Shadow Pills and Long-Term Firm Value

Shadow Pills and Long-Term Firm Value

Martijn Cremers, Scott B. Guernsey, Lubomir P. Litov, Simone Sepe

March 25 2019

Whether antitakeover defenses are beneficial or inimical to shareholder interests is the subject of a perennial debate in the corporate finance literature. Scholars on both sides of the debate, however, agree that the “poison pill” is perhaps the most powerful anti-takeover defense. While details vary across different implementations of the pill, the basic defensive mechanism provides existing shareholders with stock purchase rights that entitle them to acquire newly issued shares at a substantial discount in the “trigger” event that a hostile bidder obtains more than a pre-specified percentage of the company’s outstanding shares. As a result,  the adoption of a poison pill grants the board of directors the ability to substantially dilute the ownership stake of a hostile bidder, de facto giving the board veto power over any hostile acquisition.

Empirical studies have long attempted to investigate whether the adoption of a poison pill increases or decreases firm value. While earlier findings were largely inconclusive, over the past decade most of these studies have documented evidence that the adoption of a pill is negatively correlated with firm value. However, this result is difficult to interpret, as the decision to adopt a pill is endogenous and poison pills can be unilaterally adopted by the board of directors. This means that even firms that do not currently have a poison pill in place still have a “shadow pill,” that is, the right to adopt a pill at any time.

Our paper contributes to the debate on the value of the poison pill by shifting the focus of attention from “visible” pills to shadow pills – studying the effect that arises from the right to adopt a poison pill (which right constitutes the shadow pill) rather than the actual adoption of a pill. We do so by investigating the value implications of state-level poison pill laws that validated the use of the pill in 35 U.S. states over the period 1986 to 2009, thus strengthening the relevance of the shadow pill.

Our main finding is that the availability of a stronger shadow pill results in an economically and statistically significant increase in firm value, especially for firms more engaged in innovation or with stronger stakeholder relationships. We also confirm, however, the findings of the previous literature on the negative association between firm value and the actual adoption of a pill. Overall, our results indicate that a stronger shadow pill benefits shareholders in some subsets of firms, even if a visible pill does not, suggesting that in these firms the right to adopt a pill might serve a positive governance function by signaling a firm’s commitment against disruptive short-term shareholder interference and toward more stable stakeholder relationships or longer-term investments projects.

Authors

Real name:
Scott B. Guernsey
Real name:
Lubomir P. Litov
Real name: 
Research Member
The University of Arizona; IAST - Toulouse School of Economics