We recently saw that Yahoo had removed the so called “Severance Benefits” that it had planned to implement were it ever subject to a hostile takeover. In this article, we take a closer look at this mechanism as well as how effective “Poison Pills” like this can be.
A Poison Pill is a strategy employed by companies to ensure that the existing managment is not harmed by a hostile takeover. We know that takeovers can be accomplished by more ways than one. In the recent interactions between Yahoo! and Microsoft, there was a threat in the air that Microsoft would either replace Yahoo!’s board members with those more sympathetic to it at the AGM, or buy up a dominating percentage of Yahoo! share.
Image Credit: Steven Fernandez
Yahoo! management has every right to be afraid of something like this since it would be quite likely that Microsoft would want to replace a number of Yahoo! managers with their own people. In order to prevent this from happening (After all, no one likes to lose their jobs), Yahoo! enacted a clause that in the event of a hostile takeover, Yahoo employees could avail themselves of massive benefits by walking away.
These massive benefits would of course financially harm the company effectively raising the cost of the takeover by hundreds of millions of dollars. This “Poison Pill” is like a suicide attempt. The threat is, don’t try and take me over, otherwise I’ll self destruct.
The question is, is this threat credible? In Game theory, a credible threat is one where the person who is making the threats actually benefits by carrying out the said threat. By this logic, if a robber takes hostage a single victim, threatening to shoot him if the police came in, would he actually do it? After all, killing the hostage provides him with no protection afterwards and will probably only increase his sentence! The only reason why he would ever carry out his threat and kill the hostage, was if he was insane. A perfectly rational robber would never kill a single hostage. This is why it is sometimes best to be insane.
The situation is strikingly similar when discussing corporate Poison Pills. It’s reasonable to assume that Yahoo! management holds a considerable stake in the company, and harming the company will harm them too. Moreover, the Poison Pill will be swallowed only if the hostile takeover succeeds. Assuming that the Pill is swallowed, this cannot reverse the acquisition. What then is the purpose of swallowing the pill? It is just a threat, and not a very credible one. The managment doesn’t gain anything by swallowing a pill that hurts the company after the acquisition has taken place.
One can devise a Poison Pill in such a way that it reduces the effectiveness of a hostile takeover by allowing existing shareholders (But not the acquirer) to purchase shares at a discount. This means that having bought a certain percentage of Yahoo! (in this case, 15%), Yahoo! shareholders can then get more shares at a huge discount. This means that the percentage of shares owned by Microsoft will come be less than 15% and may not be enough for a takeover. This is called a Dilution Poison Pill.
Will this be effective? Let’s say that Microsoft has bought 15% of Yahoo! stock for tens of billions of dollars. That money is a sunk cost. Once they’re bought, they’re bought. Microsoft must treat this as a sunk cost, and continue to buy up more Yahoo! shares to gain a controlling interest since the additional cost of buying the shares is much less than the amount already sunk in. So this Poison Pill holds no threat either.
The only way that the management can effectively threaten to swallow the pill, was if they were considered insane. Unfortunately, the Insane argument doesn’t really work in a corporate environment. In fact, an insane management has no right to run the company at all. And thus the Poison Pill threat is negated.