Defenses Against Hostile Takeovers

There are several ways to defend against a hostile takeover. The most effective methods are built-in defensive measures that make a company difficult to take over. These methods are collectively referred to as "shark repellent." Here are a few examples:

  • The Golden Parachute is a provision in a CEO's contract. It states that he will get a large bonus in cash or stock if the company is acquired. This makes the acquisition more expensive, and less attractive. Unfortunately, it also means that a CEO can do a terrible job of running a company, make it very attractive for someone who wants to acquire it, and receive a huge financial reward. 
     
  • The supermajority is a defense that requires 70 or 80 percent of shareholders to approve of any acquisition. This makes it much more difficult for someone to conduct a takeover by buying enough stock for a controlling interest.

  • A staggered board of directors drags out the takeover process by preventing the entire board from being replaced at the same time. The terms are staggered, so that some members are elected every two years, while others are elected every four. Many companies that are interested in making an acquisition don't want to wait four years for the board to turn over.

  • Dual-class stock allows company owners to hold onto voting stock, while the company issues stock with little or no voting rights to the public. That way investors can purchase stocks, but they can't purchase control of the company.


     

In addition to takeover prevention, there are steps companies can take to thwart a takeover once it has begun. One of the more common defenses is the poison pill. A poison pill can take many forms, but it basically refers to anything the target company does to make itself less valuable or less desirable as an acquisition:

  • The people pill - High-level managers and other employees threaten that they will all leave the company if it is acquired. This only works if the employees themselves are highly valuable and vital to the company's success.

  • The crown jewels defense - Sometimes a specific aspect of a company is particularly valuable. For example, a telecommunications company might have a highly-regarded research and development (R&D) division. This division is the company's "crown jewels." It might respond to a hostile bid by selling off the R&D division to another company, or spinning it off into a separate corporation.

  • Flip-in - This common poison pill is a provision that allows current shareholders to buy more stocks at a steep discount in the event of a takeover attempt. The provision is often triggered whenever any one shareholder reaches a certain percentage of total shares (usually 20 to 40 percent). The flow of additional cheap shares into the total pool of shares for the company makes all previously existing shares worth less. The shareholders are also less powerful in terms of voting, because now each share is a smaller percentage of the total.  

Some of the more drastic poison pill methods involve deliberately taking on large amounts of debt that the acquiring company would have to pay off. This makes the target far less attractive as an acquisition, although it can lead to serious financial problems or even bankruptcy and dissolution. In rare cases, a company decides that it would rather go out of business than be acquired, so they intentionally rack up enough debt to force bankruptcy. This is known as the Jonestown Defense.

In the next section, we'll weigh the costs and benefits of hostile takeovers.

Other Forms of Prevention
Greenmail is similar to blackmail, but it's green to represent the money the target must spend to avoid the takeover. If the acquiring company is on the verge of a controlling interest, they might offer the target the option to buy their stock back at a premium price. Sometimes, acquisition isn't the goal -- the acquiring company is just buying stock so they can sell it back and make a profit on the greenmail payment.

The White Knight is a common tactic in which the target finds another company to come in and purchase them out from under the hostile company. There are several reasons why they would prefer one company to another -- better purchase terms, a better relationship or better prospects for long-term success.

With the Pac-Man Defense, a target company thwarts a takeover by buying stocks in the acquiring company, then taking them over.