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Corporate Defence Mechanisms to prevent Hostile Takeovers

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April 21, 2022

Why in news?

Publicly listed companies are most exposed to threats of a hostile takeover. However, with time, they have come up with varied defence mechanisms to prevent such takeovers.

What is the issue?

  • Recently, billionaire Elon Musk now has said that he wants to buy Twitter outright, taking it private to restore its commitment to free speech.
  • Elon Musk currently owns about 9% of Twitter shares.
  • The company's board has resisted this and deployed the “poison pill” mechanism.

What is a ‘Poison Pill’ defence?

  • A poison pill is officially known as a shareholder rights plan.
  • A poison pill is a defense tactic utilized by a target company to prevent or discourage hostile takeover attempts.
  • Poison pills allow existing shareholders the right to purchase additional shares at a discount, effectively diluting the ownership interest of a new, hostile party.
  • Poison pills often come in two forms
    • Flip-in strategy- Allows the shareholders, except for the acquirer, to purchase additional shares at a discount.
    • Flip-over strategy- Allows the stockholders to purchase the shares of the acquiring company at a deeply discounted price if the hostile takeover attempt is successful
  • The mechanism protects minority shareholders and avoids the change of control of company management.
  • Poison pills also often open the door to further negotiations that can force a bidder to sweeten the deal.
  • If a higher price makes sense to the board, a poison pill can simply be cast aside, clearing the way for a sale to complete.
  • Twitter’s mechanism- Twitter's plan works by imposing a significant penalty on any investor that builds up a stake of at least 15% in the Twitter without the board's approval.
  • If Musk were to hit the 15% threshold, the Twitter board can grant shareholders the right to buy one-thousandth of a share of preferred stock for each common share they own, at a price of 210 dollars.
  • That option makes it virtually impossible for anyone to buy Twitter.

What are the other corporate defence mechanisms to prevent hostile takeovers?

  • Greenmail Defence- In this, the target company pays a premium, known as greenmail, to purchase its own shares back at inflated prices from a corporate raider.
  • After accepting the greenmail payment, the raider generally agrees to discontinue the takeover and not buy any more shares for a specific time.
  • Crown jewel defence- Crown jewels are the most profitable or valuable corporate units or assets that belong to the company.
  • The Crown Jewel Defense strategy is when the target company of a hostile takeover sells its most valuable assets to reduce its attractiveness to the hostile bidder.
  • Pac-man defence- It prevents a hostile takeover by initiating a reverse takeover.
  • In a Pac-Man defense, the target firm tries to acquire the company that has made a hostile takeover attempt.
  • The target company could make use of its ‘war chest’ or securing finances from outside for the reverse takeover bid.
  • White Knight defence- A white knight is a hostile takeover defense whereby a 'friendly' company acquires a corporation at fair consideration when it is on the verge of being taken over by an 'unfriendly' acquirer.
  • The unfriendly bidder is generally known as the "black knight."

 

References

  1. https://www.thehindu.com/business/markets/explained-poison-pill-and-other-corporate-defence-mechanisms-to-prevent-hostile-takeovers/article65329707.ece?homepage=true
  2. https://www.investopedia.com/terms/w/whiteknight.asp
  3. https://www.investopedia.com/terms/p/pac-man-defense.asp
  4. https://www.investopedia.com/terms/g/greenmail.asp#:~:text=What%20Is%20Greenmail%3F,to%20stop%20the%20takeover%20bid.
  5. https://corporatefinanceinstitute.com/resources/knowledge/deals/crown-jewel-defense-takeover/
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