Practical analysis for investment professionals
14 April 2016

Defensive Anti-Takeover Board Measures

In the heart of the 1980s, so-called “corporate raiders” making their hostile takeover bids for publicly traded firms struck fear into the hearts of management and boards of directors. This was the era of Barbarians at the Gate and The Art of the Deal. In response to the wave of unwanted corporate suitors, boards throughout the United States began adopting anti-takeover provisions carefully crafted by crafty lawyers. Eventually similar plans were embraced by boards at companies across the globe.

Firms in the 1980s argued convincingly that these measures were in the best interests of their shareowners because they ensured that a target company’s board could negotiate a fair price for those shares in the event of a takeover. This thinking was supported by the Supreme Court of Delaware, which upheld the right of boards of directors to enact anti-takeover provisions in the landmark 1985 case of Moran v. Household International, Inc. Over time, however, what actually happened was that almost all bids disappeared and anti-takeover measures were never triggered because potential raiders were forced to deal with the boards rather than the shareowners directly.

Among the colorfully named takeover defenses that developed are:

  • Poison pills
  • Scorched-earth policies
  • Golden parachutes
  • Lobster traps

Poison Pills

These measures are so named because any unwanted takeover attempt (i.e., one not first vetted by a company’s board of directors) creates consequences that are the financial equivalent of swallowing a cyanide capsule. In a classic example of misdirection, boards of directors and their lawyers started calling these provisions “shareholders rights” plans.

There are two principal forms of poison pills, a “flip in” and a “flip over.” In a flip in, the more common of the two, every shareowner except for the bidding firm is allowed to buy more shares of the targeted company at a significant discount. Typically the discount is half the current market price. This tactic immediately dilutes the value of the shares held by the potential acquirer, and usually to a point below the critical threshold at which that firm could win a board seat or secure a controlling equity position and thus dictate the direction of the company. In a flip over, the target’s existing shareowners are granted the right to purchase discounted shares in the company after it is acquired. Again, the idea is to create excruciating levels of dilution in the shares owned by the acquiring firm.

Scorched-Earth Policies

Here the tactics undertaken by a board of directors are all designed to ruin the operating viability of the company it serves. Common examples include selling off strategic assets and taking on exorbitant amounts of debt. In other words, the board of the targeted company does everything in its power to destroy the company’s value in the eyes of a bidder.

Golden Parachutes

Executives and board members of target firms often lock in substantial benefits packages for themselves should they be ousted in an unwanted takeover. These plans are called golden parachutes because they ensure that corporate insiders who are forced to leave their positions float back to earth protected by a parachute and much wealthier (more golden). It is hard not to think of these measures as a form of institutionalized bribery. After all, if a potential acquirer wants the cooperation of a target firm’s board and its acceptance of a bid, all it needs to do is pay the board members enough to ensure an affirmative vote.

The Lobster Trap

The lobster trap is so called because in the real world, it is designed to catch large, sellable lobsters, while allowing the younger, smaller, and not-yet-developed crustaceans to escape. Typical stipulations of a lobster trap hold that if any shareholder has a greater than 10% position in the company without board authorization to have such a stake, then all outstanding convertible securities of the target firm cannot be converted into voting shares. The lobster trap developed because clever acquiring firms circumvented other takeover defenses by taking large positions in convertible securities.

While the above are among the most common anti-takeover tactics, there are many others, including supermajority board vote requirements, staggered board of director terms, and the solicitation of white knights or other, more friendly bids.

So what is the net effect of all these measures?

Earlier this week, we asked readers of CFA Institute Financial NewsBrief readers: Are defensive board tactics, such as shareholders rights/poison pill plans good for or detrimental to shareholders? A definitive 77% of the 564 respondents answered that they are detrimental. The remaining votes were about equally divided between those who think anti-takeover tactics have a positive impact for shareholders (12%) and those who hadn’t considered the issue (11%).


