Defense Strategies Against Hostile Takeovers - Thesis Example

Defense Strategies against hostile takeovers Preventive Measures Preventive measures refer to the defenses against hostile takeovers which reduce the likelihood of a financially successful hostile takeover. They include the following: Poison Pills Staggered board Supermajority amendment Golden Parachute Golden Parachutes Golden parachutes refer to compensation agreements provided by a company to its top management. They act as both proactive and reactive defense measures against hostile takeovers. Golden Parachutes are provided by Yahoo to its employees. Benefits offered to top executives include stock options, bonuses, severance pay, etc. Golden Parachutes are motivated by dismissal of employees including the top management when control over the company is changed. Golden parachutes are costly for the acquiring firm, especially if they do not want to retain the management of the target company. Dismissal of the existing employees would mean that the acquiring company will have to pay hefty benefits as send-off packages to the dismissed employees (Harris, 1990). This makes acquisition expensive for potential acquirers, making them to think twice about their acquisition intentions. The Golden Parachute is effective to the extent that it benefits stakeholders and enables a company to prevent any hostile takeover (Harris, 1990). Golden Parachutes make it easier for stockholders to hire and retain managers in industries that are prone to mergers and acquisition. The defense mechanism also helps the executive to remain objective about the company during a takeover process. Furthermore, it increases the cost of a takeover; hence discouraging bidders from acquiring the target company. This is because Golden Parachutes make it prohibitively expensive for potential acquirers to acquire a target company if they want to dismiss the managers of the target company. Dismissing managers in a company with Golden Parachutes comes with a high price. Golden Parachutes were applied at Fortune 1000 companies from 35% in 1987 to 81% in 2001. Citigroup Inc. applied Golden Parachute when they offered John Reed $30 million as severance pay and $5 annually for life. Staggered Board Amendments A company seeking to acquire another company may try to get representations in the board of the targeted company so that the acquirer can have voting power and influence other board members to accept the bid or persuade shareholders to accept the takeover. This type of defense against takeovers requires the approval of shareholders in a shareholders’ meeting in order to be created. Members of the board are chosen with the support of shareholders. In order to be a member of staggered board, the acquirer needs to purchase shares to vote in order to enable a single shareholder to sit with members of the targeted company’s board (Bebchuk et al, 2002). Staggered board makes the process gaining control and influence on the board to be time-consuming and costly. A staggered board is constructed by dividing the members of a company into groups (Faleye, 2007). For example, a board of 12 members may be divided into four groups of 3 members. A company with staggered board elects its board members by submitting only a group of members for re-election each year. Therefore, the whole board cannot be replaced on one annual meeting. Due to the structured nature of a staggered board, the whole board can only be replaced after three years. A targeting company may take three seats in the first election by buying shares, but it will take it another two years to get majority representations in the board. In this case, staggered board is effective because it creates delays before an acquirer gains control of the whole board immediately (Bebchuk et al, 2002). The period of two or three years that an acquiring company may take before gaining full control of the board is often associated with further expenditures which may make it more difficult for the targeting company to get finance for acquiring the target company. The targeted company therefore becomes less attractive and is protected against a hostile takeover. Coates and Subramanian (2002) suggest that the staggered board defense is moderately effective in protecting a target company from hostile takeovers. It increases the chances of the target company remaining independent for some period of time. However, a staggered board may result negative impact to the shareholders if the takeover becomes successful because the shareholders will get a lower acquisition premium from the bidder. Staggered board defense strategy is moderately effective on its own, and cannot be the ultimate protective mechanism against acquisition. However, it can be very effective if it is combined with other defense measures to avoid acquisition. Poison Pills Poison pill is also referred to as shareholder plan. It is a tactic used by corporations as a defensive tactic against a potential takeover. Developed in 1982 by Takeover lawyer Martin Lipton, shareholder rights plans have grown to become one of the most controversial mechanisms of defense against takeovers. It prevents bidders from negotiating a price for shares directly from shareholders; and as a result hurting the bidder, the target company, and sometimes even the target company’s shareholders. This mechanism forces bidders to negotiate the sale of shares with the board. The poison spill enables the target company to make its shares less attractive to bidders. The first poison pill was applied 1983 in Brown vs. Lenox Takeover in 1983. There are various types of poison pills: flip-over, back-end plans, flip-in, voting plans, chewable pill, bank mail pill and shadow pill. Flip-in and flip-over are the most common types of poison pills. Flip-in provides defense to the company by allowing its shareholders to buy more shares at a discount. In this case, the company’s management provides shareholders with shares at a discount if an acquirer attempts to buy a certain percentage of the company. The acquirer is not given the discount, so it becomes expensive for that acquirer to purchase the shares of the company. Some experts estimate that an unwanted potential