Institutional Investors in the U.S. and the Repeal of Poison Pills: A Practitioner’s Perspective

Wednesday, January 1st, 1992 at 12:00 am by Mark R. Wingerson, Christopher H. Dorn
Mark R. Wingerson, Christopher H. Dorn, Institutional Investors in the U.S. and the Repeal of Poison Pills: A Practitioner’s Perspective, 1992 Colum. Bus. L. Rev. 223

Over the past several years there has been in the academic literature a proliferation of articles investigating the economic consequences of the rise in the number of institutional investors. Many have sought to distill their effect on the behavior of corporations and on corporate governance in general. This article seeks to contribute to that debate by investigating a possible motivation underlying the recent increase in the number of shareholder initiatives, sponsored by institutional investors, to repeal the shareholder rights plans often called “poison pills.”

In Part II, this article begins by describing the rise in institutional investor activism. During the last quarter century the investment holdings of institutional investors increased dramatically and, at the same time, indexed investing became a common method of managing the investment decision-making for increasingly larger and more diversified portfolios. One consequence of these developments has been a deterioration in institutional investors’ ability to monitor corporations directly in order to enhance the performance of their investment portfolios. Another consequence has been a loss of liquidity – that is, the option to sell in the event company performance is not acceptable. This loss of liquidity results partly from the increasing size of the institutional holdings and partly from the reduction in takeover activity which had served to provide a premium-priced exit for holdings regardless of size. As a result institutional investors adopted a strategy to introduce “disciplinary” forces to the marketplace that would passively motivate corporations to improve their performance. This strategy included shareholder initiatives on matters which directly impact corporate governance issues and, in some cases, proxy contests to ensure their passage; attempts to convince companies to accept shareholder advisory committees; and efforts to change the selection process for so-called independent directors. The most consistent and popular referendum initiative has been a precatory proposal calling for the repeal of poison pills.

In Part III, this article presents an overview of poison pills and discusses various views concerning their purpose and effect. The most commonly held view is that poison pills are motivated by a desire for entrenchment and that they achieve this purpose. Since this view forms the basis for the common under-standing of why institutional investors support initiatives for the repeal of poison pills, this view is examined in the light of available data and the authors’ practice experience. It is suggested that, regardless of motivations for installation, poison pills appear to increase takeover premiums rather than prevent takeovers.

In Part IV, this article addresses the following question: if poison pills enhance shareholder value in takeover situations, why do institutional investors seek their removal? Possibilities considered and put aside are: first, that institutional investors either don’t know or don’t believe the evidence that poison pills enhance value; second, that institutional investors feel that poison pills are useful for protecting shareholder value in take-over situations where the shareholders are widely dispersed but are unnecessary now because of increased shareholding concentration; third, that while poison pills increase takeover premiums for announced deals, they are still undesirable because they deter marginally priced potential takeovers; and fourth, that institutional investors are not pursuing financial objectives. This article presents the hypothesis that institutional investors are very well aware of the lucrative premiums generated by poison pills in takeover situations, but that they are consciously seeking to avoid such large premiums. The article proceeds to suggest a rational explanation for this apparently bizarre behavior.

Finally, in Part V, the authors explore some of the legal implications of this hypothesis for the law of the fiduciary duty of directors by examining, in this context, the recently failed takeover attempt by Pirelli S.p.A. of Continental AG.

Author Information

Wingerson (Partner, Shearman & Sterling, Frankfurt, Germany); Dorn (Associate, Shearman & Sterling, New York, NY)