Both, macaroni defense and poison pill are corporate defence mechanisms against hostile takeovers, or with other words – strategies used by a company when it does not want to be taken over by another one.
In a macaroni defense, the Board of Directors of the potential target company decides to issue a large number of bonds to be redeemed at excessively higher prices when the company is taken over, thus limiting the financial powers of the potential buyer and overall making the deal economically unattractive.
Example: Company A is forcibly trying to acquire company B, whose management goes for a macaroni defense, issuing bonds of $1 million which will be redeemable at 200% of the face value in case there is a change of control at Company B. The bidder who is planning to buy Company B with a $1,000 face value would have to redeem it at $2,000 if Company A buys Company B, which doubles the costs of acquisition and usually discourages Company A to go ahead with the offer.
The cost of the hostile takeover expands as macaroni expands when placed in boiling water, hence the name of the tactic.
Another tactic to discourage hostile takeovers, is the poison pill, where instead of issuing bonds, the target company issues rights to all existing shareholders, with the exception of the hostile bidder, to make the acquisition deal less attractive for the raiders and a hard pill to swallow.
The adoption of a poison pill plan only requires a vote by the Board of Directors without the approval of the shareholders, usually offers preferred stock options (special dividends or payments) and comes with a provision that the Board can alter or redeem the rights when required.
Once approved, each right entitles the holder, upon occurrence of a hostile takeover threat, to purchase preferred stock of the company (“flip-in”) or common stock of the acquirer (“flip-over”) at a predetermined price, usually equal to twice the right’s exercise price, with both methods eventually diluting the acquirer’s interest and making the deal quite expensive.
Shareholder rights plans were first defined in the early 1980, with the poison pill defence invented by mergers and acquisitions lawyer Martin Lipton in 1982 during a takeover battle in Texas, USA and named after the popular espionage tactic of spies carrying poison pills to swallow when caught by an enemy. With one of the most popular poison pill plans from the last decade, the Netflix’s stockholder rights plan adopted in 2012 to be triggered if an investor acquires the remarkably low 10% of the company’s shares, or 20% in the case of institutional investors.
A suicide pill, on the other hand, is an extreme strategy where the Board of Directors prefers the company not to exist rather than to be taken over.