Lex is a premium daily commentary service from the Financial Times. It helps readers make better investment decisions by highlighting key emerging risks and opportunities.
Two icons of the 1980s collided last week when J.C. Penney Co. Inc. instituted a poison pill. Time will tell if the retailer is dead, but the legal fight over poison pills is over. The measure, designed to prevent hostile takeovers, has been extremely controversial but is now perfunctory to the point of banality. The J.C. Penney announcement hardly elicited a yawn, let alone cries of corporate perfidy. This is as it should be. Not only is the legal question settled, but poison pills can play a useful role in protecting shareholders. Investors are better concerned with staggered boards and supervoting shares.
The mechanics of the J.C. Penney pill are straightforward: If anyone, without permission from the board, acquires more than 10 per cent of the shares of J.C. Penney, all remaining shareholders have the right to purchase new shares at a steep discount, diluting the hostile party's stake and preventing it from acquiring control. The worry is that poison pills entrench failed bosses and prevent shareholders from deciding about takeovers themselves. Courts, however, have repeatedly affirmed the right of boards to make these judgments.
Imagine J.C. Penney with no poison pill in place. Then, say, Carl Icahn observes a battered stock price and begins to accumulate shares. In a few weeks he has acquired 30 per cent of the stock, paying at no premium. Suddenly he demands significant say in the company's strategy. The poison pill ensures not that Carl Icahn will be forever barred from purchasing a stake or the company, but rather that he negotiate his deals through the board that represent all shareholders.
Only about a tenth of companies have pills, according to FactSet – but nearly all boards can implement them without shareholder approval. So investors are best served if they can elect the best board and the company's rules do not inhibit that.