Poison Pills
Poison pills refer to securities that are
created by a firm to safeguard itself from hostile takeover
bids. These securities take time to provide exercisable
rights to their holders, thereby making it costly and difficult
to gain control of a firm. If an acquirer still manages
to takeover, then the securities will be akin to “economic
poison” for them.
The Board of directors generally adopt ‘poison
pills’ without the approval of shareholders. The rights
that are provided by a poison pill plan can be changed by
the Board or redeemed by the firm when required. These provisions
force the acquirer to negotiate directly with the Board,
thus enhancing its bargaining power for a fair price.
Types of Poison Pills Plans
The first poison pills plan was introduced
in late 1982. There are five main types of poison pill plans:
(1) Preferred stock plans: Poison pill
plans used prior to 1984 were also known as original plans.
Under this plan, a firm issues a dividend of convertible
preferred stock to its common shareholders. Here, the holders
are entitled to one vote per share, and a higher dividend
amount than that given to common stock holders. The holders
of the preferred stock can exercise special rights, when
an outside party acquires a large block of the firm’s
voting stock.
First, preferred stock holders (apart from
the large block holder) can redeem the preferred stock for
cash at the highest price paid during the past year, by
the large block holder for the firm’s common or preferred
stock.
Second, in case of a merger the preferred
stock can be converted into voting securities of the acquirer,
with a total market value no less than the redemption value
in the first case.
Thus this plan was designed to avoid dilution
that could be effected by the majority shareholder
(2) Flip-over rights plans: The most
popular poison pill plan, it was introduced in late 1984
and was adopted by many firms. In this plan, shareholders
receive a common stock dividend in the form of rights to
acquire the firm’s common stock or preferred stock,
at an exercise price well above the current market price.
In case of a merger, the rights would “flip over”
to permit the holders to purchase the acquirer’s shares,
at a substantial discount. The flip-over plan does not prevent
an acquirer from obtaining a controlling interest in the
target, though it does make takeovers expensive, for the
acquirer must obtain most of the rights. This is not easy,
since most shareholders will prefer to hold on to their
rights, which are more valuable than any premium that the
acquirer may offer.
(3) Ownership flip-in plans: Under
this plan, holders of rights are allowed to purchase the
shares of the targeted firm (i.e. targeted for acquisition)
at a large discount. If an acquirer accumulates target shares
in excess of a threshold or “kick-in” point (i.e.
25 – 50%) ,his rights will become void. In most cases,
the ownership flip-in plans deter acquisition of a substantial
equity position. If the acquirer makes a cash tender offer
for all outstanding shares, the flip-in provision is waived.
(4) Back-end rights plans: In this
plan, shareholders receive a rights dividend. If an acquirer
obtains shares of a firm in excess of a limit, holders (excluding
the acquirer )can exchange a right and a share of the stock
for senior securities or cash equal in value to a back-end
price set by the board of directors of the targeted firm.
As the back-end price is higher than the stock’s market
price, it acts as a minimum takeover price, which deters
acquisition of a controlling interest.
(5) Voting plans: Voting plan is an
anti-takeover defence plan. These plans are implemented
by issuing a dividend of preferred stock with voting rights.
Here, if an investor acquires a substantial block of a firm’s
voting stock, preferred holders (other than the large block
holder) become entitled to super voting privileges. Hence,
it is difficult for the block holder to obtain voting control.
