Greenmail

Greenmail is a financial strategy involving the purchase of enough shares in a company to threaten a hostile takeover, thereby forcing the target company’s management to buy these shares back at a premium to thwart the potential takeover. While not illegal, greenmail is often regarded as an unethical practice and can be damaging to the long-term health of a company and its shareholders. This practice gained notoriety during the 1980s when corporate raiders would frequently use it to extract large sums of money from companies.

Origins and Definition

The term “greenmail” comes from the combination of “greenback,” a slang term for U.S. dollars, and “blackmail.” It accurately reflects the coercive nature of this financial tactic. In essence, it involves buying a notable amount of a company’s stock and threatening management with a hostile takeover unless they repurchase the shares at a premium. The company pays this premium to avoid the takeover, hence paying a figurative ransom akin to blackmail.

Legally, greenmail resides in a gray area. While extortion through threats is clearly illegal, greenmail falls under strategic investment maneuvers and leveraged buyouts. However, increasing awareness and regulatory frameworks, like the Internal Revenue Code (Section 5881), have tried to curb such practices by introducing excise taxes on the premium paid to repurchase shares.

Mechanics of Greenmail

Step-by-Step Breakdown

1. Accumulation of Shares: An investor or group of investors will make substantial purchases of a company’s shares, clandestinely acquiring a significant percentage. This buildup is often gradual to avoid alerting the company or broader market to their intentions.

2. Threat of Takeover: Once a sizable stake is acquired, the investor threatens a hostile takeover or starts a proxy battle, which can drastically disrupt the company’s operations and destabilize its management.

3. Negotiation for Premium: The targeted company, facing the threat of a disruptive takeover, often negotiates with the investor to repurchase the shares at a premium price. The premium is essentially the ransom paid to prevent the hostile actions.

4. Execution of Greenmail: The company buys back the shares at the agreed premium, often using cash reserves, debt, or other financial strategies, depleting valuable resources that could have been used for growth, R&D, or dividends.

High-Profile Cases

Carl Icahn and TWA

One of the most famous practitioners of greenmail is Carl Icahn. In the 1980s, Icahn began accumulating shares of Trans World Airlines (TWA) and succeeded in gaining a controlling interest. Once in power, Icahn forced TWA to buy back shares at a premium, resulting in significant financial strain on the airline.

Occidental Petroleum and Greenmail Payment

In 1984, Occidental Petroleum paid a premium to David Murdock, a notable investor who had acquired a significant share of the company, to thwart his potential takeover. Occidental’s management bought back Murdock’s shares at a premium, which ultimately cost the company millions of dollars.

Disney and Saul Steinberg

In a well-publicized instance, Saul Steinberg escalated his purchase of shares in Disney during the 1980s, presenting a takeover threat. Disney decided to repurchase Steinberg’s shares to regain corporate control, resulting in a large payout that many investors saw as detrimental to the company’s financial health.

Impact on Companies

Short-Term Effects

• Immediate Share Price Increase: In the short term, the announcement or the disclosure of a greenmail situation may lead to an increase in the company’s share price due to the buyback at a premium.
• Management Distraction: The threat of a hostile takeover can divert company management’s attention away from core business operations, focusing resources and energy on resolving the immediate crisis.

Long-Term Effects

• Depletion of Resources: The funds used to buy back shares at inflated prices can severely deplete the company’s financial reserves, hindering its ability to invest in growth opportunities, research and development, or even regular operations.
• Shareholder Distrust: Existing shareholders may become wary of future investments, leading to a potential decline in shareholder confidence and market value. The perception of weakness in the management might result in a negative reputation, affecting future transactions and stock performance.
• Increased Debt: Companies often resort to borrowing to fund the share repurchase, increasing their debt load and potentially impacting their credit ratings. This increased debt burden can lead to higher interest payments and reduced financial flexibility.

Regulatory Environment

Legislation and Tax Reforms

To mitigate the adverse effects of greenmail, regulatory authorities have implemented several measures. For example, the Internal Revenue Code (Section 5881) imposes a 50% excise tax on greenmail profits, which serves as a deterrent to such practices.

Furthermore, securities laws like the Securities Exchange Act and various state anti-takeover statutes have made it more difficult for corporate raiders to successfully engage in greenmail activities. The implementation of poison pills, shareholder rights plans, and staggered board structures are among the measures companies have adopted to protect themselves from hostile takeovers and greenmail.

Institutional Investor Vigilance

Institutional investors, who often hold significant stakes in companies, have become more vigilant about greenmail practices. They actively monitor and influence corporate governance to ensure that actions detrimental to shareholder value are avoided. Proxy advisory firms also play a crucial role in guiding institutional investors on voting policies and anti-takeover measures.

Ethical Considerations

While legal loopholes and regulatory frameworks can address the mechanics of greenmail, the ethical implications are a different matter.

Corporate Governance and Fiduciary Duty

The fiduciary duty of corporate boards and management is to act in the best interests of the company and its shareholders. Greenmail practices potentially contradict this duty by prioritizing short-term solutions over long-term stability. Companies engaging in greenmail may face criticism for undermining corporate ethics and neglecting their responsibility to stakeholders.

Moral Hazard and Market Behavior

Greenmail can create a moral hazard, where corporate raiders perceive an incentive to engage in predatory behavior without facing substantial consequences. It fosters a speculative environment, leading to less stable market conditions. This undermines investor confidence and distorts true market value, resulting in a detriment to overall market health.

Alternatives to Greenmail

Strengthening Internal Controls

Companies can adopt proactive measures to mitigate the risk of hostile takeovers and greenmail. Strengthening internal controls and implementing robust corporate governance practices can play a crucial role in safeguarding against such threats. Regularly reviewing anti-takeover provisions and maintaining healthy lines of communication with shareholders are essential steps in this process.

Strategic Investor Relations

Building positive relationships with institutional investors and other key stakeholders can help create a strong network of support that deters hostile actors. Transparency and proactive communication regarding company strategies, performance, and risks can foster trust and reduce the likelihood of greenmail.

Shareholder Rights Plans

Implementing shareholder rights plans, commonly known as “poison pills,” can make it difficult for an aggressive acquirer to gain control of the company without the approval of the board. These plans typically involve issuing new shares to existing shareholders, diluting the acquirer’s stake and making the takeover more expensive and less attractive.

Notable Firms Involved in Anti-Takeover Measures

J.P. Morgan

J.P. Morgan provides financial advisory services that include helping companies to develop and implement anti-takeover strategies. For more about J.P. Morgan’s services related to Mergers & Acquisitions, you can visit their official website: J.P. Morgan.

Goldman Sachs

Goldman Sachs has a dedicated team that focuses on advising companies about managing and preventing hostile takeovers, including greenmail scenarios. Their approach includes deploying defenses such as poison pills and staggered board structures. For further information, visit: Goldman Sachs.

Wachtell, Lipton, Rosen & Katz

A prominent law firm specializing in corporate law, Wachtell, Lipton, Rosen & Katz is known for pioneering the “poison pill” defense mechanism against hostile takeovers. Companies often seek their expertise in crafting robust anti-takeover strategies. More details about their services can be found here: Wachtell, Lipton, Rosen & Katz.

Conclusion

Greenmail continues to be a contentious subject in the corporate world. While it may offer short-term financial gains for a select few, the practice undermines long-term shareholder value and corporate stability. Strengthening regulatory frameworks, bolstering internal controls, and fostering transparent relationships with shareholders are essential in defending against such predatory tactics. Ethical considerations remain paramount, with corporate governance playing a critical role in upholding the integrity and trust within the financial markets.