The Illusory Protections of the Poison Pill

Abstract:     
This paper describes the operation of the standard preferred stock rights plan with a flip-in feature. Rather than a static look at the initial dilution of a bidder's investment when the flip-in rights become exercisable, we examine a dynamic model, where the bidder then proceeds to acquire the remaining shares of the target corporation in a hostile acquisition. We find surprisingly modest levels of dilution from the standard rights plan, amounting to less than 10% of the total value of the target. This modest dilution is primarily a function of the fact that rights provide a one-time dilution when a bidder's investment in the target is relatively modest - no more than 15% of its stock in most cases. While rights plans can destroy part of this value, they generally do not destroy it all. We explore the reasons for the limits of such plans, and the reasons why no one has deliberately swallowed a pill.

Keywords: rights plan, poison pill, takeover defense, dilution

JEL Classifications: G34, K22

Working Paper Series