Greenmail

GREENMAIL IS the practice of buying back raiders' shares at a higher market price in order to block a hostile takeover. R. Edward Freeman and colleagues (1987) distinguished between the threat condition for greenmail and the compliance condition. The threat condition to the holding company consists of the greenmailer threatening to engage in a hostile takeover of a company unless the management buys back the greenmailer's stock at a premium.

The compliance condition is simply that the management is forced to buy back or repurchase greenmailer's stock holdings at a costly premium. This distinction allows us to consider the morality of greenmail under two basic heads: The criminality of the threat of greenmail, and the morality of exacting compliance.

Managers' behavior is most often dictated by career concerns. They value their esteemed positions because of the goods they can enjoy in their managerial position. Hostile takeovers are not usually favorable to the interest of labor as stakeholder, and hence it may be of considerable importance that labor have some say when defense mechanisms or greenmail payments are considered. Paying greenmail enables management to guard their interest while further providing job security, whereas other stakeholders are vulnerable to takeovers and have little means of being empowered during such attempts Therefore, there may be particular cases where an exorbitant amount is paid out to save management jobs, and the cost of making greenmail payments is absorbed by employees being given lower wages than otherwise expected.

Greenmail is one of the mechanisms used by top management teams to defend their companies against hostile takeovers. This term refers to a type of transaction in which corporations' repurchase a block of stock from a dissident stockholder declaring himself a takeover contender to top management's control position. Hostile acquisitions of a corporation amounts to a short-term tactic for immediate financial gains for the contending force. In general, making greenmail payments to the aggressing force generally causes a drop in the stock price of the repurchasing firm.

The commonly accepted theory is that paying greenmail exemplifies entrenched management protocol and harms shareholders (an example of[Page 381] agency theory). Stockholders' rights activists concerned with the adoption of corporate governance best practices have been vigorously opposed to greenmailing asserting that the process deprives the shareholders any potential of economic benefits created by a “clean” takeover.

A contradictory theory in the debate suggests the opposite effect to greenmailing outcomes. The assertion is that greenmail payments benefit shareholders by providing flexibility to management. If this theory is true, the absolute prohibition of greenmail would reduce the value of a company's stock entirely. In pursuit of a company acquisition, the action does not go un-noticed by investors, who view the takeover attempt action to designate the company shares as decreasing in value, and the undervaluing of shares creates a chain reaction leading to sharp and sudden value in the company being acquired. The resulting undervalued shares are quickly acquired by the dissident stockholder at less than fair market value. However, what stock (at the newer undervalued price) is available to the takeover entity is not also available to the other shareholders. Thus, the other shareholders, once locked out from repurchasing undervalued shares, will instead see the takeover entities receiving a significant premium above the current market price.

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