Greenmail

Greenmail is a corporate finance term referring to a situation where a company pays a premium to repurchase its own shares from a hostile investor or potential acquirer in order to prevent a takeover. The term combines “green” (money) and “blackmail,” implying a form of financial coercion where the threat of a hostile takeover is used to extract profit from the target company.
In essence, greenmail occurs when an investor acquires a significant stake in a company, threatens to take control, and then agrees to sell their shares back to the company at a higher price, profiting from the arrangement while abandoning the takeover attempt.

Definition

Greenmail is the practice of buying a substantial number of shares in a company and then coercing the company to repurchase those shares at a premium above the market price to avert a potential takeover or disruptive shareholder activism.
This tactic allows the investor to make a short-term profit without completing the takeover, while the target company incurs a financial loss and often damages its reputation.

Mechanism of Greenmail

The process of greenmail generally unfolds in the following stages:

1. Acquisition of Shares:
   • An investor or corporate raider buys a significant stake (often 5–20%) in a company, signalling potential takeover intentions.
2. Hostile Threat:
   • The investor hints at or announces a possible takeover bid, creating concern among the company’s management and shareholders.
3. Negotiation:
   • To protect themselves from a hostile takeover or loss of control, the company’s management offers to repurchase the shares at a premium price.
4. Sellback and Profit:
   • The investor sells the shares back to the company, earning a substantial profit from the difference between the purchase price and the buyback price.
5. Abandonment of Takeover:
   • The investor withdraws the takeover threat after receiving payment, while the company’s management retains control.

Example

Suppose an investor buys 10% of Company A’s shares at ₹200 per share, signalling interest in a takeover.Fearing a hostile bid, Company A’s management agrees to buy back the shares at ₹280 per share to eliminate the threat.

• Purchase cost to investor = ₹200 × 10,00,000 = ₹20 crore
• Buyback amount = ₹280 × 10,00,000 = ₹28 crore
• Profit (Greenmail gain) = ₹8 crore

The investor walks away with a substantial profit without acquiring control of the company.

Motives Behind Greenmail

1. Profit Seeking:
   • The investor aims to earn a quick profit through coercion rather than an actual acquisition.
2. Management Protection:
   • Company executives may agree to pay greenmail to maintain their positions and prevent loss of control.
3. Avoidance of Hostile Takeovers:
   • Companies may consider greenmail a defensive tactic to avoid being acquired under unfavourable conditions.
4. Short-Term Stability:
   • The repurchase temporarily stabilises share prices by removing uncertainty associated with the takeover threat.

Disadvantages of Greenmail

While greenmail may temporarily protect management control, it carries several negative consequences:

1. Financial Loss:
   • The company pays a high premium, leading to reduced profits and depletion of shareholder value.
2. Unfair to Other Shareholders:
   • The premium is paid only to the raider, disadvantaging ordinary shareholders who receive no such benefit.
3. Encourages Predatory Tactics:
   • Success of one greenmail attempt may attract other opportunistic investors.
4. Damage to Reputation:
   • The company’s willingness to succumb to greenmail can reflect weak management and poor governance.
5. Conflict of Interest:
   • Management may prioritise self-preservation over shareholders’ best interests.

Greenmail vs. Takeover

Defensive Measures Against Greenmail

To prevent such coercive tactics, companies may adopt various anti-greenmail strategies:

1. Standstill Agreements:
   • The investor agrees not to buy additional shares or pursue a takeover for a specified period in exchange for compensation.
2. Anti-Greenmail Provisions:
   • Corporate charters or shareholder agreements prohibit selective share repurchases at a premium.
3. Poison Pills:
   • Issuing new shares or rights to existing shareholders to dilute the raider’s ownership and make takeovers more expensive.
4. White Knight Strategy:
   • Seeking a friendly investor or company to counter the hostile bidder.
5. Regulatory Oversight:
   • Many jurisdictions have introduced disclosure and taxation rules to discourage greenmail.

Legal and Regulatory Aspects

• In the United States, greenmail gained notoriety during the 1980s corporate raider era, involving financiers such as Carl Icahn and T. Boone Pickens.
• To discourage the practice, U.S. tax reforms such as the Internal Revenue Code Section 5881 (1987) imposed a 50% excise tax on greenmail profits.
• The Securities and Exchange Commission (SEC) also strengthened disclosure requirements under the Williams Act, mandating investors to disclose ownership exceeding 5%.