Scorched-Earth Defense: Hostile Takeover Countermeasure

The scorched-earth defense is a strategy used by companies to thwart hostile takeovers by disposing of valuable assets, often leading to diminished earning power and value.

The scorched-earth defense is a tactical measure employed by companies to fend off hostile takeovers. In this strategy, a targeted company disposes of its most valuable assets—often referred to as its “crown jewels”—to make itself less attractive to the acquiring entity. However, this maneuver usually leads to a significant and often permanent reduction in the company’s earning power and overall value.

Implementing a Scorched-Earth Defense

Key Components

• Crown Jewels: These assets are often the most lucrative and vital parts of the company.
• Disposal Methods: Assets can be sold, leased, or entirely divested.
• Objective: The primary goal is to make the company less attractive to the hostile bidder.

Types of Scorched-Earth Defense

• Asset Sale: Selling off the crown jewels to a friendly third party.
• Golden Parachutes: Implementing lucrative contracts that provide substantial benefits to key executives in case of an acquisition.
• Poison Pills: Issuing new shares to existing shareholders to dilute the value held by the hostile bidder.

Example

In the 1980s, Phillips Petroleum utilized a scorched-earth defense by selling its core assets to avoid a hostile takeover by T. Boone Pickens. Although the strategy succeeded in deterring the acquisition, Phillips suffered long-term repercussions on its operational capacity and market value.

Historical Context

The term “scorched-earth” originates from military strategy, where retreating armies would destroy anything that might be useful to the advancing enemy. In the corporate world, this analogy translates to companies engaging in self-destructive behaviors to fend off hostile takeovers.

Pros and Cons

Advantages

• Deterrence: It can effectively thwart an unwanted takeover.
• Control: Maintains the existing management team’s control.

Disadvantages

• Long-term Impact: Permanent damage to the company’s value and earning potential.
• Reputation: Can harm relationships with investors, stakeholders, and the market.

Related Terms

• Hostile Takeover: An acquisition attempt that the target company’s management opposes.
• White Knight: A more favorable company that acquires a target facing a hostile takeover.
• Greenmail: The practice of purchasing enough shares in a company to threaten a hostile takeover, only to resell them at a premium to the target company.

FAQs

What is the primary goal of a scorched-earth defense?

The primary goal is to make the company less attractive to the hostile bidder by disposing of its most valuable assets.

Can a scorched-earth defense backfire?

Yes, it can lead to a significant, often permanent, reduction in the company’s earning power and overall value.

Are there less drastic alternatives to a scorched-earth defense?

Yes, companies can implement other anti-takeover measures such as poison pills or golden parachutes, which may not be as damaging.

References

• DePamphilis, Donald. Mergers, Acquisitions, and Other Restructuring Activities. Academic Press, 2021.
• Gaughan, Patrick A. Mergers, Acquisitions, and Corporate Restructurings. Wiley, 2020.

Summary

The scorched-earth defense is a desperate but sometimes necessary measure for companies facing hostile takeovers. By disposing of valuable assets, the company aims to deter the acquisition, albeit at the cost of its future profitability and value. It is a high-risk strategy that underscores the lengths to which companies will go to protect their autonomy.

This defense mechanism, while effective in the short-term, often has long-lasting negative impacts, making it a double-edged sword in the realm of corporate takeovers.