Introduction

Company directors generally tend to be viewed as shareholders' agents[1][2] and natural allies thereof[3], but, sometimes, the interests and wishes of said parties tend to be mutually exclusive[4]. The events transpiring during hostile takeovers are one of the prime examples of such an occurrence[5][6][7][8]. The purpose of this research is to critically analyze the options at the directors' disposal when going against the immediate wishes of company shareholders (i.e. owners) when attempting to circumvent a takeover.

In order to elaborate on a problem, the subject matter thereof needs to be defined firsthand. A hostile takeover, as well as its counterpart, a friendly takeover, is a type of a corporate acquisition, meaning that one company buys either all or a majority of the shares of another corporation, essentially, becoming its owner[9][10]. The difference between this types of acquisitions is that when a friendly takeover is in place, the acquiring company deals directly with the management of its target and brokers a deal of sale via them. As opposed to this is the situation with hostile takeovers, where the board of directors (i.e. the group responsible for the management of said company) is generally bypassed, the acquirer preferring to lodge a bid with the shareholders themselves[11], effectively, asking the owners of the corporation to side with them instead of those individuals, whom the shareholders themselves deemed to be knowledgeable and professional enough to be trusted with running their own company.

An overwhelming majority of corporate governance theories state, that it is the interests of the shareholders that need to be upheld and nurtured by the board of directors in the first place, everything else being of lesser importance[12][13][14]. In light of such a sentiment being the dominant line of though, one might think that the very notion of defending against hostile takeovers is opposed to the core ideas of corporate governance and should be discouraged, instead of being the focus of studies aimed at providing recommendations regarding the best ways of utilization thereof. This research, however, deeply disagrees with such an opinion, though, nevertheless, it is still something that needs to be made clear before proceeding to the primary part of the paper.

First of all, it should be emphasized that not all theories of corporate governance consider the shareholders to be more important than any other involved parties put together[15][16]. The prime example of this is the stakeholder theory, which emphasizes that it is not the shareholders, but the company in its entirety, the needs of which are paramount[17][18]. Therefore, defending the entity against hostile takeovers can be justified by stating that the board of directors is looking out for those who would suffer if the bid was to be allowed through and the purchase did transpire[19]. It would be the employees, the customers and all those involved with the target corporation in one way or another, that stood to lose quite a bit due to the company being taken over and it is exactly their interests that the directors are looking out for when fighting off the predator[20]. Alternatively, one could state that the shareholders’ wishes do not necessarily coincide with what is best for them and, if allowed to govern the company as they please, without it being taken over, the directors will be able to further maximize the shareholders wealth, effectively acting in their interests despite circumventing their immediate desires.

The possible defenses against hostile takeovers at the board of directors' disposal can by categorized into two distinct types - preventive and active defenses. Preventive measures are employed in order for the likelihood of a successful takeover bid to be dramatically reduced if not completely nullified. As for the active defenses, their usage lies in the implementation thereof upon the submission of a bid by the acquiring company[21].

Preventative Measures

Poison pill defense - Essentially, it consists of a so called "flip-in" shareholder rights plan, which means that even before any actual threat of a takeover appears, the existent shareholders of the company are issued rights of a subscription to new shares (sometimes even more than their current amount of shares). The significance of such rights is that they can be conditional, as in they would depend upon a certain occurrence, for example - a takeover[22]. Such an action enhances the standing of both the board of directors as well as the existing shareholders, while weakening the position of any potential newcomers[23]. As a result, the acquiring company may find that even if the expenditure is taken and they acquire a majority of the target's shares, the remaining shareholders might exercise their flip-in rights and dilute the newfound majority by a significant margin, significantly increasing the costs of a takeover. In a number of cases, this can be significant enough to ward off potential acquirers[24]. Despite its flaws and potential problems, the said measure is quite valuable an asset for those wishing to guarantee the independence and survival of their company. The poison pill has no economic ramifications[25], so it does not put any strain on the resources of the company in question, being an instrument that even the financially weakest of corporate entities can resort to. In essence, it grants a significant bump it the sense of safety and security at somewhat lesser risks and, therefore, should be often utilized, an advice that the world of corporate governance has indeed heeded[26].

