Corporate takeovers became a prominent feature of the U.S. business landscape during the 1970s and 1980s. Hostile acquisitions generally involve poorly performing firms in mature industries and occur when the board of directors of the target is opposed to the sale of the company. In this case, the acquiring firm has two options to proceed with the acquisition—a tender offer or a proxy fight.
Tender Offers and Proxy Fights
A tender offer represents an offer to buy the stock of the target firm either directly from the firm’s shareholders or through the secondary market. The purchaser typically offers a premium price to encourage the shareholders to sell their shares. The offer has a time limit, and it may have other provisions that the target company must abide by if shareholders accept the offer. The bidding company must disclose its plans for the target company and file with the SEC. Sometimes, a purchaser or group of purchasers will gradually buy up enough stock to gain a controlling interest (known as a creeping tender offer), without making a public tender offer. This is risky because the target company could discover the attempted takeover and take steps to prevent it.
Because it allows bidders to seek control directly from shareholders— by going “over the heads” of target management—the tender offer is the most powerful weapon available to the hostile bidder. Indeed, just the threat of a hostile tender offer can often bring a recalcitrant target management to the bargaining table, especially if the bidder already owns a substantial block of the target’s stock and can demonstrably afford to finance a hostile offer for control. Although hostile bidders still need a formal agreement to gain total control of the target’s assets, this is often easily accomplished once the bidder has purchased a majority of voting stock.
When there are strong differences between a board and a company’s shareholders about the firm’s long-term strategy, its executive compensation policies, or a merger or acquisition proposal, a proxy fight is likely to ensue. This occurs when the board sends out its proxy statement in which it seeks shareholder approval for a variety of actions. Proxy contests are usually waged to replace members of the board of directors, but they can also be used to gain support in other efforts like an acquisition. They tend to involve publicly traded companies but can also target closed-end mutual funds.
A leveraged buyout (LBO) is a variation of a hostile takeover. In an LBO, the buyer borrows heavily to pay for the acquisition, either from traditional bank loans or through high-yield (junk) bonds. This can be risky, since incurring so much debt can seriously harm the value of the acquiring company.
The management and directors of target firms may resist takeover attempts either to get a higher price for the firm or to protect their own self-interests. The most effective methods are built-in defensive measures that make a company difficult to take over. These methods are collectively referred to as “shark repellent.” Here are a few examples:
- A golden parachute, or change-of-control agreement, is an agreement that provides key executives with generous severance pay and other benefits in the event that their employment is terminated as a result of a change of ownership of the company. Golden parachutes are voted on by the board of directors and, depending on the laws of the state in which the company is incorporated, may require shareholder approval. Some golden parachutes are triggered even if the control of the corporation does not change completely; such parachutes open after a certain percentage of the corporation’s stock is acquired.
- The supermajority is a defense that requires 70% or 80% of shareholders to approve of any acquisition. This makes it much more difficult for someone to conduct a takeover by buying enough stock for a controlling interest.
- A staggered board of directors drags out the takeover process by preventing the entire board from being replaced at the same time. The terms are staggered, so that some members are elected every 2 years, while others are elected every 4 years. Many companies that are interested in making an acquisition are not willing to wait 4 years for the board to turn over.
- Dual-class stock allows company owners to hold onto voting stock, while the company issues stock with little or no voting rights to the public. This allows investors to purchase stock, but they cannot purchase control of the company.
- With a Lobster Trap strategy, the company passes a provision preventing anyone with more than 10% ownership from converting convertible securities into voting stock. Examples of convertible securities include convertible bonds, convertible preferred stock, and warrants.
In addition to preventing a takeover, there are steps boards can take to thwart a takeover once the process has begun. One of the more common defenses is the adoption of a so-called poison pill. Poison pills can take many forms and refer to anything the target company does to make itself less valuable or less desirable as an acquisition. Some examples include the following:
- A legal challenge. The target company may file suit against the bidder alleging violations of antitrust or securities laws.
- The people pill. High-level managers and other employees threaten that they will all leave the company if it is acquired. This only works if the employees themselves are highly valuable and vital to the company’s success.
- Asset or liability restructuring. With asset restructuring, the target purchases assets that the bidder does not want or that will create antitrust problems, or sells off the assets that the suitor desires to obtain. The so-called Crown Jewel defense is an example. Sometimes a specific aspect of a company is particularly valuable. A pharmaceutical company might have a highly regarded research and development (R&D ) division—a crown jewel. It might respond to a hostile bid by selling off the R&D division to another company, or spinning it off into a separate corporation. Liability restructuring maneuvers include the so-called Macaroni defense—an approach by which a target company issues a large number of bonds with the condition that they must be redeemed at a high price if the company is taken over. Why is it called a Macaroni defense? Because if a company is in danger, the redemption price of the bonds expands like macaroni in a pot! Issuing shares to a friendly third party—the so-called White Knight defense—to dilute the bidder’s ownership position is another often-used tactic. In rare cases, a company decides that it would rather go out of business than be acquired, so they intentionally accumulate enough debt to force bankruptcy. This is known as the Jonestown defense.
- Flip-in. This common poison pill is a provision that allows current shareholders to buy more stock at a steep discount in the event of a takeover attempt. The provision is often triggered whenever any one shareholder reaches a certain percentage of total shares (usually 20% to 40%). This dilutes the value of the stock; it also reduces voting power because each share becomes a smaller percentage of the total
- Greenmail. Greenmail is defined as an action in which the target company repurchases the shares of an unfriendly suitor at a premium over the current market price.
- The Pac-Man Defense. A target company thwarts a takeover by buying stock in the acquiring company, then launching a takeover.
Despite the seemingly obvious advantages, takeover defenses of all kinds lately have become the target of increasingly potent shareholder activism. The primary shareholder complaints against poison pills are that they entrench management and the board and discourage legitimate tender offers. Institutional Shareholder Services (ISS; now part of RiskMetrics Group), an influential provider of proxy voting and corporate governance services, recommends that institutions vote in favor of shareholder proposals requesting that the company submit its poison pill or any future pills to a shareholder vote, or redeem poison pills already in existence. In addition, a company that has a poison pill in place that has not been approved by shareholders will suffer a significant downgrading in the ISS’s ratings system. Today, about one third of the Standard & Poor’s 500 companies continue to have poison pills.
Shareholder proposals requesting the company to submit its poison pill or any future pills to a shareholder vote, or to terminate an existing poison pill, are not binding on a board—even if overwhelmingly approved by the shareholders. However, if a company fails to implement a proposal approved by the shareholders, there likely will be significant negative consequences for the company and its incumbent directors, including the perception that the company is not responsive to the wishes of its shareholders, substantial withholding of votes in director elections, and downgraded corporate governance ratings.