted when a board declares and pays a dividend consisting
of rights to purchase stock from the company. The rights are governed by a “rights
plan,” and a rights agent is appointed to act for rights holders in respect of
their rights, much as an indenture trustee would act for bondholders under an
indenture. If specified events occur (such as a hostile acquisition of more
than a specified amount of a company’s stock), the pill is triggered, and the
rights allow holders (other than a hostile bidder) to purchase stock at a
discounted price. The resulting dilution of the putative acquirer's interest
would make proceeding with a bid against the target board's approval a very
costly affair. In absence of shareholder approval requirement in a
company's charter or bylaws, the board of directors may adopt a poison pill
unilaterally. A shareholder rights plan may be adopted in response to an
unsolicited offer, or a board may adopt such a plan purely for preventative
purposes.
Blank Check Preferred Stock: This is a method companies use to simplify the
process of creating new classes of preferred stock to act as a takeover defense
in the event of a hostile bid for the company or raise additional funds from
sophisticated investors without obtaining separate shareholder approval. To do
this a company must amend its articles of incorporation to create a class of
unissued shares of preferred stock whose terms and conditions may be expressly
determined by the company's board of directors.
(3) Regulatory/Antitrust/Legal Defenses:
A) State Takeover Laws:
They impose rules that are similar to stringent charter amendments for all
corporations chartered in that state. Some of them include freezeout, control
share cashout, fair-price, and disgorgement statutes.
Freezeout Provisions: Freezeout provisions force an investor who surpasses
a certain ownership threshold in a company to wait a specified period of time
before gaining control of the company. Currently, 33 states have adopted
freezeout provisions. Freezeout periods range from two years to five years, an
unacceptable waiting period in most instances. Trigger thresholds vary from 5%
in Massachusetts to 25% in Maine
Control Share Cashout Provisions: Control share cashout provisions give dissident
shareholders the right to ‘cashout’ of their position in a company at the
expense of the shareholder who has taken a control position. In other words,
when an investor crosses a preset threshold level, remaining shareholders are
given the right to sell their shares to the acquirer, who must buy them at the
highest acquiring price. Maine , Pennsylvania , and South
Dakota
Fair-Price Provisions: Fair-price provisions
require the acquirer to pay a price set by formula for all shares acquired in
the back-end of an acquisition. The potential acquirer may offer a price for
the block of shares needed to gain control of the target company and
subsequently offer a lower price for the remaining shares. Fair-price provision
ensures that all the shares be bought at the same price reducing the raider’s
ability to discriminate between tendering and non-tendering shareholders. This
provision requires special approval of a merger proposal, often by a
supermajority of disinterested shareholders, in the event of a two-tiered
tender offer for the company's shares.
Disgorgement Provisions: Disgorgement provisions require that an acquirer or
potential acquirer of more than a certain percentage of a company's stock pay
back, or disgorge to the company any profits realized from the sale of that
company's stock purchased 24 months before achieving control status. All sales
of company stock by the acquirer occurring within a certain period of time
(between 18 months and 24 months) prior to the investor's gaining control status
are subject to these recapture-of-profits provisions. Ohio
and Pennsylvania
B) Antitrust Investigation:
This can slow down bid cases frequently and generally are started by someone in
the industry.
C) Interfirm Litigation:
This can be effective since target charges that bidder failed to disclose
something material in SEC filings.
(4) Other Defenses:
Anti-Greenmail Provision: Greenmailing is a variant of the corporate
raid strategy of asset
stripping whereby an undervalued company is taken over and sold off
for a profit. The Anti-Greenmail provision prohibits the target company to
repurchase the stock from the raider at a substantial premium to prevent a
takeover. As a majority shareholder may be able to influence the board into
purchasing shares at a significant premium, the anti-greenmail provision
requires that a majority of shareholders (excluding the majority shareholder)
agree to the buyback at the specified premium.
Golden Parachutes Provision: Golden Parachutes are lump sum payments made to
target management if fired due to takeover. It is a
payment or compensation package negotiated in advance and given to a director/officer
who loses his or her job as a result of a merger or acquisition. Golden
parachutes usually include a severance package, bonuses, the continuation of
benefits, vested stock options, and other perks. They are usually small
relative to size of deal, so probably not much deterrence effect.
Crown Jewel Defense: This is a contract to
sell attractive assets to a third bidder contingent on hostile bid.
Pac Man Defense: This allows the target
to make competing tender offer for shares of bidder.
Employee Stock Option Plans (ESOPs): Employees get equity claim in the firm, but
management votes the shares of the stock in ESOPs.
Black Knight: A
company that makes a hostile takeover offer on a target company.
An allusion to the fairytale villains, this term
demonstrates how a targeted company sees its adversary. Fairytale black knights
are associated with kidnapping princesses, slaying peasants, burning villages,
and generally having unpleasant personalities.
Gray Knight: A
second, unsolicited bidder in a corporate takeover. A gray knight enters the
scene in order to take advantage of any problems between the first bidder and
the target company. Think of a gray
knight as a circling vulture waiting to pick clean the leftovers. In some parts
of the world gray is spelled "grey."
White Knight:
A company that
makes a friendly takeover offer to a target company that is being faced with a
hostile takeover from a separate party.
Yellow Knight: A company that was once making a
takeover attempt but ends up discussing a merger with the target company.
Suicide Pill: A defensive strategy by which a target
company engages in an activity that might actually ruin the company
rather than prevent the hostile takeover. Also known as the "Jonestown
Defense”.
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