The Poison Pill

By Guest Contributor

Kimarie Shěn

Poison pill strategies have been defensive tactics that allow companies to thwart hostile takeover bids from other companies. Many companies may find themselves unprepared when facing such bids. By adopting a poison pill strategy, a company can be somewhat reassured that acquiring companies will approach its board of directors, not the shareholders. Poison pill strategies are also known as shareholders’ protection rights plans.

During the late 1950s and early 1960s, several large corporations began acquiring other companies to diversify their operations. Diversification allowed them to offset their losses in a failing industry with profits from other unrelated, successful industries. Such phenomena caused concerns about the potential of conglomerates to concentrate excessive economic power in the hands of a few corporations. This led to the passage of the Williams Act in 1968, which required the acquiring company to fully disclose the terms of an impending acquisition and to allow a period for competing offers for the target company to be made. By the late 1970s, the pace of acquisition nearly came to a halt. In 1982, however, the U.S. Supreme Court passed a landmark ruling in the case of Edgar v. MITE Corp. that invalidated the basis for anti-takeover laws in 37 states. Furthermore, under the Reagan administration, the U.S. Department of Justice followed a lax policy towards enforcing anti- takeover laws. No longer able to shelter themselves against unfriendly takeover bids, many companies opted to devise anti-takeover strategies.


The FLIP-OVER RIGHTS PLAN – Most poison pill strategies involve some form of discrimination against the acquiring company. The most commonly used strategy is called the “flip-over” or the shareholder rights plan. Under this strategy, the holders of common stock of a company receive one right for each share held, which allows them an option to buy more shares in the company. The rights have a set expiration date and do not carry voting power. They are worthless at the time of the offering because the exercise price is set well above the going market price of common shares. A shareholder cannot sell these rights independently as they trade together with the shares.

The FLIP-IN RIGHTS PLAN – A variation of the flip-over is the “flip- in” plan. The plan allows the rights holder to purchase shares in the target company at a discount upon the mere accumulation of a specified percentage of stock by a potential acquirer. This strategy allows more power than the “flip-over” rights plan and, therefore, has become a common form of poison pill adopted by many U.S. corporations.

The POISON DEBT – The target company issues debt securities on certain stipulated terms and conditions in order to discourage a hostile takeover bid.

The PUT RIGHTS PLAN – Under this plan, the target company issues rights to its stockholders in the form of a dividend. This form of poison pill strategy is rarely used by the U.S. corporations.

The NET EFFECTS OF POISON PILL STRATEGIES – Is to make it prohibitively expensive for an acquirer to buy the control of a company. The underlying assumption is that the board will always act in the best interest of the shareholders, a view that is explicitly rejected by agency theorists.

Boards of directors invariably argue that poison pill strategies have exactly the opposite effect on stock values. They help maintain their independent decision making power to run their companies in the best interests of the shareholders. Poison pill strategies also provide bargaining strength to the board in order to extract the most value for the stock from a potential acquirer.

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