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Golden Parachutes: Knight

Golden parachutes provide generous severance packages to management if a takeover occurs. While they are intended to deter takeovers by raising acquisition costs, the deterrence effect is likely small because severance payments are a minor part of acquisition costs. Additionally, golden parachutes may actually increase the likelihood of a takeover by reducing management's inclination to resist it.

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40 views2 pages

Golden Parachutes: Knight

Golden parachutes provide generous severance packages to management if a takeover occurs. While they are intended to deter takeovers by raising acquisition costs, the deterrence effect is likely small because severance payments are a minor part of acquisition costs. Additionally, golden parachutes may actually increase the likelihood of a takeover by reducing management's inclination to resist it.

Uploaded by

Luciene Santos
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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Golden Parachutes This colorful term refers to generous severance packages pro

vided to management in the event of a takeover. The argument is that golden


parachutes
will deter takeovers by raising the cost of acquisition. However, some authorities
point
out that the deterrence effect is likely to be unimportant because a severance package,
even a generous one, is probably a small part of the cost of acquiring a firm. In
addition,
some argue that golden parachutes actually increase the probability of a takeover. The
reasoning here is that management has a natural tendency to resist any takeover
because
of the possibility of job loss. A large severance package softens the blow of a
takeover,
reducing management’s inclination to resist.
Poison Pills The poison pill is a sophisticated defensive tactic that Martin Lipton,
a well-known New York attorney, developed in the early 1980s. Since then a number
of
variants have surfaced, so there is no single definition of a poison pill. For example, in
October 2013, famed auction house Sotheby’s enacted a poison pill to ward off hedge
fund Third Point, which was run by activist investor Dan Loeb. Sotheby’s poison pill
was somewhat unique in that it kicked in if an activist investor acquired more than 10
percent of the company’s stock or a passive investor acquired more than 20 percent of
the company’s stock. If either of these events happened, every shareholder except the
shareholder causing the poison pill to become active would be given the right to buy
new stock at half price. At the time, Sotheby’s had about 69 million shares
outstanding.
If Third Point acquired more than 10% of the stock (6.9 million shares), every share
holder except Third Point could have bought a new share for every one previously
held.
If all shareholders exercised this option, Sotheby’s would have had to issue 62.1
million
(= .90 × 69 million) new shares, bringing its total to 131.1 million. The stock price
would drop sharply because the company would be selling shares at half price. The
bid
der’s percentage of the firm would drop from 10 percent to 5.3 percent (= 6.9 mil
lion/131.1 million). Dilution of this magnitude causes some critics to argue that
poison
pills are insurmountable.
White Knight and White Squire A firm facing an unfriendly merger offer
might arrange to be acquired by a friendly suitor, commonly referred to as a white
knight.
The white knight might be favored because it is willing to pay a higher purchase
price.
Alternatively, it might promise not to lay off employees, fire managers, or sell off divi
sions. White knights often can increase the amount paid to the target firm. For
example,
in 2017, Australian-based Macmahon received a bid of A$.145 per share from
CIMIC,
which was already Macmahon’s largest shareholder. In response, Macmahon found a
white
knight in Amman Mineral Nusa Tenggara (AMNT), which agreed to a services
contract
from Macmahon for the life of an AMNT gold and copper mine, as well as the
purchase
of a 44.4 percent stake in Macmahon for A$.203 per share.
Management instead may wish to avoid any acquisition at all. A third party, termed
a white squire, might be invited to make a significant investment in the firm, under
the
condition that it vote with management and not purchase additional shares.
Recapitalizations and Repurchases Target management often will issue debt
to pay out a dividend—a transaction called a leveraged recapitalization. A share
repurchase,
where debt is issued to buy back shares, is a similar transaction. The two transactions
fend off takeovers in a number of ways. First, the stock price may rise, perhaps
because
of the increased tax shield from greater debt. A rise in stock price makes the
acquisition
less attractive to the bidder. However, the price will rise only if the firm’s debt level
before
the recapitalization was below the optimum level, so a levered recapitalization is not
recommended for every target. Consultants point out that firms with low debt but with
stable cash flows are ideal candidates for recaps. Second, as part of the
recapitalization,
management may issue new securities that give management gre

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