Question

Discuss briefly how the following could adversely affect the financial position of a corporation (a) Greenmail (b) Poison Pill.

Answer 1

A) Greenmail

Greenmail is money paid to an individual to stop aggressive behaviour or to discourage it. It's an anti-takeover mechanism in mergers and acquisitions in which the target company charges a premium, known as greenmail, to buy back its own stock shares from a corporate raider at inflated prices.

Anti-greenmail provisions are inluded in the charters of companies onorder to prvent the Board of Directors from approving the payment of greenmails. Though these measure are taken, it is practices widely in many implicit ways.

1. Complying with greenmail threat is never beneficial to a firm, as the takeover leads the acquirer firm to be in a better position whereas ends up on a negative note for the target firm.

2. Manaement cannot be responsive to the needs of various stakeholders and must act to the wishes of acquirer.

3. For  firms with a relatively large prior runup, the precommitment not to pay greenmail is value enhancing. On the other hand, If the prior runup reflects takeover rumors, then this evidence is consistent with the proposition that greenmail payments amidst takeover speculations are value decreasing.

4. Greenmail payments that abort takeover bids tend to reduce the expected return to the arbitrageurs. The activity of arbitrageurs has the important effect of lower- ing transaction costs of both financing and executing takeovers.

B) Poison Pill

The term poison pill refers to a defense strategy used by a target firm to prevent or discourage a potential hostile takeover by an acquiring company. Potential targets use this tactic in order to make them look less attractive to the potential acquirer. Although they're not always the first—and best—way to defend a company, poison pills are generally very effective.

1. Posion pills increase the cost of acquisitions thereby creating disincentives to stop the takeover attempts completely.

2. The stock values get diluted, which makes investors necessary to purachse new shares inorder to retain their position. This maynot be acceptable to all.

3. Following such aggressive practices can distance the potential institutional investors.

3. Through this strategy, inefficient managers still remain on top positions (not giving chnace for new venture capitalists to come and make the firm better off by adopting innovative strategies) and continue to take decisions that might not lead the firm to growth, adversely affecting its financial position too.