What Is a ‘Poison Pill’ Defense?

A poison pill is a defensive strategy used by companies to ward off takeovers but is less well known to investors.

The defense mechanism was developed in the 1980s as company leaders faced corporate raiders and hostile acquisitions and tried to protect their businesses.

A poison pill is a maneuver that makes a company less attractive to a potential acquirer by making it more expensive to buy shares of the target company above a certain threshold.

Carliss Chatman, an associate professor of law at Washington and Lee University, said that the whole point of it was to make the offer from the board more attractive.

The board can use the strategy to try and force a direct negotiation with the potential buyer.

A poison pill is a shareholder rights plan that can be found in a company's charter or by-laws.

Ann Lipton, an associate professor of law at Tulane University, said that poison pills allow certain shareholders to buy additional stock at a discounted price.

The shareholder who triggered the poison pill is the only shareholder who can't make these discounted purchases. When a person hits a threshold for how many shares they own, it is triggered. If they hit that threshold, the value of their shares will be discounted by other shareholders.

Securities experts say that investors rarely attempt to break through a poison pill threshold.

Papa John's adopted a poison pill in July of last year to prevent its founder from taking over. After using a racial slur on a conference call and setting off an uproar, the founder of the company resigned as chairman of the board.

If Mr. Schnatter and his family members or friends raised their stake in the company to 31 percent or more, the poison pill would have allowed them to buy stock at a discount. The dispute ended in March of 2019.

If Mr. Musk bought 15 percent or more of the shares, the market would flood with new shares. It would be difficult to buy a large portion of the company if that were to happen. Mr. Musk holds more than 9 percent of the company's stock.

Ms. Lipton said that a company could be limited by the ceiling in its charter on how many shares it could issue. She said a company has other options if it hits the ceiling.

If the company is sued for violating its fiduciary duties, poison pills could be avoided. The courts have shown reluctance to interfere.

She said that boards have a lot of latitude to decide what is in the best interest of shareholders. Poison pills are often implemented on a temporary basis to give boards more time to consider their options.

Professor Chatman said it was very. She said that hostile takeovers are not as common as they were in the 1980s because potential acquirers assume that companies have poison pill provisions in place.

The poison pill that was used to fight off Carl Icahn would have made it more expensive for him to accumulate more shares of the company.

Men's Wearhouse survived an acquisition attempt in October of 2013). A. Bank Clothiers used a poison pill. Men's Wearhouse acquired Jos. The owner of both companies filed for bankruptcy in August 2020.

The McDonald's Corporation adopted a poison pill plan in September of 1985 after rumors that Philip Morris was targeting it. The Walt Disney Company adopted one a few years later, saying it was a sound and reasonable way of protecting the interests of all stockholders.