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Subject 5. Takeovers and Their Defense Mechanisms PDF Download
There are a variety of both pre- and post-offer defenses a target can use to ward off an unwanted takeover bid.

Pre-Offer Takeover Defense Mechanisms

Some of these defense mechanisms are used in combination with each other.

Poison Pills

Existing shareholders get rights, which are triggered when there is a significant purchase of the firm' shares, to buy the company's shares at a bargain price. This will make the raider's shares lose value.

There are different types of poison pills.

  • The flip-in is a provision in the target company's corporate charter or bylaws. The provision gives current shareholders of a targeted company, other than the hostile acquirer, rights to purchase additional stocks in the targeted company at a discount rate. These rights to purchase occur only 1) before a potential takeover, and 2) when the acquirer surpasses the "kick-in" or threshold point of obtaining outstanding shares (usually 20 - 50%). No potential acquirer or other shareholder will risk triggering a poison pill by accumulating more than the threshold level of shares because of the threat of massive discriminatory dilution.
  • A flip-over gives the current shareholders of a targeted firm the option to purchase discounted stock after the potential takeover. Following a takeover, the rights would "flip over" and allow the current shareholder to purchase the unfriendly competitor's shares at a discount. If this tool is exercised, the number of shares held by the unfriendly competitors will realize dilution and price devaluation.
  • A dead hand provision states that only the original directors who put the provision into place can dismantle the pill, so any new directors are prevented from interfering. The dead hand provision prevents the removal of the poison pill, a strategy used to discourage a hostile takeover, even if shareholders of the target company favor the takeover.

Poison Puts

They give bondholders of the target company the privilege of redemption at or above par if certain designated events occur, such as a hostile takeover, the purchase of a big block of shares, or an excessively large dividend payout. Poison puts are popular anti-takeover devices because they create an onerous cash obligation for the acquirer. They also protect the bondholder from the deterioration of credit quality and rating that might result from a leveraged buyout that added to the issuer's debt.

Incorporate in a State with Restrictive Takeover Laws

Some states are more "target friendly" than others, and companies that don't want a potential hostile merger offer may consider reincorporating in such states that have enacted stricter anti-takeover laws.

Staggered Board of Directors

If a company has a "staggered board", its directors are elected for terms of more than one year and only a segment of the board stands for election in any year. Therefore, a potential acquirer cannot replace the entire board in one year even if it controls a majority of the votes. Using an example of a three-year staggered board, at each annual meeting, one third of the directors or nominees would be eligible for shareholder ratification for a three-year period. The effect is that it would take at least two years to elect enough directors to take control of the board. Usually an acquirer does not want to wait that long in a merger transaction.

Restricted Voting Rights

This is a mechanism that restricts shareholders from voting their shares if their equity ownership is above some threshold levels (e.g., 15%). The mechanism encourages any potential acquirers to negotiate with the board of directors since the board can release the shareholders from the constraint.

Supermajority Voting Provisions

A "supermajority" voting provision is a provision placed in a company's charter documents which would require a "supermajority" (ranging from 66 to 90%) of shareholders and shareholder votes to approve any type of acquisition of the company. It makes an acquisition more time-consuming and expensive for the acquirer.

Fair Price Amendments

A fair price amendment is an addition to a company's bylaws that prevents an acquiring firm or investor from offering different prices for the shares held by different stockholders during a takeover attempt. The amendment tends to discourage takeover attempts by making them more expensive.

Golden Parachutes

This describes a very liberal compensation package for managers who lose their jobs because of a takeover. The availability of the golden parachute will ensure that the managers will not have an incentive to fight any takeover of the company at the cost of the shareholders.

Post-Offer Defense Mechanisms

These are defensive mechanisms that can be used once an offer has been made.

"Just Say No" Defense

The management at the target company can simply lobby the shareholders not to take the offer.

Litigation

Target companies often file time-consuming lawsuits against the acquirers so they can at least create more time to develop other resources (e.g., finding a white knight).

Greenmail

The target company buys back its own shares from the acquirer at a substantial premium to the fair market price. In return, the acquirer agrees to abandon the takeover attempt. This is less common now partly due to the Federal tax treatment of greenmail gains (a 50% excise tax).

Share Repurchase

The target company may buy back its own shares from the public at an attractive price. To stay competitive the acquirer needs to raise its bid. A share repurchase uses cash of the target company which may become more leveraged and thus less attractive to the acquirer.

If a company uses a significant amount of debt to purchase all of its outstanding shares, the action is known as a leveraged buyout (LBO).

Leveraged Recapitalization

It is similar to a LBO, except that some shares remain in public hands.

Crown Jewel Defense

The target company may sell off its most attractive assets to a friendly third party or spin off the valuable assets in a separate entity. Consequently the unfriendly bidder is less attracted to the target's assets.

Pac-Man Defense

The name comes from the video game. The target firm attempts the takeover of the bidder and thus, hopes to takeover before being taken over. The technique is rarely used.

White Knight Defense

A "white knight" is a company that comes to the rescue of a corporation that is being taken over. In many cases this may start a bidding war which can cause the winner to overpay. This is called the winner's curse.

White Squire Defense

A white squire is similar to a white knight, except that it only exercises a significant minority stake, as opposed to a majority stake. A white squire doesn't have the intent to take over a company, but rather serves as a figurehead to a defense to a hostile takeover. The white squire may often also get special voting rights for their equity stake. An example of a white squire might be Warren Buffett.

Learning Outcome Statements

f. identify and explain pre-offer and post-offer takeover defense mechanisms;

CFA® 2023 Level I Curriculum, Volume 3, Module 18

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