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Shadow pills and visible value

2 July 2019

The article at a glance

The “poison pill” (formally known as a “shareholder rights plan”) has a long and contentious history in the United States as a …

Poison pills stamped with a skull and crossbones.
Scott B. Guernsey
Dr Scott B. Guernsey

The “poison pill” (formally known as a “shareholder rights plan”) has a long and contentious history in the United States as a tactic to deter takeovers.[1] While details can vary across different implementations, the key defensive mechanism of the pill provides existing shareholders with stock purchase rights that entitle them to acquire newly issued shares at a substantial discount in the “trigger” event that a hostile bidder obtains more than a pre-specified percentage of the company’s outstanding shares (e.g. 10 to 15 per cent).[2] As a result, poison pills permit a firm’s board of directors the ability to substantially dilute the ownership stake of a hostile bidder, de facto giving the board veto power over any hostile acquisition.

Correspondingly, law and finance scholars generally agree that the poison pill is perhaps the most powerful anti-takeover defence (e.g. Malatesta and Walkling 1988; Ryngaert 1988; Comment and Schwert 1995; Coates 2000; Cremers and Ferrell 2014). However, whether a firm’s managers use the poison pill to the benefit or detriment of its shareholders is the subject of an enduring debate in both the corporate finance literature and in US state courts.

Prior empirical studies have attempted to investigate the value implications of a firm’s decision to employ a poison pill as a strategy to deter takeovers. While earlier findings were mixed, over the past decade most studies have found that the adoption of a pill is negatively associated with firm value (e.g. Bebchuk, Cohen and Ferrell 2009; Cuñat, Gine, and Guadalupe 2012; Cremers and Ferrell 2014). Unfortunately, however, this result is challenging to interpret, as the choice to adopt a pill is endogenous – meaning, for example, that the finding might imply that a firm was losing value and decided to adopt a pill in response rather than the conclusion that the adoption of the pill led to lowered firm value. Adding to the difficulty of researchers, since poison pills can be unilaterally adopted by a firm’s board of directors, even firms that do not currently have a poison pill in place still have the right to adopt a pill at any time – this right is termed by scholars as a “shadow pill” (Coates 2000).

In the article “Shadow Pills and Long-Term Firm Value“, CERF Research Associate Scott Guernsey, and research collaborators Martijn Cremers (University of Notre Dame), Lubomir Litov (University of Oklahoma), and Simone Sepe (University of Arizona), contribute to the debate on the value implications of the poison pill by shifting the focus from “visible” (or realised) pills to shadow pills – that is, studying the effect that arises from the right to adopt a poison pill rather than its actual adoption. To do this empirically, the study’s tests focus on US state-level poison pill laws (“PPLs”) – enacted by 35 states between 1986 and 2009 – which legally validated the use of the pill, hence strengthening these firms’ shadow pill.

Using the staggered enactments of PPLs by different states in different years, the authors find that firms incorporated in states with a stronger shadow pill experience significant increases in firm value, and especially for firms with stronger stakeholder relationships (e.g. with a large customer or in a strategic alliance) and more engaged in innovation (e.g. R&D investments or with patents). Additionally, the study confirms the prior literature’s results on a negative correlation between firm value and actual pill adoption.

Overall, the authors’ findings suggest that a stronger shadow pill can benefit certain firms’ shareholders, even if a visible pill does not, indicating that for these firms the right to adopt a pill could serve as a function of good corporate governance by credibly signalling a firm’s bond toward more stable stakeholder relationships and/or longer-term investment projects through its commitment against potential disruptions from short-term shareholder interference via the takeover market.


Bebchuk, L., Cohen, A. and Ferrell, A. (2008) “What matters in corporate governance?” Review of Financial Studies, 22: 783-827

Coates IV, J.C. (2000) “Takeover defenses in the shadow of the pill: a critique of the scientific evidence.” Texas Law Review, 79: 271-382

Comment, R. and Schwert, G.W. (1995) “Poison or placebo? Evidence on the deterrence and wealth effects of modern antitakeover measures.” Journal of Financial Economics, 39: 3-43

Cremers, M. and Ferrell, A. (2014) “Thirty years of shareholder rights and firm value.” Journal of Finance, 69: 1167-1196

Cuñat, V., Gine, M. and Guadalupe, M. (2012) “The vote is cast: the effect of corporate governance on shareholder value.” Journal of Finance, 67: 1943-1977

Malatesta, P.H. and Walkling, R.A. (1988) “Poison pill securities: stockholder wealth, profitability, and ownership structure.” Journal of Financial Economics, 20: 347-376

Ryngaert, M. (1988) “The effect of poison pill securities on shareholder wealth.” Journal of Financial Economics, 20: 377-417

Slaughter and May (2010) A guide to takeovers in the United Kingdom.

[1] The use of the poison pill is not permitted in the UK because: (i) it is viewed as a breach of fiduciary duty, and (ii) it is disallowed by General Principle 3 and Rule 21 of the City Code (Slaughter and May 2010).

[2] This describes the “flip-in” poison pill which has become largely majoritarian in the US; for other methods see: “preferred stock plans”, “flip-over” poison pills, “back-end rights plans”, “golden handcuffs” and “voting plans”.