Greenmail

Discussion

One of the most wasteful entrenchment devices, greenmail payments are targeted share repurchases by management of company stock from individuals or groups seeking control of the company. Since only the hostile party receives payment, usually at a substantial premium over the market value of its shares, the practice discriminates against all other shareholders. With greenmail, management transfers significant sums of corporate cash to one entity, most often for the primary purpose of saving their jobs. Such transferred cash could, absent the greenmail payments, be put to use for reinvestment in the company, payment of dividends, or to fund a public share repurchase program. Thus, the greenmailer receives a lucrative reward for doing nothing more than raising the specter of a change in control (whether the potential acquirer actually planned to follow through with the threatened takeover or not), incumbent management remains in power, and shareholders are left with an asset-depleted and often less competitive company.

Impact On Stock Price

The negative effect of greenmail on stock prices is well documented. A 1984 study by the SEC's Office of the Chief Economist concluded in part that:

Evidence of negative effects of greenmail on stock prices supports the view that targeted share repurchases are counter to the best interests of the nonparticipating target shareholders. The costs imposed by this [type of] transaction are both the direct costs of the premium payment to the block seller and the indirect costs of foregone expected benefits from a change in corporate control.[1]

The SEC study looked at the effects on the market price of targeted companies from (1) the announcement of an acquisition of a large block (often referred to as a "foothold position") with the resultant increase in share prices, (2) through the interim period between the acquisition of the foothold position and the greenmail payment, (3) to their subsequent decline following the announcement of a greenmail payment to the blockholder. The SEC discovered that, on average, the appreciation in share prices was more than offset by their ultimate decline.

Available Research

This conclusion is consistent with the findings of several other studies.[2] For instance, Bradley and Wakeman determined that private stock repurchases that mark the termination of a takeover bid result in a 13-percent loss to nonparticipating shareholders.[3] Another examination of antigreenmail amendments suggests a strong correlation between a firm's proposed antigreenmail amendment and the firm's abnormal stock price run-up over the three months prior to the proxy mailing date. Should the stock price run-up reflect takeover rumors, it can be concluded that greenmail payments amid takeover speculation are value decreasing.[4]

Intangible Costs of Greenmail

Additionally, greenmail payments usually expose the company to negative press and may result in lawsuits by shareholders. The costs associated with these justifiable expressions of discontent with management can go beyond just legal and public relations expenses. When a company's name is associated with such a practice, company customers may think twice about future purchases, employee morale is adversely affected, and goodwill plummets, all at the expense of shareholders.

Measures To Prohibit Greenmail

Since greenmail is so overtly abusive to shareholder interests and often disruptive to management, many companies have proposed antigreenmail charter provisions. Shareholder proposals to prohibit greenmail are also become quite common. Not surprisingly, the proposals, whether sponsored by management or by shareholders, often receive overwhelming approval and are rarely defeated. Perhaps no other issue better illustrates the lengths to which management at some companies will go in order to entrench themselves, in blatant violation of the trust placed in management by shareholders. It follows that any attempts to do away with greenmail deserve unqualified support.

Antigreenmail and Bundled Proposals

Unfortunately, antigreenmail proposals sponsored by management have often been bundled with other less popular proposals, so that a vote for one was a vote for both. Given the popularity of antigreenmail proposals with shareholders, this was an effective method for management to ensure passage of less popular proposals which could be linked, rightly or wrongly, with antigreenmail protection.

The October 1992 SEC proxy reforms require that unrelated items be presented to shareholders separately, although a company may still condition the passage of one proposal on the passage of another, if its state of incorporation permits it to do so. When faced with an instance in which it is not altogether clear that the benefits to be derived from an antigreenmail amendment outweigh the costs associated with conditioned negative governance provisions, shareholders should vote against the proposal, and request that management resubmit the items as unconditioned proposals.

Statutory Antigreenmail Provisions

State-mandated antigreenmail provisions prevent a company from repurchasing, without board and disinterested shareholder approval, blocks of stock (usually five percent or more) at a premium, if the block has been held for less than a predetermined period. New York was the first state to adopt greenmail restrictions, and was later joined by several other states that also restrict the payment of greenmail: Arizona, Michigan, Minnesota, Tennessee, and Wisconsin. Michigan repealed its antigreenmail provision in 1997.

Greenmail drains a company of its liquid assets. Such payments are usually made to shareholders in a position to take control of a company. Greenmail gives controlling shareholders an incentive to sell their stake in the company for sizeable profits. From management's perspective, the company rids itself of potential hostile acquirers through the payment of greenmail.

Greenmail restrictions are typically adopted as part of omnibus state takeover legislation to appease shareholder advocates. When states are solicited by individual companies to protect themselves from pending takeovers, the legislature includes greenmail restrictions to counterbalance other more restrictive antitakeover provisions. Yet, restricting a company from paying greenmail, although generally a positive move, hardly compensates for the simultaneous adoption of control share, stakeholder, and freezeout provisions.

Allowances For Greenmail

Most statutes allow the payment of greenmail if it is not discriminatory and is made to all remaining shareholders. In this case, however, the company runs the risk of being forced to buy all of its remaining public stock, a contingency most companies prefer to avoid.

Antigreenmail provisions vary among states. For example, Wisconsin allows companies to buy back up to five percent of a shareholder's block at a premium without violating antigreenmail provision. Minnesota restricts greenmail payments for large blocks of shares held for less than six months, while other states restrict payments for shares held less than three years. The amount of stock a company may buy at a premium ranges from three percent to ten percent of outstanding shares.

Any restrictions on greenmail payments should be seen as positive. However, states should go further and ban payment of greenmail altogether. Restrictions that limit the degree to which companies can pay greenmail will undoubtedly save the company capital that could be plowed back into its operations. As such, any payment of greenmail, no matter how small, should be viewed as a waste of corporate assets.

Pale Greenmail

A later variation on the theme of standard greenmail arose from attempts to avoid the negative press and shareholder furor that usually accompany greenmail payments. "Pale greenmail," a phrase coined by Dean LeBaron of Batterymarch Financial Management, is nothing more than an effort by management and greenmailers to disguise the true nature of their transaction behind the veil of a restructuring or public share acquisition (as opposed to a targeted share acquisition) and, following its passage, to avoid the federal tax penalty.

Probably the most notorious example of pale greenmail is Goodyear Tire & Rubber Co.'s buyout of Sir James Goldsmith in 1986. Goodyear management purchased all of Goldsmith's 12.5 million shares for $49.50 each (plus $3 per share for "expenses") and, to appear generous, offered $50 per share for 40 million public shares out of a total of 109 million shares outstanding. Thus, Sir James netted approximately $90 million. At the same time, Goodyear shareholders received, on average, $0.50 more per share on less than half of their holdings, while the remainder of their shares dropped to only $41.75 per share on the day the Goodyear board approved the transaction.

Impact of Pale Greenmail

Pale greenmail typically has the effect of depressing the value of shares that remain outstanding following a buyback. Therefore, even though shareholders participate in pale greenmail, the effect is the same as with standard greenmail: that is, management pays off an investor who has targeted the company, and the average shareholder suffers -- usually through a drop in share value following the transaction that is greater than any premium received. Unfortunately, since pale greenmail is typically disguised as part of a restructuring effort, it is not easily discovered. Even when discovered, the exact effect on share value is not easily determined, as the benefits to the proposed restructuring may outweigh the negative effects of the proposed share repurchase.