CFA Level II ExamCorporate IssuersMedium
A company is considering implementing a poison pill defense mechanism. Which of the following statements most accurately describes the primary purpose of a poison pill?
- ATo make the target company less attractive by significantly increasing its debt.
- BTo dilute the ownership stake of an acquiring party, making a hostile takeover more expensive.
- CTo trigger an automatic sale of the target company to a 'white knight'.
- DTo force the acquiring party to negotiate with the target's board rather than attempting a tender offer directly to shareholders.
Show answer & explanationAnswer & explanation
Correct answer: B. To dilute the ownership stake of an acquiring party, making a hostile takeover more expensive.
A poison pill (shareholder rights plan) is designed to make a hostile takeover prohibitively expensive or difficult by allowing existing shareholders (excluding the acquirer) to purchase additional shares at a significant discount, thereby diluting the acquirer's ownership stake and increasing the cost of acquisition.
Why the other options are wrong
- A. This describes a 'Pac-Man' defense or perhaps a recapitalization, not a standard poison pill.
- C. A white knight is a friendly acquirer, and a poison pill doesn't automatically trigger a sale; it's a deterrent.
- D. While it often *has the effect* of forcing negotiations, its primary mechanism is dilution, which makes the takeover expensive, thus incentivizing negotiation.
Poison Pill
A poison pill (shareholder rights plan) is a defensive tactic used by a target company to make a hostile takeover more difficult or expensive by diluting the acquiring party's ownership.
- Grants existing shareholders (excluding the acquirer) the right to buy new shares at a discount.
- Triggers when an acquirer accumulates a certain percentage of shares (e.g., 10-20%).
- Makes the target significantly more expensive to acquire.
Memory trick: Defending Deals: Deter, Delay, Deny.