What are Shareholder Rights Plans?

The corporate world is more than just boardrooms and business suits. While calm and orderly mergers and acquisitions would be par for the course in a perfect world, oftentimes hostile takeovers must be dealt with.

Shareholder rights plans were designed for that reason. Here’s a brief overview of what they are, how they work and why Canada is trying to phase them out.

Different types of shareholder rights plans

Shareholder rights plans are generally used to prevent companies from being taken over. If you’ve ever seen an old spy movie where an agent bites down on a cyanide capsule to avoid being caught, you’ll understand why they are referred to as “poison pills.”

These types of plans come in various forms, from preferred stock plans to voting plans, and they’re all intended to give existing shareholders a way to defend against takeovers. Usually once a specific trigger is activated, the plan will come into play.

For instance, in a flip-over rights plan, a company would take on large amounts of debt in order to make itself less appealing to outside suitors. As whoever takes over the company would eventually have to pay off the debts, the hope is they would forgo taking over the company.

Another example is the backend-rights plan. This strategy involves a company changing employee stock options to allow workers to cash in as soon as the organization is taken over. The idea is for employees to leave in mass numbers, costing the company both large amounts of money and talent.

Are shareholder rights plans effective?

In addition to giving companies an out in the face of hostile takeovers, shareholder rights plans are popular because they can be tailored to suit a company’s specific needs. The various options make it easy for a company to settle on a suitable poison pill, as the flexibility allows organizations to structure which assets will be affected.

However, shareholder rights plans also come with their own unique disadvantages. First and foremost, poison pills can be damaging.

Take the preferred stock plan, in which companies issue a large number of new shares. That dilutes the value of the stock, which can make a company a less attractive option for takeover. However, it also hurts the company and forces investors to purchase new shares in order to receive the same level of ownership they enjoyed previously.

Additionally, getting everyone on the same page regarding a poison pill can be difficult. Some shareholders may wish for a takeover to happen, as it will result in a premium price for their shares. However, if management is able to implement a shareholder rights plan, it can prevent that from happening. This can lead to resentment on the part of investors, and ultimately discourage other investors from buying into the company.

Shareholder rights plans in Canada

Poison pill plans are controversial the world over, but Canada is leading the charge in the attempt to phase out these options.

The Globe and Mail reported in September that the Canadian Securities Administrators organization is trying to eliminate poison pills as a defensive strategy by implementing a longer time period during which bidders can provide companies with different or better offers.

Similarly, the Financial Post stated recently that securities regulators in all 13 provinces and territories have shown support for overhauling takeover laws in order to phase out shareholder rights plans. According to the news source, poison pills are typically used by companies in order to buy time for other bidders to make an offer or for suitors to put forth a better offer. The idea is that by extending the amount of time a hostile bid must remain open, lawmakers can accomplish the same thing without the poison pill process, which is often messy.

However, poison pills aren’t the only pills making headlines. So-called “voting pills” are becoming increasingly popular among Canadian companies, a separate article from the Financial Post notes. This strategy is designed to block or slow down investors who try to challenge an organization’s board of directors.

Whereas poison pills are activated when there’s a bid to take over a company, voting pills can be used without such an occurrence taking place. However, like with poison pills, voting pills can significantly dilute company shares, weakening the power of investors.

The goal, according to company leaders, is to protect all shareholders from activist investors teaming up to essentially gain control of a company without paying shareholders the premiums they would generally receive during a traditional takeover. At the same time, some observers are worried voting pills will give board members total control over the direction of a company without answering to shareholders.

While the Canadian Securities Administrators has only tackled poison pills so far, it’s unlikely it will view voting pills in a better light.