The hostile takeover process is somewhat like a chess match, with the target company being pitted against the hostile bidder. During the fourth merger wave of the 1980s, the tactics and defenses deployed against hostile takeovers came to be greatly refined. Before the 1980s, the usual knee-jerk reaction of a target company when faced with an unwanted bid was to file a suit alleging antitrust violations. Today such a defense would usually be construed as weak and ineffective.
However, in the 1960s and 1970s, when antitrust policy was much more stringent, especially during the 1960s, this was a much more credible response. At such times, if the antitrust lawsuit was not successful, then the bidder tried to pursue more friendly suitors and prepare a list of white knights, as such friendly suitors are referred. By the 1980s, when hostile bidders were initiating tender offers with increasing aggressiveness, targets began to catch up to bidders, and the arms race between bidders and targets took force in earnest. Targets enlisted the services of adept attorneys and investment bankers, who devised increasingly sophisticated takeover defenses.
There are two types of takeover defenses. Preventive takeover defenses are put in place in advance of any specific takeover bid. They are installed so that a bidder will not attempt a takeover. Active takeover defenses are deployed in the midst of a takeover battle where a bidder has made an offer for the company. Although there are a variety of both types of defenses, many of them are less effective than when they were initially created.
The most effective preventive takeover defense is a poison pill. Poison pills are also called shareholders’ rights plans. Rights are shortterm versions of warrants. Like warrants, they allow the holder to purchase securities at some specific price and under certain circumstances. Poison pills usually allow the rightsholders to purchase shares at half-price. This is usually worded as saying the holder can purchase $200 worth of stock for $100.
Poison pills are an effective defense because they make the costs of a takeover very expensive. If the bidder were to buy 100% of the outstanding shares, it would still have to honor the warrants held by former shareholders, who would then be able to purchase shares at half-price. Because this usually makes an acquisition cost prohibitive, bidders seek to negotiate with the target to get it to dismantle this defense. Sometimes the bidder makes direct appeals to shareholders, requesting them to take action so they can enjoy the premium it is offering and which management and the board may be preventing them from receiving. Target management and directors, however, may be using the protection provided by the poison pill to extract a suitable premium from the bidder. Once a satisfactory offer is received, they may then dismantle this defense, which can usually be done easily and at low cost to the target company.
Other types of preventive takeover defenses involve different amendments of the corporate charter. One such defense is a staggered board, which alters the elections of directors so that only a limited number of directors, such as one-third, come up for election at one time. If only one-third of the board could be elected at one time, then new controlling shareholders would have to wait for two elections before winning control of the board. This hinders bidders who make an investment in the target and then cannot make changes in the company for a period of time. Such changes may be a merger with the bidding company or the sales of assets, which might be used to help pay off debt the bidder incurred to finance the acquisition of the target’s stock.
Other common corporate charter amendments are supermajority provisions, which require not just a simple majority but a higher percentage, before certain types of changes can be approved. If a pocket of shareholders will not vote with the bidder, such as managers and some employees who are worried about their jobs, then a bidder may not be able to get enough shares to enact the changes that it needs to take full control of the company.
Still other corporate charter changes include fair price provisions. These work similarly to fair price state corporation laws, except they are installed in the corporation’s own bylaws. They require that bidders pay what they define as fair compensation for all shares that are purchased. It is especially focused on two-tiered bids, which seek to pay lower compensation to the back end of an offer. Fair price provisions are not considered a strong takeover defense.
Other corporate charter changes include dual capitalizations. These feature different classes of stock, which afford different voting rights and dividend entitlements to holders of the shares. They often involve one class of super voting rights stock, which usually pay very low dividends. These shares are usually distributed to all shareholders, but those who are interested in augmenting their control, such as managers, may retain it while others may accept a follow-up offer by the company to exchange these shares for regular voting and dividend- paying stock. The end result of such a stock offering/dividend distribution is that increased control is concentrated in the hands of shareholders who typically are more “loyal” to the corporation and who would be less likely to accept an offer from a hostile bidder. SEC and stock exchange rules limit the extent to which companies can issue and trade such shares.
Companies may also try to prevent a takeover by moving to a state that has stronger antitakeover laws than the state in which it may be incorporated. This often is not an effective defense. Many companies that have such concerns usually are already incorporated in a favorable state or are incorporated in Delaware, which has many attractive features in its antitakeover laws.
A target company can take several steps when it is the receipt of an unwanted bid. Drawing on the defense that has been used for many years, it could file a lawsuit. Unless there are important legal issues it could argue, this often is not enough to stop a takeover. It may, however, provide time, which may enable the target to mount other defenses. This may include selling to a more favored bidder — a white knight. It may also involve selling shares to a more friendly party. This can be done in advance of an offer or as an active defense. The buyer in such sales is referred to as a white squire.
During the 1980s, targets were more likely to try to greenmail the bidder to get it to go away and leave the company independent. Greenmail, which plays on the word blackmail, involves the payment to the bidder of a sufficient amount so that it retreats and does not continue with the takeover. Many changes have occurred since the mid-1980s, when this active defense was used more liberally. The changes include tax penalties on such payments as well as corporate charter amendments that companies have passed limiting their ability to pay greenmail. Greenmail is usually frowned on by shareholders who find their financial resources being used to prevent a bidder, who might be willing to pay a premium for their shares, from making a successful offer.
Greenmail is often accompanied by standstill agreements, whereby a bidder agrees to not purchase shares beyond some limit. In exchange for those agreements, the bidder receive certain compensation. We still see standstill agreements today for various reasons, and they are used independent of greenmail.
Targets may also restructure the company to make it less attractive to a bidder, or it may make some of the same changes that are being suggested by a bidder, thereby taking this recommendation away from the bidder. Restructuring the company may involve both asset sales and purchases. The company may also restructure its capitalization to increase its debt, making it more leveraged. Capital structure changes may have some impact by making the company less attractive and by reducing the amount of debt that can be raised by a bidder to finance the target’s own takeover.
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