Field Notes Poison Pills - The Next Round
IN PRINT ARCHIVE CIR Spring 1999
|POISON PILLS THE NEXT ROUND|
|By Paul Halpern|
On December 17, 1998, Cambridge Shopping Centres Ltd. introduced a Shareholders Rights Plan (SRP) with an expiration date of February 15, 1999. The SRP was introduced approximately 50 days after Ivanhoe's announced intention to bid and about two weeks before shareholders were mailed the actual bid. The initial bid was extended to expire February 17, 1999, conditional on redemption of the rights or waiver of the SRP application.
Ivanhoe requested a cease trade order on the rights to permit it to go forward with its bid. A joint hearing of the Ontario and Quebec Securities Commissions decided to continue the SRP until its expiration but not to permit an extension. Five days before the expiration of its bid, Ivanhoe increased both its per share bid and the number of shares it would purchase. This bid has interesting features. First, the initial bid was a partial one raising Ivanhoe's current holding of 41% of Cambridge's equity to 68%, if successful. The new bid raised its holdings to 83%. Second, the bidder is the real estate subsidiary of a large pension fund. Three other institutional investors, including one that had a 17% interest in Cambridge, were supportive of the SRP's retention. Third, given the large holding of the bidder, it was unlikely that a rival bidder would be forthcoming. Cambridge noted they had contacted a large number of companies and eight had signed a confidentiality agreement. Following the initial bid, there had been discussion of the financial adequacy of the bid and the impact on the potential future offers. Clearly, this is an issue that is left to the bidder and the existing, non-bidder shareholders and it appears that the revised bid meets some of the objections of the initial bid.
This offer is highlighted as a recent example of the process and dynamics in some takeover bids in which there is a SRP and a Securities Commission hearing. This note's purpose is to describe the evolution of the SRP in the U.S. and Canada, review some recent empirical evidence and identify some research and policy issues.
The SRP (poison pill), initiated in the United States, has evolved differently in Canada in terms of the pill's structure and legal decisions surrounding SRPs continuation in the face of a takeover bid. Considering the structure issue first, in the United States with reliance by state courts, especially Deleware, on the business judgement rule (board of directors making decisions based on sound business practice), the poison pill has been validated. The 'just say no' defense (the board considers and can reject an offer without having the offer presented to shareholders) is the result.
In reaction to this defense to SRPs, standard practice is to make a bid that includes both a takeover offer and a proxy contest identifying a slate of directors. The latter is intended to obtain board control, remove incumbents, substitute the bidder's nominees, and vote out the pill (redeem the rights). This bid strategy has had some success leading to defensive (shark repellent) strategies from potential targets.
To curtail the bidder-nominated board's ability to remove incumbent board members the 'dead hand' poison pill1 has been developed. This SRP is redeemable by a majority of continuing directors defined as those unaffiliated with the bidder and in place prior to a particular point in time, (the pill's adoption or making of the bid), or nominated by a majority of other continuing directors.
In this form, the 'just say no' defense has been converted to 'just say never' since if all incumbent directors are removed from office, no one can redeem the pill and it continues until expiry, typically a ten year lifetime. Variations of the dead hand pill are less severe, resulting in deferral of the pill's removal.
Those who believe that poison pills entrench management and weaken the market for corporate control developed an antidote to SRPs--the Shareholders Rights By-law. This by-law is a proposed amendment to the firm's existing by-laws requiring automatic expiration of the company's poison pill and other defensive measures whenever the company receives an all cash offer for all outstanding shares at a premium of at least 25 percent to pre-bid share price. Continuation of the poison pill subsequent to a bid is conditional on a shareholder vote. The only legal test of this by-law was in Oklahoma where the amendment was upheld and shareholders had to vote for the pill's introduction. Although the by-law should be wealth enhancing for target shareholders, its use is not yet widespread and will not offset the entrenchment capacity associated with amended SRPs.
In Canada, specifics of SRP and conditions under which it is continued in the presence of a takeover bid have evolved in the direction of less control of the process by incumbent management and a greater likelihood of a successful takeover bid. Both changes should lead to improved target shareholder wealth.
In the specifics of pill provisions, there has been definition simplification that determine scope and application; changes also give less discretion to boards of directors to preclude takeover bids. For example, the permitted bid provision has changed from an obvious entrenchment mechanism toward target shareholder wealth maximization. The other aspect is the pill's continuation in the course of a takeover bid. A determining element either directly or indirectly is the decision of the Securities Commission. An overarching public interest principle enunciated in the first case decided by the OSC, the Jorex case, was the "right' of shareholders to dispose of shares without undue hindrance from defensive tactics adopted by the target board.
I have reviewed cases brought forward to the Ontario Securities Commission on applications by bidders to eliminate a target company's SRP.2 The totality of decisions suggests that in a takeover contest the issue is not if the SRP will be removed, but when. The Commission's decisions are fact specific and determine whether a SRP has outlived its usefulness. Thus some uncertainty exists surrounding the Commission's decision on a particular application in terms of added time the target company board will be given to search for a new bid.
Important underlying premises in the OSC decisions are preference for auctions in takeover situations, the right of shareholders to sell shares, the principle not to comment on the poison pill's legality (an issue that should be left to Corporate Law), and in general, permission for the board to make decisions that reflect fiduciary responsibility to shareholders.
