In my book Corporate Governance after the Financial Crisis
The WSJ today reports that:
More companies are resorting to an old tactic to get rid of activist investors: Pay them to go away.
The practice, which involves buying back shares from activist hedge funds, has raised concerns among some investors because it bears similarities to "greenmail," a controversial strategy popular in the 1980s.
During the 1980s, the purchase by a corporation of a potential acquirer's stock, at a premium over the market price, came to be called "greenmail." It always struck me a very stupid response by a target management to a takeover threat. Buying off one raider provides no protection against later pursuers, except to the extent that the premium paid to the first pursuer depletes the corporate resources and makes it a less attractive target. Managers could of course, achieve such reduction in corporate resources simply by paying a dividend to all shareholders or by buying the corporation's shares from all shareholders wanting to sell. Or managers could just grow a spine and tell greenmailers to go [expletive deleted] themselves.
In any case, greenmail eventually faded away. Section 5881 of the Internal Revenue Code, enacted in 1987, imposes a penalty tax of 50 percent on the gain from greenmail, which is defined as gain from the sale of stock that was held for less than two years and sold to the corporation pursuant to an offer that "was not made on the same terms to all shareholders." This made greenmail less attractive to both sides. In addition, the development of the poison pill enabled managers to credibly resist takeover bids made by greenmailers.
But it's back:
... in the past 12 months, at least 10 companies have repurchased blocks of shares from activist investors, including Daniel Loeb and William Ackman, according to FactSet SharkWatch. That is more than in the previous six years combined.
The practice differs from greenmail in two crucial aspects. The share buybacks aren't at a premium to the market but typically at or slightly below the last trading price. They also don't follow threats of hostile takeovers. ...
The buybacks have fueled a common criticism of activist investors: They chase short-term profits at the expense of other shareholders.
"You can call it greenish mail," said Spencer Klein, a lawyer with Morrison & Foerster LLP who advises companies facing activist investors. "These investors are getting an opportunity that others aren't, and that's not a terribly popular notion."
The trend is setting off alarms even among activists, who have sought to separate themselves from the "corporate raiders" of the 1980s and portray themselves as good for all investors.
Granted, there is an argument that 1980s-style greenmail wasn't all bad. Some scholars argued that prompted target boards to seek higher bids or to enhance value (above the greenmail bidder's price) by making changes in management or strategy. The question whether greenmail deserved its bad reputation therefore is essentially an empirical one. There was some evidence that greenmail benefited nonparticipating shareholders overall, and did not appear to be a device for entrenching incumbent management. Consequently, a greenmailer may be a catalyst for change from within or for a bidding war and may therefore deserve to make a profit. Jonathan R. Macey & Fred S. McChesney, A Theoretical Analysis of Corporate Greenmail, 95 Yale L.J. 13 (1985); Fred S. McChesney, Transaction Costs and Corporate Greenmail: Theory, Empirics, and a Mickey Mouse Case Study, 14 Managerial & Decision Econ. 131 (1993).
Green-ish mail by activist shareholders, however, differs in some key respects from raider-style greenmail. First, new school greenmail seems unlikely to result in the target being put into play for a takeover bid, thereby eliminating an important way in which nonparticipating shareholders profited in the old days. Second, the key justification for shareholder activism is that activists press for changes that benefit all shareholders. But if an activist plans to profit from greenmail, it may not require the company to make real governance changes. Instead, not unlike the figleaf changes that often accompany settlements of derivative litigation, activist greenmail likely will simply generate private gains for the activist and no real improvement in the target company.
Which is precisely what I predicted.
So what do to do? The Delaware courts have upheld so-called activist pills, which are a special form of poison pill specifically designed to deter raids by activist hedge funds. Companies need to start adopting them and managers need to find the balls to use them.