Corporate charter amendments: Staggered board - These amendments constitute a number of changes to the company's legal documents, which are intended to make the corporation less attractive to potential acquirers but do not harm it in its business activities[27]. Staggered board provisions stipulate that only a part of the board can be re-elected at the same time[28] and sacking them is not an option unless they perpetrate severe offenses against the firm[29][30], meaning that the acquirer will have to be patient and wait for possibly quite a long time in order to take over the management of the company[31]. The defensive measure of the staggered board against hostile takeovers is somewhat more problematic than that of the poison pill. It offers roughly the same level of protection, while tying the hands of the shareholders, which may even prevent them from exercising effective corporate control, something that is not a risk with the poison pill[32]. Therefore, while there is nothing preventing companies from exercising several defense measures at once (moreover, the staggered board is quite often coupled with the poison pill[33]), in the event that the board of directors needs to choose between the two aforementioned measures, this research recommends the implementation of the poison pill at the expense of the classified board, as it, simply, bears less risks to the effective management of the corporation. However, in most cases, unless there are specific circumstances preventing the corporate entity from having either of the said defenses in place, this thesis advises to have both instruments employed, as they work well together and, when combined, can be a rather deadly measure against the threat of a hostile takeover.

Corporate charter amendments: Supermajority provisions - Such rules state that in order for certain actions, to be undertaken (i.e. allowing other corporations or even individuals to take over the company, replace the directors, etc.), two-thirds or more of the shareholders need to be willing to go ahead with such a decision[34]. A supermajority provision is, in essence, an amendment limiting all further changes to the bylaws by a way of requiring higher vote threshold than a simple majority[35]. This means that for a successful takeover the bidder may need to control significantly more than 50% of the shares, sometimes as high as 85%[36], something that is quite often rather difficult to achieve and, in certain cases, may yet prove to be entirely impossible[37]. If there is a strong chance of the company becoming the target of a takeover bid, then the board should most definitely consider calling the shareholders in order to have them implement the supermajority provisions within the corporate charter (the directors may choose to entice the shareholders with a carefully planned and drafted fair price clause). However, if the management judges that the chances of being taken over in a hostile manned are negligible, then they should avoid using such measures and focus on the effective running of the company.

Golden parachutes - This defense strategy consists of implementing a number of highly-priced severance packages that are given out to the members of the board[38][39]. If the amount of money specified in the severance agreement is high enough, it might lower the acquirers' inclination to invest in such a company as, in its essence, this will heighten the price of taking control of its target[40][41]. It might not be the most effective tool at the directors’ disposal, but it is, nevertheless, an option via which it is possible to insulate the target entity from a hostile takeover bid and, therefore, should be explored[42].

Active Measures

Greenmail and Standstill - The target firm may offer to pay the bidder an above-market price in exchange for the shares already purchased in order to stop their acquisition in its tracks[43][44]. If the offer is significant enough it might be reason enough for them to relent and sign an agreement, stipulating the return of the already acquired shares to the target company. Similarly, if the target company agrees to pay a hefty enough fee to the bidder, they might sign a standstill contract that would prohibit them from making further purchases of the target's shares[45]. Greenmail and standstill are one of the riskier ways of defending the company against hostile takeovers. They are guaranteed to at least somewhat hurt the company’s standing, while hiding a host of other potential problems, the least of which being the chance that the shareholders will be so incensed by this action that they may resort to removing the members of the board of directors from their posts. Greenmail is, effectively, giving in to the demands of those taking the corporation hostage and paying ransom, which is never a popular option and, therefore, should be utilized with utmost care and, even then, only in situations where other means of defending seem to be unavailable or even more risky. These are tools that need to be employed rarely and in a careful manner, or, otherwise, their negative ramifications may yet outweigh their usefulness.

White knight and white squire – The target company might look for another corporation to be acquired by, in order to thwart the original bidder[46]. This new entity, if considered a favorable option by the target's board, will either be a white knight that buys the majority of the company[47], or simply a white squire, which will become a new owner of a significant enough minority to ward off the unwanted bidder[48][49]. Such an action, effectively, is a guarantee that the company cannot survive and is doomed to be acquired, no matter what route is followed through with. The board of directors may choose such an option in order to preserve the company’s interests, but, the utilization of the said defensive mechanism heralds the loss of the target company’s independence, no matter the outcome[50]. In light of the aforesaid, this paper recommends exhausting all the other possible defense mechanisms before even contemplating looking at the white (or grey) knights and squires for help. In the event that there are no more measures to be adopted and this is the only solution, it would be advisable to try and limit the expenses in the course of coaxing the new acquirer, as well as contractually limiting its influence over the company, or, otherwise, all the hardship suffered when utilizing the said measure may easily be for naught.

