In business, the poison pill is a strategy, adopt by target company management to discourage hostile takeovers. For example, in order to make company’s shares less attractive and making a cost of acquisition high, more rights are issued on premium to existing shareholders, so that an acquirer may option for not to purchase the company or at least rethought about the decision to take over.
There are two types of the strategy:
It is a type of poison pill in which current shareholders are offered with new shares at a discount, making targeted company shares diluted and making takeover bid more difficult.
In flip out poison pill, existing shareholders are given with an option to purchase shares of an acquirer company at a discount after the takeover, again making the bid for takeover likely to unattractive.
Suppose, you are working as a chief operating officer in a listed company X with 1000 share issued. In order to utilize sufficient cash, another company Z wants to take over the company X, previous takeovers history of company Z shows that after the takeover, it always deploys new management. So what would be your concerns? And, why you will discourage takeover bid?
The target company management may choose to utilize poison pill strategy because of their fear of lost jobs or afraid that new ownership after implementing different rules might change working environment etc. So by implementing poison pill strategy, management will try to make the deal unattractive like issuing more 100 rights to current shareholders at discount, making shares diluted with increased cost of acquisition.
Why it matters (Importance)
Although the strategy is used to make the deal more expensive and unattractive for the acquirer, however, in the long run, it does not work for the best interest of current shareholders as company’s shares become more diluted causing decreased return on investment.