Detailed Definition
A “poison pill” refers to a suite of strategies used by companies to prevent or discourage hostile takeover attempts by making their shares less attractive to the potential acquirer. This tactic often involves triggering specific provisions that can have adverse effects on the would-be acquirer’s financial health or strategic objectives.
Common Types of Poison Pills
- Flip-In Poison Pill: Allows existing shareholders, excluding the acquirer, to purchase additional shares at a discount, diluting the value of the shares held by the acquirer.
- Flip-Over Poison Pill: Permits shareholders to buy the acquirer’s shares at a discounted rate post-merger.
- Back-End Rights Plan: Offers shareholders the right to convert their shares into a guaranteed amount of cash or other securities if a certain triggering event occurs.
Examples
Example 1: Friendly Asset Sale
A company targeted for a hostile takeover might sell a highly valuable asset to a friendly third party, making it less attractive to the hostile acquirer.
Example 2: Issuance of Securities
A corporation may issue new shares that can be converted at a discounted price if a takeover occurs, diluting the control and financial interest of the acquiring company.
Frequently Asked Questions (FAQs)
What is a “flip-in” poison pill?
A “flip-in” poison pill allows current shareholders to buy more shares at a discount, except for the acquirer, thereby diluting the acquirer’s stake and making the takeover less attractive.
How does a poison pill impact shareholders?
Shareholders may benefit from the increased control measures, as it can prevent hostile takeovers that undervalue the company. However, the introduction of a poison pill can, at times, reduce the stock’s liquidity and market value.
Is implementing a poison pill legal?
Yes, implementing a poison pill is legal and widely accepted within corporate governance laws. However, it must be done following strict regulatory guidelines and often requires shareholder approval.
Hostile Takeover
A hostile takeover occurs when a company attempts to acquire another company against the wishes of that company’s management and board of directors.
Staggered Directorships
Staggered directorships refer to a practice where only a portion of the board of directors is elected each year, making it harder for an acquirer to gain control quickly.
Golden Parachute
Golden Parachute is a large financial compensation package given to a company executive if they lose their job due to a takeover.
Online Resources
- Investopedia on Poison Pills
- SEC on Corporate Governance
- Harvard Law—Poison Pills: Understanding Antitakeover Strategies
Suggested Books for Further Studies
- “Mergers, Acquisitions, and Other Restructuring Activities” by Donald DePamphilis
- “Takeovers: Law and Strategy” by Janet Dine and Marios Koutsias
- “The Complete Guide to Mergers and Acquisitions” by Timothy J. Galpin and Mark Herndon
Accounting Basics: “Poison Pill” Fundamentals Quiz
### What is a primary goal of using a poison pill strategy?
- [x] To make the target company less attractive to the acquirer.
- [ ] To increase the company's stock price.
- [ ] To reward existing management with bonuses.
- [ ] To reduce the number of shareholders.
> **Explanation:** The primary goal of implementing a poison pill is to make the target company less attractive to the acquirer by diluting the shares or by other strategic means.
### What type of poison pill allows shareholders to purchase additional shares at a discount?
- [x] Flip-In Poison Pill
- [ ] Flip-Over Poison Pill
- [ ] Staggered Directorships
- [ ] Back-End Rights Plan
> **Explanation:** A "Flip-In Poison Pill" allows existing shareholders, except the acquirer, to purchase additional shares at a discounted rate, thereby diluting the acquirer's stake.
### Which poison pill type allows shareholders to buy the acquirer's shares at a discount after a merger?
- [ ] Flip-In Poison Pill
- [x] Flip-Over Poison Pill
- [ ] Staggered Directorships
- [ ] Crown Jewel Defense
> **Explanation:** A "Flip-Over Poison Pill" allows shareholders to buy the acquirer's shares at a discounted rate post-merger, diluting the acquirer's overall value.
### How does a staggered board work in preventing takeovers?
- [x] It limits the number of board members that can be replaced at a time.
- [ ] It increases the dividends paid to shareholders.
- [ ] It sells the company's valuable assets.
- [ ] It cuts down executive compensation.
> **Explanation:** A staggered board works by only allowing a portion of the directors to be elected at a time, thereby making it difficult for an acquirer to quickly gain control of the board.
### Why might a company adopt a "golden parachute"?
- [ ] To lower the bid price of the acquirer.
- [x] To offer large financial compensations to executives losing jobs due to a takeover.
- [ ] To increase the stock liquidity.
- [ ] To expand into new markets.
> **Explanation:** A "golden parachute" provides large financial compensation to company executives if they lose their jobs due to a takeover, influencing the cost analysis of the takeover.
### Which of the following is not a characteristic of a poison pill?
- [ ] Sells valuable assets to a friendly third party.
- [ ] Issues new shares to dilute value.
- [ ] Allows shareholders to buy additional shares at a discount.
- [x] Sells company's shares at a premium.
> **Explanation:** Poison pills usually involve selling valuable assets or issuing new shares to dilute value, not selling the company's shares at a premium.
### When would a poison pill be typically triggered?
- [x] When a certain percentage of shares are purchased by an acquirer.
- [ ] When the company declares bankruptcy.
- [ ] When the board of directors chooses new CEO.
- [ ] At the end of the fiscal year.
> **Explanation:** A poison pill is typically triggered when an acquirer purchases a specified percentage of the company's shares, initiating the predefined anti-takeover measures.
### How does a poison pill affect the acquirer's investment?
- [x] Reduces the attractiveness and potential returns of the takeover.
- [ ] Increases the immediate profit of the acquirer.
- [ ] Guarantees a higher return on investment.
- [ ] Cannot be used against large entities.
> **Explanation:** By introducing measures that dilute stock value or involve complex financial moves, poison pills reduce the potential returns of the takeover, making it less appealing to the acquirer.
### What legal stipulation must poison pills adhere to?
- [ ] Must increase share prices.
- [x] Must comply with corporate governance laws and regulations.
- [ ] Must favor executives only.
- [ ] Must be renewed annually.
> **Explanation:** Poison pills need to comply strictly with corporate governance laws and regulatory guidelines to be legally valid and enforceable.
### Which type of rights plan ensures conversion of shares for a fixed value of cash or other securities?
- [ ] Flip-In Poison Pill
- [ ] Flip-Over Poison Pill
- [ ] Staggered Directorships
- [x] Back-End Rights Plan
> **Explanation:** A "Back-End Rights Plan" offers shareholders the right to convert their shares into a guaranteed amount of cash or other securities upon a triggering event, providing security to shareholders against hostile takeovers.
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