Share Repurchase – Also known as share buyback[51][52], this is a defensive measure that states that, in the face of imminent danger of a hostile takeover, the company has the ability to buy some of its stock by itself, if there are enough funds available. By doing this, not only does it raise the price of the all other shares[53], but also lowers the number of shareholders that would be more easily willing to sell their part in the company[54]. Alternatively, if the company is experiencing a lack of funds or if the directors simply wish so, the members of the board might try to buy the company's shares themselves[55], in order to essentially take on the role of either the white knight or the white squire[56]. In the end, while share buyback in its classical sense can be a rather risky measure, the directors acting by themselves and purchasing shares achieves the same goals without having the aforesaid inherent problems. Therefore, this paper recommends that, when faced with an attempt at a hostile takeover, the board considers bidding on the corporate stock themselves, if they have enough funds available. If this is not an option, then other mechanisms can be employed as well, including the stated measure of share repurchase.

Takeover Litigation - The target company may opt to sue the acquirer. The objective of this litigation may be to either find and exploit a rule prohibiting such an acquisition, force the acquiring company to embroil into the proceedings lengthy and costly enough to make them lose interest or, possibly, to dig up enough skeletons in the acquirer's closet that they might become willing to a settlement stipulating a revoking of the takeover bid[57]. No matter the aim, however, the defensive mechanism at hand will almost always involve litigation between the target and the potential acquirer, though there are exceptions, of course[58].

Pac-man Defense - Perhaps the most extreme of the options at the directors' disposal[59]. A play of words on the game "Pac-Man" in which the title character is tasked with avoiding several ghosts hunting for it, but, in certain situations, may elect to swallow its pursuers instead of running away from them. Accordingly, when resorting to this type of defense, the target company may decide to buy the majority of the potential acquirer's shares[60][61], essentially becoming its owner and, as a result, obtaining the power to nullify their bid[62]. Considering such a drastic reversal of fortunes among the parties involved, it is rightly considered that the Pac-man defense is rather acutely dramatic measure and is often considered to be the most extraordinary way of defeating the hostile bid, achieving semi-notoriety as a result[63].

Positive and Negative Aspects of the Measures

In light of the variety of potential defensive measures that can be employed in order to insulate the corporate entity from being taken over by a hostile bidder, this paper will now summarize the usable mechanisms in these concluding remarks. The following will be a summary comprised of condensed recommendations and guidelines regarding the utilization of the defensive measures discussed above, that may yet prove invaluable when dealing with a bid from a hostile acquirer.

First of all, it is the stance of this paper that at least some of the passive, or preventative, measures should almost always be in place. If a company has a number of shareholders that are not part of the board of directors (something that can be attributed to the majority of corporate entities of any significant financial value), there will always be a significant risk of a hostile takeover taking place and, therefore, the management should have certain preemptive instruments at their disposal. While in certain cases they might lead to the lowering of the quality of work on part of the directors, nevertheless, the board should still strive to have as many preventative mechanisms of defense potentially being utilized as possible.

The one instrument that this thesis feels should be irreplaceable and always employed by the board of directors is the poison pill defense. Not only is it usable for an indefinite amount of time[64], meaning that once put in place, the board will never have to worry about it again, but it also comes with a host of positive influences while bringing close to no dangerous ramifications alongside it. It bears no financial costs to the company and, in itself, is essentially a grant of new powers to the shareholders, which means that there are bound to be practically no issues at all when asking them to pass the resolution verifying its implementation[65]. As for the negative repercussions, they are all dependent upon the professionalism and good will of the board members[66] and, therefore, if they are willing to go on as before, without letting additional sense of security go into their heads, they will do so, effectively negating all the drawbacks associated with the implementation of the said tactic against hostile takeovers. This will result in the implementation of a powerful defensive mechanism which will have no negative ramifications, constituting a so-called win-win for the board of directors, as well as the corporation as a whole.

As for the rest of the defensive measures, they tend to be similar in what the risks associated with them are when compared to the poison pill tactic. All the most important drawbacks that any of them usually bring alongside them tend to be the problems in performance of the directors. All these major issues stem from the fact that when there is enhanced level of security, the chance for the directors to become complacent grows by a significant margin, which may have significant negative ramifications for the corporate entity. This, of course, is entirely dependent upon the board itself and, therefore, unless they do not trust their co-members to stay professional no matter what, the directors should not have any particular qualms regarding the implementation of the passive measures. As for the positive side of things, the staggered board and the supermajority provisions are usually quite a bit useful, often turning away even the most persistent of bidders and being particularly effective against those, a takeover by whom is the one of worst possible fates that can befall a company – corporate raiders[67][68][69]. As for the golden parachute, while handy and convenient at times, it is the weakest of the passive defensive tactics and has the additional problem of its difficulty when attempting to get the shareholders to pass it[70]. Therefore, it is the passive defensive measure that comes with the lowest level of endorsement from the research at hand.

