Poison Pills and Share Rights Plans

A poison pill is a tactic designed to repel would-be suitors. The term comes from the world of espionage. Agents are supposed to bite a pill of cyanide rather than permit capture. Presumably, this prevents enemy interrogators from learning important secrets.

In the equally colorful world of corporate finance, a poison pill is a financial device designed to make it impossible for a firm to be acquired without management's con-sent—unless the buyer is willing to commit financial suicide.

In recent years, a majority of the largest firms in the United States have adopted poison pill provisions of one form or another, often calling them share rights plans (SRPs) or something similar. Figure 25.1 contains the body of a letter mailed by Contel Corporation (a large telecommunications firm) in late 1988 to its stockholders announcing its adoption of such a plan and sketching some of the features.8

SRPs differ quite a bit in detail from company to company; we will describe a kind of generic approach here. In general, when a company adopts an SRP, it distributes share rights to its existing stockholders.9 These rights allow shareholders to buy shares of stock (or preferred stock) at some fixed price.

The rights issued with an SRP have a number of unusual features. First, the exercise, or subscription, price on the right is usually set high enough so that the rights are well out of the money, meaning that the purchase price is much higher than the current stock price. The rights will often be good for 10 years, and the purchase, or exercise, price is usually a reasonable estimate of what the stock will be worth at the end of that time.

In addition, unlike ordinary stock rights, these rights can't be exercised immediately, and they can't be bought and sold separately from the stock. Also, they can essentially

8Contel's SRP appears to have achieved its purpose. In the summer of 1990, Contel management agreed to a friendly merger with GTE Corporation.

9We discussed ordinary share rights in Chapter 16.

Ross et al.: Fundamentals I VIII. Topics in Corporate I 25. Mergers and I I © The McGraw-Hill of Corporate Finance, Sixth Finance Acquisitions Companies, 2002

Edition, Alternate Edition

Adoption of a Share Rights Plan, or SRP

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