A Shareholder Rights Plan is also known as a Poison Pill. It is a defensive tactic used by a company to thwart an attempted hostile takeover. This action, one of a number of so called shark repellents, can be preemptive to either deter possible acquirers altogether or implemented on a reactionary basis. At this point, the tactic may be to continue repelling the unwanted takeover approach or used as a mechanism to improve the negotiating position of the target. A major criticism of the Shareholder Rights Plan is the creation of management entrenchment. The pill ultimately protects management jobs and those of the board whilst denying shareholders the gains associated with an acquisition premium. The tactic comes under frequent attack from activist investors.
Following the Covid-19 pandemic, a number of companies elected to adopt a temporary shareholder right plan. See our article Covid-19 and Merger Arbitrage Trading for more on this topic. This action, it is claimed, is to protect firms from unwanted opportunistic low ball bidding by acquiring firms taking advantage of depressed stock prices. It is unclear at this stage whether or not this was a cover for management entrenchment or a genuine concern for maximizing shareholder wealth.
Enacting The Shareholder Rights Plan
The Shareholder Rights Plan is usually triggered when a shareholder acquires stock in the target firm above a predetermined threshold, for example 15%. At this time, a dividend is distributed to the other existing shareholders giving them the right to acquire an additional share in the firm. This is done to such an extent that a takeover becomes uneconomical following the losses caused as the stock price adjusts accordingly. This is known as a flip-in pill. For an in-depth analysis of the differences between flip-in and flip-over pills please refer to our article Hostile Takeovers and Merger Arbitrage – What All Traders Should Know. This article also covers a discussion of additional hostile takeover defense tactics.
Poison Pills are not allowed in the United Kingdom under Takeover Panel rules. This is an important distinction with he U.S. when comparing average historical merger arbitrage spreads. As the likelihood (DCP) of a successful takeover is increased in this jurisdiction, the average spreads will naturally be tighter.