When it comes to defending the company against the bids of those wishing to take it over despite the protests of the board of directors, the majority of the risks and issues usually stem not from the passive mechanisms, but the measures which require immediate action. They tend to be the “hail-maries” of sorts, as in being the last line of defense, when all else has already failed. Therefore, while active tactics of defending the target corporate entity might be quite a bit more dangerous than the passive ones, at the stage when they often happen to be utilized, they are usually still better than the only remaining alternative – losing the company to a hostile bidder.

The one type of active defense against potential hostile takeovers that this research feels most comfortable getting behind is the share repurchase. It means that the company is buying back its own shares, effectively removing them from the market. This, by itself, enhances the price of the remaining stock, effectively making the existing shareholders somewhat richer, while further making life difficult for the hostile bidder[71]. Additionally, the company can buy back the stock from those individuals that the board feels would be most likely to part with them anyway, meaning that the aggressor will have to deal with people quite a bit less inclined to sell their share in the corporation. The money spent by the company is not being wasted (unless the market acts in an unlikely manner and the stock price fails to rise, which is not something that can happen often), as not only is the target being insulated from further danger of being taken over, but also, the measure at hand makes the financial standing of the remaining shareholders all the better as the shares held by them turn into a larger percentage of the company’s capital, significantly expanding their monetary value[72]. The risks that may stem from the utilization of this mechanism are rather negligible, as the chance of the stock prices not rising or any other negative occurrences are extremely low[73]. The issue with share buyback is not the dangers it poses, but the cost of its implementation. Quite often the corporation will be likely to have a large number of shares, quite a lot of which may be rather pricey, meaning that the entity will have to come up with significant funds in order for this defensive tactic to succeed. Sometimes in order to do so, the management of the corporation will start saving up sizable sums of money, while others will elect to take large loans. Both these options tend to be quite risky and problematic, the former bringing alongside the possibility of the actual business of the company being somewhat neglected and underfunded due to the management being concentrated upon making the said savings, while the latter is not only risky, but expensive as well due to the need to pay interest in return for the loan. Therefore, while the measure at hand still remains the pick of choice of this paper, it is recommended to use it more prominently when having cash reserves without depriving the business of needed funds and when there is no need for taking out a loan[74]. 

One more positive side of the share repurchase option is the chance for the directors themselves to buy out those stockholders who feel more inclined to sell their share of the corporation. This is an even better way out for the company, as it will have to expend literally none of its own resources and will yet gain a chance to survive the hostile bid[75]. Moreover, the confidence of the directors that they have in their company (as they are willing to buy its shares with their own personal funds) can easily cause the market to react, further pushing up the price of the shares of the said entity. Unfortunately, the problem of cost creeps in again, but considering how good an option this is, it must still always be on the table. This pair of mechanisms is by far the most positive and risk-averse of options at the board’s disposal and should be utilized if there is need for them as well as even the slimmest of chances of their employment.

As for all the remaining active tactics of defense, they vary in terms of risks that are associated with them as well as their measure of effectiveness. Greenmail and standstill is quite a bit effective, with minimal risks stemming from it, although it does involve paying money for nothing, effectively succumbing to some of the demands of the hostile entity, which does make this instrument highly unpopular[76][77]. The mechanism of the white knight as well as the white squire (and their grey counterparts) is the least effective (as it guarantees that the target entity will be taken over, something that is almost directly opposite of the original intention of the directors, although it can be quite effective if the goal is not general survival but instead the aim is to exclusively survive this one hostile bid) and the most risky mechanism (as the new owner may prove to be far less benevolent than what was initially thought by the board), but it may cost nothing to the target entity, which can sometimes be the decisive factor[78][79]. Takeover litigation can be tremendously ineffective as well (if the court rules in favor of the acquirer) and immensely risky[80][81], while having quite a bit of costs associated with it[82][83], due to which it is the least recommended way of trying to defend a company from a hostile bid, as far as this research is concerned. And, finally, while the Pac-man tactic may be very effective, it is also usually enormously costly and constitutes a rather risky endeavor, something that quite a lot of people can take issue with[84].

Conclusion

In the end, it is clear that there are a variety of potential defensive tactics that can be implemented in order to fight off a hostile takeover. Their effectiveness, as well as the risks associated with them, varies, but, undeniably, all of them have their place and usage in the current corporate world. They are extremely diverse and suited for differing situations, which means that at least one of the defensive measures discussed above can be employed in virtually any situation, being the best way out for the target entity in the case at hand.

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