A shareholder rights plan, widely known as a poison pill, is a defensive measure adopted by a company's board to deter anyone from acquiring a large stake or taking control without the board's agreement. Under the plan, every shareholder is issued a right that becomes exercisable if a person or group acquires more than a stated percentage of the company's shares. When triggered, the rights allow all holders except the acquirer to buy new shares at a deep discount, which massively dilutes the acquirer's stake and makes the takeover far more expensive.
The device is characteristic of the United States, where it is permitted under state corporate law, and is also used in Canada and Japan. It is intended to force a would-be acquirer to negotiate with the board and so to give directors time and bargaining power. Rights plans are largely unavailable in the United Kingdom and much of Europe, where takeover rules restrict boards from frustrating a bid.
History
The rights plan was devised in 1982 by the lawyer Martin Lipton during the wave of hostile bids in the United States. Its legality was confirmed in 1985, when the Delaware Supreme Court upheld a plan in Moran v. Household International. Later Delaware cases established that a board's use of a pill is subject to enhanced judicial review: directors must show that they reasonably perceived a threat and that the response was proportionate. By the 1990s a majority of large US companies had a plan in place.
Pressure from institutional investors and proxy advisers from the 2000s onwards led most companies to let their standing plans expire. The common practice now is to keep a plan "on the shelf", drafted but not adopted, so that the board can put it in place within a day if a threat appears. Many companies did so during the market fall of 2020, and Twitter adopted one in April 2022 after Elon Musk disclosed a large holding.
How it works
The board declares a dividend of one right for each ordinary share. Initially the rights have no separate existence: they trade with the shares, cannot be exercised and have no real value. They detach and become exercisable only when an acquirer crosses the trigger, commonly set between 10 and 20 per cent of the shares. The two main mechanisms are:
- Flip-in. Each right held by anyone other than the acquirer may be used to buy the target's own shares at, typically, half the market price. The acquirer's rights are void.
- Flip-over. If the target is later merged into the acquirer, each right may be used to buy the acquirer's shares at half price.
Many plans also let the board exchange each right for one share instead, which achieves dilution without holders paying cash. The board can redeem the rights for a nominal sum at any time before the trigger, and this is how a pill is removed when the board approves a deal. In practice the dilution is so severe that pills are almost never deliberately triggered; their effect lies in the threat.
Variations
Plans differ in duration and trigger. Institutional investors generally expect a term of no more than one year unless shareholders approve longer. Some plans include a "qualified offer" clause that exempts fully financed all-cash bids open for a minimum period. A special type, the net operating loss pill, uses a trigger just under five per cent to prevent ownership changes that would restrict the company's use of past tax losses under US tax rules. Features that stop a newly elected board from redeeming the pill, known as dead-hand and slow-hand provisions, have been struck down in Delaware.
How a bidder responds
A pill does not make a company takeover-proof. A determined bidder can make a takeover offer conditional on the pill being redeemed and, at the same time, run a proxy contest to replace the directors at the next shareholder meeting with nominees who will redeem it. Winning such a contest depends on proxy voting by institutions. The pill is therefore most powerful when combined with a staggered board, where only a fraction of directors stand for election each year. Bidders may also ask a court to order redemption, arguing that the board is in breach of its fiduciary duties.
Debate
Supporters argue that a pill protects shareholders from coercive or underpriced bids and from creeping acquisitions of control in the market without payment of an acquisition premium, and that it strengthens the board's hand in negotiating a higher price. Opponents see it as a tool for entrenching management, an instance of the agency problem between managers and owners, since it lets directors block offers that shareholders might wish to accept. Empirical studies of the effect on shareholder value have reached mixed conclusions.
In the United Kingdom, the Takeover Code prevents a board from taking action that could frustrate an offer without shareholder approval once a bid is in prospect, and European Union takeover rules allow member states to apply a similar principle. Defensive tactics there rely instead on persuading shareholders, and the wider field is covered under mergers and acquisitions. The rights issued under a pill should not be confused with the subscription rights of a rights issue, which raise new capital.