Research from UD professors examines poison puts, a hot topic in corporate governance

1:33 p.m., March 9, 2016--The use of “poison puts” – a controversial tool that allows bondholders to cash in bonds in the event of a company’s takeover – has grown dramatically in recent years.

Poison puts, known as a type of “poison pill” defense, protect against hostile takeovers. But critics argue that this tactic silences activist shareholders and makes it more difficult for company control to change hands when necessary.

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However, research on poison puts from University of Delaware finance department chair and associate professor Helen Bowers and assistant professor Frederick Bereskin found no evidence that the tactic was associated with weaker corporate governance.

Bereskin explained that these findings “can be interpreted either as a sign that poison puts substitute for other means of entrenchment, or that they are less related to governance than bondholders’ contracting concerns.”

The research also indicates specific features of companies most likely to use poison puts, explaining that each company’s results are based around a number of environmental factors.

“Much of our evidence is consistent with poison puts… being largely driven by the unique contracting environment of these firms,” Bowers said. 

And while poison puts may result in entrenchment of management, Bowers continued, “their use may be driven by firms’ contracting environment and bondholders’ legitimate risk-shifting concerns.”

This research is particularly important because it sheds light on the complex and infrequently discussed relationship between lenders and shareholders, said executive director Jon Lukomnik of the Investor Responsibility Research Center Institute (IRRCi), which supported the study.

Lukomnik explained that the study noted a number of interesting paradoxes, saying, “Firms which issue poison puts have reasonable shareowner protections, yet the bond indentures themselves may serve to entrench through discouraging merger and acquisition activity.”

“Another paradox is that the prevalence of poison puts actually may be driven by improved shareowner rights as lenders may be concerned about shareowners forcing companies to take uncomfortable levels of risk,” Lukomnik explained. 

Bowers and Bereskin’s research reported a number of interesting additional findings, including:

• The use of poison puts varies significantly by industry. They were included in only 10 percent of bond issues in the financial industry but in 76 percent of health care firms’ issues. 
• Firms with higher credit ratings rarely use poison puts. Those with credit ratings of A or higher included poison puts in their bonds only 10 percent of the time, while those with with credit ratings of BB+, BB, or BB- included poison puts in 73 percent of their bond issues. 
• The use of poison puts began its steep incline in popularity in 2007.

All of these findings help to paint a more detailed picture of the role that poison puts will play in the future of corporate governance.