Poison pill

Definition

A poison pill is a defensive strategy used by a company to deter hostile takeover attempts by making its stock less attractive to potential acquirers. This tactic typically involves issuing new shares or rights that are triggered when a certain percentage of ownership is acquired, diluting the value of existing shares and making the takeover more expensive. Poison pills are designed to protect shareholder interests and maintain control of the company.

5 Must Know Facts For Your Next Test

1. The term 'poison pill' was first used in the 1980s as companies sought ways to defend against aggressive takeover bids.
2. There are two main types of poison pills: flip-in and flip-over. A flip-in allows existing shareholders to buy more shares at a discounted price after a takeover attempt, while a flip-over allows them to buy shares in the acquiring company at a discount after the merger.
3. Poison pills can discourage potential acquirers by increasing the cost of the acquisition, often leading them to abandon their efforts.
4. While poison pills are effective for defense, they can also lead to negative consequences, such as reducing stock price or making it harder for shareholders to sell their shares.
5. The legality and effectiveness of poison pills have been upheld in many jurisdictions, though they can sometimes lead to legal challenges from shareholders who feel their interests are not being prioritized.

Review Questions

• How does a poison pill strategy specifically impact the dynamics of a hostile takeover attempt?
  • A poison pill strategy significantly alters the dynamics of a hostile takeover by increasing the cost and complexity for the acquiring company. When a target company implements this strategy, it typically allows existing shareholders to purchase additional shares at a discount when an acquirer crosses a certain ownership threshold. This dilution of shares can deter potential buyers, as they would face greater financial hurdles and risks in trying to gain control, thus protecting the target company's management and existing shareholders.
• Evaluate the advantages and disadvantages of using a poison pill as a takeover defense mechanism.
  • Using a poison pill as a defense mechanism comes with both advantages and disadvantages. On one hand, it effectively discourages hostile takeovers by making them financially unattractive and giving the target company's board more negotiating power. On the other hand, it can lead to negative perceptions among investors, possibly lowering stock prices or limiting shareholder liquidity. Additionally, if used excessively, it may create conflict between management and shareholders who desire greater flexibility in capitalizing on attractive offers.
• Critically assess how poison pills might influence shareholder rights and overall corporate governance practices within a company.
  • Poison pills can significantly influence shareholder rights and corporate governance practices by prioritizing management's control over market dynamics. While they can protect existing management from unwanted takeovers, they might also restrict shareholders from exercising their rights to vote on potentially beneficial acquisitions. This tension raises questions about the balance between defending against hostile takeovers and ensuring that shareholders' interests are adequately represented. As a result, companies must carefully navigate the implementation of poison pills to maintain investor confidence while effectively safeguarding against unsolicited bids.

Related terms

Shareholder Rights Plan: A strategy that grants shareholders certain rights that can be exercised in the event of a takeover attempt, often including the ability to purchase additional shares at a discounted rate.

Hostile Takeover: An acquisition attempt by an entity that is not welcomed by the target company's management or board of directors, often leading to a battle for control.

Greenmail: A practice where a company buys back its shares at a premium from a hostile acquirer, effectively paying them to go away and avoid a takeover.