Are defensive board tactics, such as shareholders rights/poison pill plans, good for or detrimental to shareholders?

Are defensive board tactics, such as shareholders rights/poison pill plans, good for or detrimental to shareholders?


Not surprisingly, these results reflect much of the scholarship on the subject. Researchers exploring whether anti-takeover measures are beneficial for shareowners consistently find that they are not. For example, a 2007 study demonstrated that return on equity was actually higher for banks that did not adopt a poison pill plan in the year after competitors had implemented one. The reason is simple: Fewer bids result in less demand for a target firm’s stock and consequently a lower share price for existing shareowners. Some jurisdictions around the world have banned certain defensive anti-takeover methods, as the United Kingdom did through its Takeover Panel rules.

Offense: An Alternative to Defense

So if poison pills and golden parachutes are off the table, what is a well-meaning board of directors and management team to do if they genuinely want to prevent activist shareholders from harming the long-term value of the company through short-term takeover activity? Simply put: manage the business so well as to to drive up the value of shares to such an extent that any takeover is prohibitively expensive and allows no room for error in a potential bid.

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

About the Author(s)
Jason Voss, CFA

Jason Voss, CFA, is a content director at CFA Institute, where he tirelessly focuses on improving the ability of investors to better serve end clients. He is the author of the Foreword Reviews Business Book of the Year Finalist, The Intuitive Investor. Jason also ran a successful blog titled What My Intuition Tells Me Now. Previously, Voss was a portfolio manager at Davis Selected Advisers, L.P., where he co-managed the Davis Appreciation and Income Fund. He holds a BA in economics and an MBA in finance and accounting from the University of Colorado.

Ethics Statement

My statement of ethics is very simple, really: I treat others as I would like to be treated. In my opinion, all systems of ethics distill to this simple statement. If you believe I have deviated from this standard, I would love to hear from you: jason.voss@cfainstitute.org

2 thoughts on “Defensive Anti-Takeover Board Measures”

  1. Savio Cardozo says:

    Hello Jason
    Before I begin thank you for taking the time to put this article together.
    I was one of the “detrimental to” voters.
    Over the years I recall debating on this blog short-term versus long-term shareholders (I do not think corporate raiders and activist investors should get the bum rap they do – I am very definitely in the momentum trading camp, and think that Bill Ackman should visit Toronto more often – the old boy network is alive and well).
    Your last sentence is particularly one that should interest both long-term and short-term shareholders.
    If a company is so incredibly well-managed, then short-term shareholders, like myself, should be kicking themselves for giving up future price increases, and long-term folks will be laughing their way to the bank.
    And this is where corporate boards come in.
    Like the Senate in Canada, perhaps it is time to get rid of them.
    Technology these days let shareholders weigh in on pretty much anything that a board can, in nano seconds. So instead of cronyism we can have a true democracy.
    Until this nirvanic state is reached long term shareholders should welcome corporate raiders.
    My two cents for the cause.
    Thank you again for your many enjoyable and insightful articles.
    Kind regards
    Savio

    1. Hello Savio,

      Thank you, as always, for your thoughtful comments. Part of the reason that corporate raiders and activist investors get a bum rap is that there is a shocking lack of appreciation for the fact that the term ‘shareholders’ creates an expectation of homogeneity. In reality, there are many different shareholders investing in a company and all with different investment problems they are trying to solve. This is why the concept of ‘shareholder value’ is bizarre. Great idea, but for which shareholders are you creating value? The HFT millisecond shareholder? The day trader? The dividend investor? The deep value investor? The growth investor?

      Separately, I only ever knew of one company here in the U.S. that did not have a single anti-takeover measure in place. Sad. The company then was Sealed Air. I am not sure if they still are in that state. But it was courageous of them to go so strongly against the grain.

      Will I be meeting you in Montreal at the CFA Institute Annual Conference?

      Yours, in service,

      Jason

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