Question

focus on what is greenmail, why might it be considered unethical, who might be affected by it, what can be done about it, and how to evaluate it from a finance perspective.

Answer 1

Greenmail is the practice of buying a voting stake in a company with the threat of a hostile takeover to force the target company to buy back the stake at a premium. In the area of mergers and acquisitions, the greenmail payment is made in an attempt to stop the takeover bid. The target company is forced to repurchase the stock at a substantial premiumto thwart the takeover.

It is considered unethical because it forces the target company to pay a very high price compared to acquisition price to thwart the takeover bid, it is a kind of blackmail money paid to stop aggressive behavior of a new shareholder.

The existing shareholders as well as the cash flow of the company is impacted by greenmail payments. This is because the company will be forced to repurchase the shares from the acquirer at a higher price compared to market price and further it entails outflow of cash from the company. This will result in reduction of overall value of the company as some time the payments are made from precious cash reserves.

Companies introduce certain measures called poison pills to prevent such acquirers from indulging in greenmail. The poison pills result in increase in cost of acquisition of shares for the acquirers.