Poison Pill Plans Are Bad for Shareholders

One of the recurring themes of this blog has been criticisms of capitalism as practiced by corporate America.  I have specifically called for a reformation of corporate culture in the United States multiple times.  One of the most egregious excesses of the corporation is the nearly unanimous use of “poison pill” plans by companies.  Unfortunately, most of the general public, and most investors, don’t have a clue as to what poison pill plans are.  Here is a brief overview of this devilish destroyer of shareholder value.

1.  Poison pill plans were almost universally adopted by boards of directors without ever putting these plans to a shareholder vote.  Instead, modifications were made to corporate “articles of incorporation.”  That is, by a single vote that cannot be rescinded, these plans were put into place.

2.  The poison pill plans were widely adopted in the 1980s when the business climate was one of the “corporate raider.”  These folks were simply looking to buy low, sell high by buying under performing companies, making them more efficient, and then reselling them.  The environment in the 1980s was one of hostility toward these folks.  And in that environment poison pill plans were implemented nearly universally.

3.  To ward off a “hostile” takeover is the goal of poison pill plans.  Typically these plans only go into effect when two conditions are met.  The first, is that the potential acquirer of a business must negotiate directly with the board of directors of a company to avoid the poison pill plan going into effect automatically.  The second condition is that barring an acquirer dealing with the board directly, if the acquirer attempts to buy a controlling interest in the business, typically > 20%, then the pill plan goes into effect.

4.  There are two types of poison pill plans…

The first is known as a “flip in.”  In this situation, when an acquirer crosses a threshold percentage amount of ownership of a target company then current shareholders (except the acquirer) are often automatically issued more shares in the business and at deeply discounted prices.  This is typically done in some fixed proportion.  So if the flip in poison pill is triggered, current shareholders may receive the right to purchase 0.4 new shares for every share they already own.  In other words, the takeover price is increased because the total number of shares outstanding increases dramatically, massively diluting the percentage ownership of the acquirer.

The second type is known as a “flip over.”  In this situation current stockholders are given the ability to purchase discounted shares in the successor company.  That is, if the acquisition is completed then current shareholders can purchase shares in the new company.  The effect is the same as with a flip in poison pill plan.

5.  The goal of the pill plan is to make the cost of an unwanted takeover prohibitive.

So what is the effect of a poison pill plan on the actual owners of the business; i.e. the shareholders; i.e. you and me?  The argument by corporations for 30+ years has been that poison pill plans benefit shareholders by increasing the amount of money in shareholder pockets when “hostile” bids are made.

Overlooked is the fact that poison pill plans allow poorly run businesses to hide from responsibly running a business.  For the surest protection against a poison pill plan is a well run business that results in a naturally high stock price that makes a takeover impossible.  You see, takeovers only work because the prospective acquirer sees additional value that can be squeezed out from the business.  Ultimately, a better run business means a higher share price for shareholders.  But poison pill plans mean that the corrective force provided by the threat of a “hostile” takeover is removed.  So there is no outside market force enforcing efficiency on the business.

Put bluntly, poison pill plans are anti-capitalistic.  They predominately benefit board members and their management teams by ensuring that they can run a business for their own benefit to the detriment of shareholders.  Disgusting.

Which brings me to the most important news of the new year, and one of the most important pieces of news in the last 30 years.  Yes, really.  Air Products & Chemicals launched a “hostile” bid for a rival business, Airgas.  The bid triggered Airgas’s poison pill plan which Air Products & Chemicals is fighting in a Delaware court.  Most importantly, a Delaware judge will be issuing a ruling in the next several weeks.  This is important because most U.S. businesses are incorporated in Delaware because that state’s laws strongly favor corporations.  So a change in the legality of the poison pill plan in Delaware will affect almost every important U.S. business.

Let’s hope that the Delaware judge recognizes the absurdity of poison pill plans and rejects their continued legality.

Jason