Greenmail

What Is Greenmail?

Greenmail is a specific strategy within corporate finance where a company repurchases its own shares at a premium price from a corporate raider or large shareholder to prevent a hostile takeover or significant corporate disruption. This tactic is akin to a "ransom" payment, where the target company buys back the shares to remove the threat posed by the shareholder activism of the acquiring party⁴², ⁴³. The aim of greenmail is for the existing board of directors and management to maintain control and prevent unwanted changes in the company's strategic direction or operations⁴⁰, ⁴¹.

History and Origin

The term "greenmail" is a portmanteau of "greenbacks" (U.S. dollars) and "blackmail," reflecting its controversial nature. It gained widespread notoriety in the 1980s, an era characterized by a surge in aggressive mergers and acquisitions and highly leveraged buyouts³⁷, ³⁸, ³⁹. During this period, prominent corporate raiders, such as T. Boone Pickens and Sir James Goldsmith, would acquire substantial blocks of shares in target companies and then threaten a takeover, pressuring the company to repurchase their stake at an inflated price³⁵, ³⁶.

One notable instance involved Sir James Goldsmith and Goodyear Tire & Rubber Co. in 1986. Goldsmith purchased an 11.5% stake in Goodyear and signaled his intent for a takeover. In response, Goodyear launched a restructuring plan and ultimately repurchased Goldsmith's shares, allowing him to walk away with approximately $90 million in profit³⁴. Similarly, in 1984, Saul Steinberg's Reliance Group amassed a large stake in Walt Disney Co., leading the company to repurchase his shares at a premium to avoid Steinberg's interference³¹, ³², ³³. These high-profile cases contributed to greenmail becoming a highly debated topic, viewed by many as a form of legal extortion.

Key Takeaways

• Greenmail involves a company buying back its shares from a large investor at a premium to avoid a hostile takeover or other disruptive actions.³⁰
• The practice became particularly prevalent in the 1980s amidst a wave of corporate mergers and acquisitions.²⁷, ²⁸, ²⁹
• It is often criticized for benefiting the greenmailer at the expense of other shareholders and for depleting company resources.²⁴, ²⁵, ²⁶
• Regulatory measures, including a 50% excise tax on greenmail profits, have made the practice less common since the early 1990s.²³

Formula and Calculation

Greenmail does not involve a specific financial formula or calculation in the traditional sense. Instead, it is a direct negotiation between the company's management and the greenmailer regarding the premium to be paid for the stock repurchase. The premium is the difference between the price at which the shares are repurchased and their prevailing market value or the price at which the greenmailer initially acquired them.

Interpreting Greenmail

Interpreting greenmail involves understanding the motivations of both the "greenmailer" and the target company's management. From the perspective of the greenmailer, the action is often a strategic move to generate quick profits by leveraging the threat of a tender offer or proxy fight. They aim to exploit perceived undervaluation or weak defenses within the target company²².

For the target company's management and board, paying greenmail is typically seen as a defensive maneuver to avoid a costly and disruptive takeover battle, preserve the company's current management structure, and protect its strategic direction²⁰, ²¹. However, critics argue that this decision may not always align with the long-term interests of all shareholders, as it expends company funds that could otherwise be invested in growth or returned through dividends.

Hypothetical Example

Imagine "Company Alpha," a publicly traded firm whose shares are trading at $50 per share. An activist investor, "Mr. Raider," believes Company Alpha is undervalued and begins accumulating shares on the open market. Mr. Raider eventually acquires 15% of Company Alpha's outstanding stock, costing him $50 million (1 million shares x $50/share).

Mr. Raider then publicly announces his significant stake and expresses his intention to launch a hostile takeover bid or push for a complete overhaul of the management team. Fearing the disruption and potential loss of control, Company Alpha's board initiates negotiations with Mr. Raider. After intense discussions, Company Alpha agrees to repurchase Mr. Raider's 1 million shares for $65 per share, a $15 premium over the current market price. The total cost to Company Alpha is $65 million.

