Poison Pill: A Defense Strategy and Rights Plan

What is a poison pill?

The poison pill is psychology-based defense technique that protects minority shareholders from hostile management changes or an unprecedented takeover. It uses techniques to raise the acquisition cost to a high level and create disincentives in the event of a takeover. The poison pill effectively blocks the procurement of stakes exceeding a certain portion of the company outstanding shares. It promises to give extra discounted or free shares to all shareholders, except those who trigger it.

The goal is to stop outsiders gaining control of the company without having to negotiate with its board or pay a negotiated price to all shareholders. The defense of poison pills has been recognized by courts as valid. Corporate boards are not required to accept any offer that is not in the long-term interests of the company.

Corporate takeovers are common. They involve the transfer of control over a publicly traded company from one company to another or a private equity company. They are usually done on terms that the target company’s board accepts. U.S. courts have held that company boards can exercise broad discretion when deciding whether to pursue a deal.

Successful hostile takeovers are rare because company boards have powerful tools such as the poison pill to protect their wishes.

The Advantages of a Poison Pill

The board of a company has a fiduciary obligation to protect all shareholders. An outsider may only want or need to satisfy a minority to gain control via a tender offer. The poison pill is used to prevent majority-controlled takeovers from disregarding minority shareholders’ interests.

It discourages vulture bids that seek to profit from a temporary fall in share prices. Hundreds of U.S. businesses adopted shareholder rights plans as a result of market declines that occurred at the beginning of the COVID-19 pandemic.

Drawbacks to Poison Pills

A poison pill will discourage motivated buyers from purchasing more company stock. This can lead to a lower share price, at least for the short term. If the new board chooses to replace a company board, it can make a poison tablet disappear.

Poison pills are discriminatory against activist buyers. They also restrain trading in company stock. Therefore, they require justification and sometimes have sunset provisions.

Why are poison pills used?

A poison pill prevents an activist investor from taking control of a openly traded company. Deals that involve the board consenting to a change in control usually provide a substantial premium the Mart. This contrasts with the share purchase in market transactions that poison pills aim to discourage.

What are the disadvantages of poison pill?

Self-serving boards and incumbent managers can frustrate shareholder efforts to remove them to improve company performance. Corporate governance advisors advise companies to limit their scope and duration, ensure that plans address a specific goal, threat, and have a high threshold for triggering.

What is the legal precedent for poison pill use?

Delaware is home to many large listed companies. The courts have held that corporate boards can exercise wide discretion to prevent the accumulation of controlling stakes. However, they must respond proportionally and based upon a reasonable perception of a threat.

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