Shareholder Rights Plan (more appropriately called Poison Pill)

Our Best Practices View:

“Shareholder Rights Plan” is a sinister name for a practice aimed at corroding shareholder rights.  We believe there is no good poison pill and support resolutions opposing such provisions.  If complete elimination of poison pills is not feasible, we will support resolutions to soften it as much as possible.

Now for the part that is just as silly as serious:  A somewhat tolerable Poison Pill (note the contradiction in terms) will be chewable both ways, not a jaw-breaker, will not have a dead hand or slow hand, but also not a no-hand either and have a 20% trigger.  All these morbid, but real financial terms will be explained later.

A typical “shareholder rights plan” is usually triggered when 10% of outstanding shares are acquired by a single shareholder or a shareholder group.  (A public offer triggers the poison pill effectively as well unless the board agrees to suspend it).  It gives the “right” to the holders of the remaining 90% to acquire newly issued shares at a nominal price.  This way, the owners of the 10% are diluted to 5.26% without an increase in company value.  In effect, half of their share is distributed between the other shareholders.  The board can usually suspend poison pill at will.

Poison pill invention is widely attributed to a corporate lawyer, Martin Lipton, who devised it in 1982 in response to an increase in corporate raids.  Poison pills were later upheld by Delaware courts, even though they extent different treatment to the same classes of shares.  Public companies further lobbied to remove any other legal impediment to poison pills.

Poison pills have been proven to corrode shareholder value, and shareholders normally fight them.  Some studies have suggested that companies with shareholder pill provisions tend to get a greater premium than companies without, supposedly because boards negotiate on behalf of shareowners.  However, this is not an objective view because:

1. These studies have not taken into account the large percentage of bids that fail because of the poison pill, leaving shareholders with no premium at all.  The most recent case: Mircrosoft’s attempt to acquire Yahoo.
2. These studies have not take into account the drag on the initial price that was caused by poison pill to begin with. 
3. These studies have not taken into account the fact that in the absence of poison pill, the price of shares increase before the tender because there is more buying and a higher expectation of a successful takeover.

About 3,000 US public companies now have “shareholder rights” provision.

The justification for poison pills is to give the board the ability and the time to negotiate the best deal for shareholders and to find competing buyers.  However, a good board will be proactive in knowing potential buyers.  There are as many other reasons given for poison pill as there are lawyers in the room, but all of them do not stand up to scrutiny of logic.  Usually poison pills serve the incumbent boards and management to negotiate payments for themselves. 

Here are the various features of poison pills, mentioned above:

Chewable:  Usually the board has full control of invoking the poison pill.  A chewable pill allows the shareholders to vote on invoking it.  A two-way chewable pill also allows the shareholder to vote on suspending it.  The reason it should be two-way is to prevent the board from favoring its own bidder, such as a leveraged buyout by the management, at the cost to shareholders.  

Jawbreaker: Often poison pill provisions appear chewable, but enough “goodies” or details are hidden inside to in effect make them not chewable.   This is something like a scene in a Japanese monster movie when the hero throws something bad into the monster’s mount, screaming “chew on this.”

Dead hand:  This is my favorite; right out of a Zombie movie.  A dead hand provision means that even after the board is fired, it can control the poison pill.  How is this in shareholder’s best interests?   This is probably the most sinister provision.  A Delaware supreme court ruled dead hand provision illegal.  However, it is expressly allowed by law in Georgia and Pennsylvania.  Many other pro-management states allow it.  It couldn’t that that these states’ legislatures are full of Zombies?

Slow hand: This is more like a ghost movie: the fired board controls the poison pill for 90 days.

No hand:  This one is either from Frankenstein or from Curse of The Mummy II: if the incumbent board is fired, no one can control the poison pill; it just gets a life of its own.  It would take a shareholders’ meeting and a vote of shareholders (sometimes as high as 80%) to remove the poison pill.

Real money provision: Shareholders must actually spend some money to acquire the newly-issued shares.  This can be accomplished in a variety of ways, including setting a 10X1 increase instead of a 1x1 or putting a price on the extra issue that is above just nominal.  Many believe that the real money provision is positive because it actually compels shareholders to invest.  However, the newly-issued shares are still priced below market, and some shareholders can be restricted or unable to invest, which means that they too would get diluted.  Our position is that real money provision can violate even more shareholder rights than it helps.

Links to resources about Poison Pills:

Great primer, written by Prof. Ian Giddy of NYU:  http://pages.stern.nyu.edu/~igiddy/cases/goldfield.htm

Here is what Carl Icahn has to say about poison pills:  http://www.icahnreport.com/report/2008/06/absurdity-of-th.html

Law journal perspective: http://iblsjournal.typepad.com/illinois_business_law_soc/2005/03/shareholder_rig.html