In this scenario, Mr. Raider makes a profit of $15 million ($65 million - $50 million) by simply threatening a takeover. Company Alpha avoids the takeover but uses $65 million of its cash reserves for the stock repurchase, which is a significant outflow of capital.

Practical Applications

While less common today due to increased regulation and scrutiny, greenmail still appears in various forms within corporate strategy and finance. Companies facing activist shareholders or potential hostile takeovers may consider different anti-takeover defenses. The practice highlights the ongoing tension between shareholder rights and managerial control in publicly traded companies.

Regulatory bodies, such as the U.S. Securities and Exchange Commission (SEC), require individuals or entities acquiring significant stakes (typically over 5%) in a public company to disclose their holdings through filings like Schedule 13D. This transparency is intended to provide other shareholders with information about potential takeover attempts.¹⁹. Although direct greenmail payments are heavily taxed (a 50% excise tax on gains in the U.S. was introduced in 1987), some argue that more subtle forms or negotiated buybacks continue to occur.¹⁸

Limitations and Criticisms

Greenmail has faced significant criticism for several reasons. Primarily, it is often viewed as a practice that prioritizes the short-term interests of a few investors (the greenmailer) and the incumbent management over the long-term shareholder value of the company¹⁵, ¹⁶, ¹⁷. Critics argue that company funds used for greenmail could be better allocated to strategic investments, research and development, or returning capital to all shareholders through dividends or equitable buybacks¹³, ¹⁴.

The financial implications for the target company can be severe. Repurchasing shares at a premium can lead to a significant drain on liquidity and increase debt levels if the company borrows funds for the buyback, negatively impacting its capital structure¹². Some academic studies have shown that greenmail payments, particularly when used to thwart an imminent takeover threat, can lead to a decline in the value of the firm's stock for non-participating shareholders¹⁰, ¹¹. Furthermore, the payment of greenmail can signal to the market that the company's management is more concerned with entrenching itself than maximizing shareholder wealth.

Greenmail vs. Hostile Takeover

Greenmail and a hostile takeover are closely related but represent different stages or outcomes in a corporate control battle. A hostile takeover is an attempt by an acquiring company or individual to gain control of a target company against the wishes of the target company's current management and board⁸, ⁹. This can be achieved through various means, such as a tender offer directly to shareholders or a proxy fight to replace the board⁷.

Greenmail, on the other hand, is a defensive tactic employed by the target company to prevent a hostile takeover. When faced with the threat of such an acquisition, the target company's board may opt to pay greenmail by buying back the threatening shareholder's stake at a premium. The key distinction is that a hostile takeover is the attempted acquisition, while greenmail is a defense mechanism against that attempt, resulting in the greenmailer's exit rather than a change of control for the entire company.⁵, ⁶

FAQs

Is greenmail legal today?

While not explicitly illegal, greenmail is heavily regulated and subject to significant disincentives. In the United States, a 50% excise tax on greenmail profits was introduced in 1987 to discourage the practice⁴. Additionally, many companies have adopted anti-greenmail provisions in their corporate charters, preventing the board of directors from approving such payments.

Who benefits from greenmail?

The primary beneficiary of greenmail is the "greenmailer" or corporate raider who sells their shares back to the company at a premium, realizing a quick profit², ³. The target company's incumbent management and board may also benefit by retaining control and avoiding a disruptive takeover. However, other shareholders who do not sell their shares often bear the cost, as the company's financial resources are expended without a direct benefit to their shareholder value.

How does a company defend against a hostile takeover if not through greenmail?

Companies employ various other defensive strategies against hostile takeovers, often referred to as "poison pills" or "shark repellents." These can include issuing new shares to dilute the acquirer's stake, staggered board elections, or finding a "white knight" (a friendly acquirer) to make a competing offer. Many of these defenses are aimed at making the target company less attractive or more expensive to acquire¹.