acquirer or bidder loses four or five times more if she swallows a poison pill in order to acquire a target company. Flip-over allows shareholders to purchase shares of the acquirer at a discount after the merger. Shareholders are given one right for each share held with an expiry date and no voting power. In the event of an unwanted acquisition bid, the rights are traded separately from shares. In the event of a successful acquisition, all shareholders except the acquirer can buy the shares of the merged entity at discount. This leads to dilution of the acquirer’s shareholding; hence making the acquisition expensive and frustrating for the bidder. Back-end plans, also referred to as note purchase rights plans allow a shareholder to get a right dividend which allows the shareholder to exchange his/her share of stock for cash or senior securities that have an equal value with the back-end price provided by the issuer’s board of directors. Voting plans dilute controlling power of an acquirer. This is done by issuing dividend of securities to its stockholders; hence allowing them to enjoy special voting privileges. If an acquirer succeeds in bidding for the target company, holders of preferred stock in the target company become entitled to super voting rights. Shadow pills are pills adopted after a bid has taken place or is not openly advertised. In this case, the bidder does not conclude the existence of a defense by simply looking at the target company. Chewable pills are pills that disappear or can be voted by shareholders if the company gets an offer in form of a price or any type of consideration. A bank Mail Pill allows the target company’s bank to refuse financing options to bidders of the target company; hence imposing financial restrictions on the acquirer and causing transaction costs. The effectiveness and importance of poising pills is that they allow management some time to find competing offers that will provide higher bidding prices. Target companies which use poison pills receive higher takeover premiums than companies without poison pills. This increases value for shareholders. Poison pills increase the negotiating power of the target company, leading to higher acquisition premiums. Poison pills are controversial and their legality is not guaranteed in all jurisdictions. For instance, poison pills are not allowed under the Takeover Panel rules of UK. This form of defense against takeovers also offers a general weakness because they can easily be redeemed by the target company’s board of directors; hence they cannot be sufficiently effective on their own. Poison pill may also harm both the acquirer and the target company. There should be another defense mechanism to be used alongside poison pills in order to make it difficult for a bidder to enter the company’s board of directors and redeem the pill. It is therefore important to use a staggered board strategy to achieve this. Super-majority amendment Usually, a company makes a decision to merge with or acquire another company with the approval of shareholders. The strategy needs majority of the company’s votes in form of shares. Supermajority amendment allows a company to raise the specific percentage required for the shareholders to approve large majority decisions such as a takeover or a merger. This amendment is always placed by the shareholders not the board, but the board decides whether to activate it. Shareholders therefore have a big role in this defense strategy. In this defense strategy, the bidding company does not have to own shares in order to acquire a targeted company. It only needs to present an acquisition proposal which can then be voted on by the shareholders. In order for the acquisition to be successful, a super-majority acceptance by the shareholders is required. A supermajority amendment is always accompanied by an escape clause which allows the board to redeem the amendment if it changes its mind and decides to enter into negotiations with the bidder. This defense mechanism is also not effective on its own to stop a company from bidding for a takeover successfully (Weston, 2001). However, it makes it difficult for a bidder to control the company immediately. This makes the deal costly and unattractive for a takeover. It gives the targeted company some time to reflect on the bid perhaps negotiate with the bidder to give a higher premium offer. Post takeover or active antitakeover defenses These defenses are applied when a hostile bid has already been attempted on the target company. They include: Greenmailing White Knight and White Squire Crown Jewel Defense Pac-man defense Treasury stock (purchase of own stock) Greenmail Greenmail is used as a defense measure in situations where the bidder’s intention is to make short term profits rather than long term control over the targeted company. It involves the repurchase of a block of shares held by a single shareholder or other stockholders at a premium above the share price in exchange for a standstill agreement. This defense therefore increases the share price of a targeted company. The payment of a ransom to the bidder at a premium is usually referred to as a goodbye kiss. Greenmail stops a bidder from purchasing the shares of a target company for a long time, usually more than five years. Greenmail stops hostile attack. However, this method is only strong and effective if the bidder targets to make short term profits. In this case, greenmail offers incentives for a bidder to cease its takeover bid and sell all its shares at a profit (Ronald et al, 1997). The method may not be effective if the bidders are seeking long-termed synergy effects and control in the targeted company. This process affects stakeholders and the target company while benefiting the predating bidder. The shareholders and the target company may lose their money. Greenmailing also ensures that the management and the employees of a targeted company remain in the company. In the event of a takeover they would have otherwise reduced their ranks or even lost their positions (Scholten, 2004). The obligation to seek shareholders’ approval before a buyback of its shares has made the use of greenmail less popular in the current business world. Goodyear