SharkRepellantPaper

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Shark Repellant

Are Controversial Anti-Takeover Measures Harmful to Shareholders?

By: Ryan D. Seelke

The past few years have been very active in the mergers and acquisitions market. Last

year there were 173 announced M&A deals above $500 Million and through June of this year

there is already 139.1 A lot of M&A deals are celebrated and regularly make the CNBC

headlines. Some make the headlines because they are viewed as a good opportunity while others

make the headlines due to the hostile nature of the deal. The target of a hostile takeover is often

an unwilling firm that wants to remain in control of it own business. In order to avoid such

takeovers many firms have adopted measures that make a deal less attractive and less beneficial

to possible acquirers. These measures combine to form what is commonly called shark repellant.

However, even though the concept is a noble one, often times, shark repellant measures are not

in the best interest of shareholders because they purposely damage the companys financial

position and take managements focus off of real business objectives.2

What is Shark Repellant

Shark Repellant is simply slang for a number of measures that a company may adopt in

order to fend off hungry acquirers.3 These measures are often contained in the corporate charter

or bylaws and are activated once a proposed merger takes shape.4 There are many different

measures used as shark repellant, however, some of the most common are (1) The Poison Pill,

(2) Scorched Earth Policies, and (3) Golden Parachute provisions. Other common measures are

super majority requirements and defensive mergers.5

1 http://bespokeinvest.typepad.com/bespoke/2007/06/2007-ma-deals.html2 http://www.investopedia.com/terms/s/sharkrepellent.asp3Id.4Id.5 http://baystreet.investopedia.com/terms/s/sharkrepellent.asp

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As mentioned above, shark repellant measures are put in the corporate charter or bylaws

and are activated only when a proposed hostile takeover is on the horizon. The goal is to make

mergers with the company less attractive and allows target companies to have the power to

decide their own fate in the marketplace.

Are Shark Repellant Measures Good for Investors

The easy question to the above question is that it depends. Some companies no doubt

have shareholders that wish to remain independent and accept the most extreme measures to

keep it that way. Others on the other hand are hurt due to the measures damaging the company

financially and in extreme cases, dealing a deathblow to them. One measure that does not

directly hurt the shareholder is the poison pill. The poison pill comes in two flavors. The first is

the Flip-In method, which calls for shareholders of a prospective target company to have the

ability to buy their companys shares at a greatly reduced price.6 The potential acquirer does not

have such a luxury, and the result is a diluted share value for the acquirer.7 The second method

is the Flip-Over method. This is where the shareholder of the proposed target company gets to

buy shares of the acquirer at a discount after the merger takes place. This too dilutes the value of

the acquiring firm and makes the proposed merger both more difficult and more expensive.8

A second popular measure is the so-called scorched earth policies. This is where the

prospective target company liquidates its valuable assets prior to a hostile offer in order to make

it appear and effectively be less desirable financially.9 Another way to accomplish this same

goal is to assume various liabilities that make the firm more expensive in the long run. This

measure has the same effect as the scorched earth policies in past military operations. Its overall

goal is to destroy anything of value so the opposing enemy (acquirer) will have nothing to gain

6 http://www.investopedia.com/terms/p/poisonpill.asp7Id.8Id.9 http://www.investopedia.com/terms/s/scorchedearthpolicy.asp

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once they get to the desired location (deal).10 However, sometimes in extreme cases, scorched

earth policies actually destroy a company forever rather than just prevent a takeover. In that

instance, the corporation ends as a valueless entity and is an example of a suicide pill.

The last measure to be discussed is perhaps the most controversial; the Golden Parachute.

The Golden Parachute, (GP for short) is a clause in an executives employment contract that

promises sometimes-extreme payment if he/she loses his job due to a merger.11 This in itself is

not too controversial, however, many times; GPs have been used when no merger was in sight.

Instead, some GPs are used for the sole purpose of inducing a poor executive to leave the

company. One example of this is the Robert Nardelli controversy at Home Depot a couple of

years ago. Mr. Nardelli came to Home Depot with high marks as an executive from G.E.

However, while in charge of Home Depot, he basically ran the company into the ground. In an

effort to get Nardelli to leave, Home Depot offered to pay him $210 Million as a Golden

Parachute.12 Nardelli took the deal and was essentially paid a huge payday for being a failure.

Since then, shareholders across the country are trying to combat excessive GPs. General Motors

for example, had a minor shareholder actually propose a proxy that would require the GM Board

of Directors to put together a shareholder vote for any GPs that they may want to give out. GM

obviously disagrees with the proposal, and as of this writing, it is unclear if the proposal will be

put to proxy or not.

Current Questions

As mentioned above, some shareholders may actually benefit from shark repellant

measures because it gives them the chance to retain control of their company. However, many

times, shareholders are actually hurt by such measures due to the loss of value of the firm.

10Id.11 http://www.investorwords.com/2201/golden_parachute.html12 http://www.executiveinvestigator.com/2007/01/03/Investors+Outraged+Over+Nardellis+Golden+Parachute.aspx

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Further, as owners of a company, many times these shark repellant measures take away power

from the shareholder if they really would like to see a deal go through. In addition, these

measures may reduce value-enhancing deals that would make shareholders of target companies

better off than if the merger were to not take place. It is also argued that these measures restrict

the free market system. In essence, these measures are subsidies to firms that make the price of

its product (firm itself) more expensive. As routinely happens, when the free market system is

interrupted, surpluses are lost and society as a whole loses.

Conclusion

Shark Repellant measures are often controversial and the focus of many debates. As

M&A deals continue to rise, more companies will attempt to protect themselves by enacting such

provisions. As time goes on, courts, the legislature, and shareholders themselves with help shape

the complex law in this important area. As a free market enthusiast and a dual JD/MBA, I have a

strong interest in the upcoming debate in this area. I feel that possible deals should be left for the

shareholder to ultimately decide. Shareholders are the ultimate owner of the company, and by

using shark repellants, directors of potential target companies may not be acting in the best

fiduciary interest of their owners. With this said, however, there still needs to be the escape

route that allows companies to protect themselves from unwanted take-overs. At this juncture, I

just do not think shark repellant is the best way.

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