In the Jorex and Ventra cases, the Securities Commissions decided to immediately cease trade the pill based on the belief that no new bidder would enter the fray and the existing bidder was unlikely to raise its bid. Target shareholder wealth had been maximized. In the CW case the pill was continued for 10 days at which time it had to be removed. In the Lac and Regal cases, pills were continued to permit the Board to search for new bidders. In the former, Lac's Chairman of the Board stated there was a chance of a third party entering the auction. In the latter, there appeared to be movement toward increasing the period over which a bid can come forward even in the face of an existing offer. Under current legislation, the waiting period for a takeover bid is 21 days from the date that the offer is mailed to shareholders. In both the Lac and Regal decisions, the Commission noted that they would reconsider their decision to continue the SRP if a majority of shareholders came forward to request termination. However, why not just remove the pill and let shareholders express their views by voting on the offer.3 Finally, in the Call-Net case, elimination of the pill was deferred until after a new deadline. If, after this date, the Directors of Fonorola had not waived the SRP in respect of the Call-Net offer, an order would be issued to cease trade the rights. This decision extends the waiting period to permit the board to find a new bid or increase the value of the existing bid.
These decisions, unlike the U.S. situation, lead to target shareholder wealth maximization from a takeover bid in the presence of a SRP. Also, decisions by the Securities Commissions have had an impact on the waiver of SRPs by firms either just prior to a hearing at a Securities Commission or independent of a hearing but during a takeover contest, perhaps in anticipation of a hearing application. In cases where the pill was pulled by the target firm, it was clear that the offer was as good as it would get, there was unlikely to be another bidder enter and in some cases, the existing bidder threatened either to remove the offer or reduce it due to changes in overall market. The first two conditions are consistent with arguments presented by the Securities Commissions to remove pills and the third is based on the target board of directors' fiduciary duty.
A number of policy and related research issues arise from the SRP area. Empirical evidence on impact of SRPs on investors in the U.S. markets is puzzling. The most recent and probably most comprehensive study of U.S. data was undertaken by Comment and Schwert who used a large sample of poison pill introduction announcements from 1983 to 1991 for NYSE, Amex, and NASDAQ firms. They observed a negative and marginally significant abnormal return4 only for the sample period when pills were first introduced1984. If there was information about a control contest prior to the poison pill's adoption, the pill's introduction reduced shareholders' wealth, a finding consistent with the entrenchment story. Finally, for NASDAQ firms introducing a poison pill, there was a negative and statistically significant impact on shareholder wealth. Interpretation of the NASDAQ result could relate to higher insider shareholdings of firms on NASDAQ than on other exchanges.
Considering evidence on the impact of SRPs on takeover frequency, Comment and Schwert conclude that reduction in activity in the late 1980s takeover market was unrelated to introduction of poison pills and other anti-takeover techniques. They observe small differences in comparing takeover activity of companies with SRPs in place to those without both before and after the pill's introduction. They also estimate a small impact on takeover probability when a SRP is in place, and thus conclude that impact of SRP on takeover deterrence is small. Finally the authors observe that pills (along with other state laws) increase the premium received by the target and thus raise the bidder's cost. This should have some deterrence effect but as observed, is not significant.
The puzzle is why SRPs have evolved in the U.S. to a potentially more virulent structure and associated reactions by institutional investors when it appears that SRPs have little impact on wealth or takeover frequency. One interpretation is that the SRP is benign. Alternatively, it is possible that firms have other means available to defend against takeovers and SRPs were marginally more effective but not enough to make a noticeable difference. Unfortunately, Canadian evidence is limited and new studies are required to investigate the impact of SRPs announcements on target and bidder shareholder wealth, the impact of regulatory decisions that in effect limit usefulness of SRPs, and the influence of SRPs on takeover activity. Associated with the latter issue is the potentially negative impact on potential bidders when it is known that there can be an auction as a result of a bid and therefore, a higher premium.
If the purpose of the SRP and in some situations, the decision of the regulator, is to extend the waiting period, why not do this directly and where they exist, remove the SRP if there is a takeover bid or prohibit introduction of a SRP after a bid has been made? Of course, the extended waiting period and resulting auction may have an impact on premium paid, expected profitability of the transaction to the initial bidder, and ultimately on number of bids.
In summary, due to the nature of regulatory decisions in Canada, the SRP, while it may slow up a takeover, or encourage an auction, will not stop it. The SRP is not a good long-term entrenchment strategy. Thus the introduction of potentially more virulent pills and resulting counter measures observed in the U.S. are not found in Canada.
1. The pills permit ousted directors 'to rule from the grave'; hence the term 'dead hand'.
2. The cases are Canadian Jorex and Manville Oil & Gas Ltd. (1992), Lac Minerals and Royal Oak Mines Inc. (1994), MDC Corporation and Regal Greeting & Gifts Inc. (1994), Tarxien Corporation and Ventra Group Inc. (1996), CW Shareholdings Inc. and WIC Western International Communications Ltd. (1998), Call-Net Enterprises Inc. and Fonorola Inc. (1998), and Ivanhoe III and Cambridge Shopping Centres Ltd. (1998).
3. It may be the case that some institutional investors would prefer to have the Commission maintain the pill than be placed in the position of voting against an offer that was in excess of the pre-bid share price.
4. The impact was measured as the net of market rate or return over the three-day period; the returns are also referred to as 'abnormal returns'. n
|Paul Halpern is professor of finance, Joseph L. Rotman School of Management, University of Toronto and chair of Canadian Investment Review's advisory board.|