Tire and Rubber Company applied Greenmailing in 1980s when it repurchased shares worth $90 million from Goldsmith (Block, 2003). Occidental Petroleum also paid $194 million greenmail to David Murdock in 1984. White Knight and White Squire These defense mechanisms require a third part in order to be effective in protecting a target firm from a hostile takeover. In a white knight defense, a company seeks a friendly firm to acquire its majority stake (Kokot, 2006). The management of the target company usually engages in negotiations for several deals. The main intention of a white knight is to maintain the independence of the target company, although it may also be used to cause the other parties to fight against each other; hence increasing the size of the bid. White knight can be used for various reasons: search for a better fit, friendly intentions, belief of not dismissing employees, and belief of better synergies. Although a targeted company seeks independence using a white knight, but the targeted company usually ends up being overtaken by the white knight (Kowalski, 1994). The main challenge with this defense measure is that it is difficult to find a white knight (friendly company). Therefore, this method is weak; it is not highly effective in protecting a target company from takeovers. The hostile firm has various strategies to defeat the white knight. First, it may make a more lucrative offer than the offer provided by the white knight. The role of the shareholders in this case is to reject the offer of the white knight if the offer given by the hostile bidder is more lucrative to them. This may lead to a competition which ends up with one of the competitors overpaying for takeover and benefiting the targeted company and its shareholders (Auerbach and Ruback , 1987). Another strategy is that the hostile bidder may wait for the white knight to complete its deal with the targeted company and then offer a takeover bid to the white knight. An example of a white knight can be seen in the acquisition of Schering by Bayer in 2006 after Merck KGAA was negotiating with Schering about a possible takeover (Van Frederikslust, et al, 2008. In this case, Bayer acted as a white knight while Merck KGAA acted as a hostile bidder and Schering was the targeted company. A white squire is also a friendly company, but it acquires a smaller portion of stake in the targeted company. However, the portion of stake purchased by the white squire is enough to prevent the hostile bidder from acquiring majority stake in the company. This method can be effective because the targeted company is able to maintain its independence by not selling its majority stake to the hostile bidder (Kowalski, 1994). However, the challenge is finding a friendly bidder or the white squire. Crown Jewel Defense When facing a hostile bid, a target company may decide to sell off its valuable assets (crown jewels) because hostile bidders always target the assets of the target company (Block, 2003). Selling off its valuable assets makes the company to appear less valuable to the hostile bidder; hence forcing them to withdraw from the hostile takeover bid. This defense mechanism is strong if it is used with the white knight defense. In this case, the target company sells its crown jewels to a friendly company (white knight). Later on, when the hostile bidder withdraws its offer, the target company may buy back its assets from the white knight at a pre-determined fixed price (Kokot, 2006). This strategy is effective, but it also has its own risks. For instance, the company puts its valuable assets and its operations in danger. Shareholders may play a big role in preventing or approving the sale of the company’s valuable assets because the assets are actually the assets of shareholders, and it the shareholders perceive that selling their assets to another company is risky, they will oppose the crown jewel defense. Pac-man defense This defense involves the target company acquiring the hostile bidder. The target company offers to buy the hostile company as a response to the hostile bid by the hostile company (Damodaran, 1997). Sometimes the targeted company may benefit from the Pac-man defense even by acquiring a small amount of shares from its attacker because with such shares it will be able to make legal claims against the attacker on the basis of minority shareholder. If the targeted company does not have enough readily available funds to purchase the attacker, it may use other tools of influence over the attacker such as rights of claim, bills of exchange and debts. A Pac-man defense is considered to benefit shareholders in certain ways. First, it ensures that the assets of the company are not auctioned, an act which often leads to the reduction of shareholder’s value and the share price. However, management should prove that they are not acting in their best interest of remaining sin office when they are purchasing the hostile company. This method is effective because it gives the target company a strong claim ground if it acquires shares of the target company. It will be difficult for the hostile bidder to acquire the target company if the later succeeds to purchase the shares of the former. Pac-man defense was applied by Martin Marietta in 1982 when it offered to buy Bendix Corporation after Bendix offered $43 million tender offer for Martin Marietta (Damodaran, 1997). Another example is when American Brands Inc. announced a cash tender offer for E-II Holdings after an attempted offer by E-II on American Brand Inc. Treasury stock (purchase of own stock) This is also referred to as targeted repurchase. It is a technique used to prevent hostile takeover by purchasing back its own shares from an unfriendly bidder. The repurchase price is usually above the market value of the shares. This method is effective because it leads to the reduction of control by the bidder over the targeted company. However, it leads to reduction of stock prices. Shareholders participate in this defense by voting to allow for the repurchase of stock from a hostile bidder. KBF Pollution Management Inc. repurchased stock from its current stockholders in 2002. 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