Ross et al.: Fundamentals
of Corporate Finance, Sixth
Edition, Alternate EditionVIII. Topics in Corporate
Finance- Mergers and
Acquisitions
(^886) © The McGraw−Hill
Companies, 2002
be canceled by management at any time; often, they can be redeemed (bought back) for
a penny apiece, or some similarly trivial amount.
Things get interesting when, under certain circumstances, the rights are “triggered.”
This means that the rights become exercisable, they can be bought and sold separately
from the stock, and they are not easily canceled or redeemed. Typically, the rights will
be triggered when someone acquires 20 percent of the common stock or announces a
tender offer.
When the rights are triggered, they can be exercised. Because they are out of the
money, this fact is not especially important. Certain other features come into play, how-
ever. The most important is the flip-in provision.
The flip-in provision is the “poison” in the pill. In the event of an unfriendly takeover
attempt, the holder of a right can pay the exercise price and receive common stock in the
target firm worth twice the exercise price. In other words, holders of the rights can buy
stock in the target firm at half price. Simultaneously, the rights owned by the raider (the
acquirer) are voided. The goal of the flip-in provision is to massively dilute the raider’s
ownership position.^10
The rights issued in connection with an SRP are poison pills because anyone trying
to force a merger will trigger the rights. When this happens, all the target firm’s stock-
holders can effectively buy stock in the merged firm at half price. This greatly increases
the cost of the merger to the bidder because the target firm’s shareholders end up with a
much larger percentage of the merged firm.
Notice that the flip-in provision doesn’t prevent someone from acquiring control of a
firm by purchasing a majority interest. It just acts to vastly increase the cost of doing so.
The intention of a poison pill is to force a bidder to negotiate with management. Fre-
quently, merger offers are made with the contingency that the rights will be canceled by
the target firm.
Some new varieties of poison pills have appeared on the scene in recent years. For
example, a “chewable” pill, common in Canada but not in the United States, is a pill that
is installed by shareholder vote and can be redeemed by shareholder vote. Then there’s
the “deadhand pill,” which explicitly gives the directors who installed the pill, or their
handpicked successors, the authority to remove the pill. This type of pill is controversial
because it makes it virtually impossible for new directors elected by stockholders to re-
move an existing poison pill. As this is being written, the pill has been declared illegal
by Delaware’s supreme court, although it has passed court challenges in other states.
Going Private and Leveraged Buyouts
As we have previously discussed, going private is what happens when the publicly owned
stock in a firm is replaced with complete equity ownership by a private group, which may
include elements of existing management. As a consequence, the firm’s stock is taken off
the market (if it is an exchange-traded stock, it is delisted) and is no longer traded.
One result of going private is that takeovers via tender offer can no longer occur
since there are no publicly held shares. In this sense, an LBO (or, more specifically, an
MBO) can be a takeover defense. However, it’s only a defense for management. From
the stockholders’ point of view, an LBO is a takeover because they are bought out.
862 PART EIGHT Topics in Corporate Finance
(^10) Some plans also contain “flip-over” provisions. These allow the holders to buy stock in the merged
company at half price.