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The premium over the market price offered by the acquirer for the target’s shares is the key driving factor used by the target to determine if it will support or resist the takeover. After deciding to resist, the target company seeks advice from their lawyers and investment banks on how fair the hostile offer is and what alternatives the board of directors has. A target can use defensive measures to keep the company independent, delay the takeover, or negotiate better terms. Defensive measures can either be applied before or after, but most attorneys recommend having defenses set up before the takeover.

Pre-Offer Takeover Defense Mechanisms

These are defense mechanisms that a target company can put in place before a takeover happens. A company that puts defense mechanisms before a takeover has more flexibility when defending against a takeover.

1. Poison Pills

A poison pill makes the target less attractive through legal devices that make it costly for an acquirer to take over without the board of directors’ approval. There two types of poison pills, the flip-in pill and the flip-over pill. The flip-in pill occurs when existing shareholders of the target company have the right to buy the shares of the target company at a discount, flooding the market with new shares. Because the acquiring company is prohibited from participating in the purchase, the acquirer is subject to significant dilution levels.

The flip-over pill allows shareholders of the targeted firm to buy shares of the acquiring company at a discounted price during a hostile takeover bid. This will effectively dilute the acquiring company’s shareholder shares.  Should the transaction turn friendly, the board can exercise a waiver.

By virtue of the dead hand provision, the target’s directors are the only ones who can cancel or redeem the poison pill. This makes it difficult trying to acquire the target without board approval.

2. Poison Puts

Poison puts give a company’s bondholders the right to sell their bonds back to the target at a pre-specified redemption price equal to or above par value as stated in the debt indenture. Therefore, the acquirer should be prepared to refinance the debt immediately after acquisition, increasing the acquisition cost.

3. Incorporation in a State with Restrictive Takeover Laws

In the United States, some states have created laws that specifically deal with hostile takeover attempts. Target companies that anticipate a hostile takeover can reincorporate in a jurisdiction with restrictive takeover laws making it difficult for an acquirer to take over the company in the new jurisdiction.

4. Staggered Board of Directors

A company can arrange to stagger the terms for board members so that only a portion of board seats are due for election each year. As a result, it would take longer to elect enough directors to take control of the board.

5. Restricted Voting Rights

The target company can restrict shareholders’ voting rights who have recently acquired large blocks of stock, such as 15% or 20%. The possibility of owning majority shares and still being unable to vote acts as a deterrent.

6. Supermajority Voting Pprovisions

The target company can change its by-laws and charter to require a higher percentage of approval by shareholders for mergers than normally is required. This is often accompanied by a provision that prevents the acquirer from voting its shares; thus, even if they own most shares of the target, the acquirer may not vote to approve the merger.

7. Fair Price Amendments

These are changes to a company’s charter and by-laws that do not allow a merger to take place with an offer below a specific threshold. By setting a specified floor value bid, the target is protected from temporary market share price declines. It also protects against two-tiered tender offers.

8. Golden Parachutes

This is a compensation agreement between the target company and its managers where the executives receive huge payouts if they leave the target company due to the merger. This makes the target management stay during the merger process and focus on maximizing shareholders value. The lack of a golden parachute can lead managers to hastily seek employment or to collude with the acquirer during hostile takeovers to the detriment of shareholders.

Post-Offer Takeover Defense Mechanisms

1. “Just Say No” Defense

The target company in the middle of a hostile takeover can simply turn down the offer. If the acquirer attempts a tender offer or a bear hug, the company management can lobby and build a case for why the offering price is inadequate or why it is not in the best interest of shareholders. The acquirer will be forced to reevaluate its price or reveal its strategy for the takeover to be successful.

2. Litigation

The target company can file a lawsuit against the acquiring company for antitrust laws or violation of securities. In practice, these lawsuits do not prevent the takeover but delay the takeover giving management time to develop another defense tactic.

3. Greenmail

A greenmail involves the target paying off an acquirer by repurchasing its shares from the acquirer at a premium. The greenmail is often accompanied by an agreement that states that the acquirer will stop pursuing the hostile takeover for a set period.

4. Shares Repurchase

Unlike the greenmail, where the target only repurchases its shares from the acquirer, share repurchase involves buying back shares from any shareholder. By increasing the price of the stock or by increasing the bid of the acquirer, a share repurchase increases the cost of acquisition for the acquisition company. Share repurchases will increase the target’s leverage making it unattractive to the acquirer.

The target company can also buy all its shares and convert them to a privately held company. This type of transaction is called a leveraged buyout. This strategy offers protection to the target company as long as shareholders’ value from the LBO is greater than the acquirer’s offer.

5. Leveraged Recapitalization

This scenario assumes a large amount of debt will be used to finance the share repurchase, while some shares will remain public. The purpose of leveraged recapitalization is to increase shareholder value over and above the acquirer’s offer through a change in the target company’s capital structure.

6. Crown Jewel Defense

The target will sell a profitable asset or subsidiary in a bid to make itself unattractive. If the subsidiary in question were the main motivation for the takeover, the sale of the subsidiary would cause the acquirer to abandon the hostile takeover bid. If a crown jewel is initiated after the announcement of a hostile takeover, the chances are that the court will rule that it is an illegal strategy.

7. Pac-Man® Defense

The target will make a counteroffer to acquire the hostile bidder. In practice, this rarely happens because it would mean a bigger firm—the acquirer—is being taken over by a smaller firm—the target. As soon as the target uses this strategy, it cannot use litigation if the takeover fails.

8. White Knight Defense

The target will respond to a hostile takeover by seeking another more suitable acquirer—the white knight—in place of the hostile bidder. This will cause the hostile acquirer to offer a higher price for the target. However, once the white knight sees the strategic advantages of acquiring the target, they will place an even higher bid. This will result in a competitive bidding situation. The bidder’s curse can prevail, and the target will end up being taken over by the white knight. The winner’s curse can also occur, and the winner of the bid ends up overpaying for the target.

9. White Squire Defense

The target will look for a friendly party and sell their minority share to the party, effectively blocking the hostile takeover without selling the entire company. The litigation risk associated with the white squire defense depends on the transaction details and local regulations. Shareholders are also required to vote on such transactions and not endorse a transaction that does not provide an adequate premium.


Which one is most likely a disadvantage of the Pac-Man® defense mechanism?

  1. It forgoes the ability to use several other defensive strategies.
  2. The target does not have to sell the entire company.
  3. It effectively stops the hostile takeover.


The correct answer is A:

Once a company uses a Pac-man® defense, it cannot use other defensive strategies such as litigation.

B is incorrect: This is an advantage of a white squire defense strategy.

C is incorrect:  This is a benefit of using the Pac-man® defense strategy.

Reading 18: Mergers and Acquisitions

LOS 18 (f) Distinguish among pre-offer and post-offer takeover defense mechanisms.

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