Poison-pill strategies, also called shareholder rights plans, are a common defense used by companies to stop hostile takeovers. A poison pill makes the target company prohibitively expensive for the bidder (the individual or company initiating the takeover) to buy. Poison pills create rights (or OPTIONS) to purchase stock at a discount, when the bidder triggers certain events, such as purchasing a certain percentage of stock. For example, a company could have a poison pill that goes into effect when a hostile bidder acquires 20 percent of the company. Poison pills are usually set up to last for 10 years, after which they can be renewed or allowed to expire. Martin Lipton, a lawyer who defended companies against hostile takeover attempts, invented poison pills in 1982. He realized that a company could make a takeover more expensive by offering SHAREHOLDERS rights to buy preferred stock at a discount if the takeover attempt succeeded. By 1985 Lipton had perfected the technique by issuing COMMON STOCK instead of preferred stock, and poison pills have been a popular defense against takeovers ever since. There are two types of poison pills: flip-over and flip-in. The flip-over strategy allows shareholders to buy stock at a discount after the takeover occurs. The right to buy shares is created when the bidder buys a certain percentage of stock. The rights don’t become exercisable until the bidder buys 100 percent of the outstanding shares. The problem with flip-overs is that they can be overcome by buying less than 100 percent of the shares. An example of this is Sir James Goldsmith’s takeover of timber company Crown Zellerbach. Shareholder rights would be activated when a bidder bought 20 percent of the outstanding stock, and once the rights became active, they would not expire for 10 years. Rights would not become exercisable (shareholders could not actually buy the stock) until the bidder bought 100 percent of Crown Zellerbach’s stock. To get around the pill, Goldsmith purchased only 50 percent of outstanding stock. This activated the pill but wasn’t enough to make the rights exercisable. Goldsmith gained a controlling interest in Crown Zellerbach but did not have to pay the price of the poison pill. To close this loophole, the flip-in poison-pill strategy was invented. In this strategy, once the bidder buys the triggering percentage of shares, the target company issues more stock. Current shareholders, except for the bidder, are allowed to buy these new shares at a discounted price before the merger. The increase in the number of outstanding shares reduces the bidder’s percentage. In the United States, a BOARD OF DIRECTORS without shareholder approval can still adopt poison-pill plans. Many companies put strategies in place as a preventative measure, so they will be ready if a takeover attempt occurs. Most prison pills are adopted with the view that they will never be triggered, but since they can be roadblocks to welcome takeovers, boards can also rescind poison pills without shareholder approval. There is much debate over whether poison pills are good or bad for a company and its shareholders. For example, they can make it harder to get rid of incompetent MANAGEMENT who may fear losing their jobs if a takeover occurs. In addition, shareholders may see the takeover as being good for the company and would not want it to be blocked. The management could use a poison pill to protect themselves at the shareholders’ expense. Some poison pills have a deadhand provision that blocks new directors from rescinding pills adopted by previous directors. Only the directors who adopted the pill, or their chosen successors, can rescind it. Any new directors (who have probably been chosen by the bidder) are unable to get rid of the pill on which the previous directors voted. Poison pills can also be inconvenient to large institutional investors, such as pension-fund managers, who must be careful not to trigger the pill by accidentally purchasing the triggering percentage of shares. To prevent this, some companies include a provision that excludes institutional investors from triggering the pill. As demonstrated, poison pills can be an effective defense in repelling hostile takeovers. They can give the targeted company greater bargaining power and will usually increase the bid price, preventing the company from being bought at a bargain price. This is good for shareholders, who will see the value of their shares rise. There have been many legal challenges to poison pills, and their legality and provisions are determined on a stateby- state basis. In 1985 the Delaware Supreme Court decided that poison pills were legal. Given that so many companies are incorporated in Delaware, this was a crucial decision. Since then courts have focused on the legality of the particulars in some pills, like the deadhand provision, but overall poison pills continue to be a very popular defense mechanism against hostile takeovers.