What Is Greenmail and How Does It Work in Finance?
Explore greenmail, a controversial financial maneuver where companies pay to deter unwanted corporate control.
Greenmail is a financial maneuver in corporate finance where a target company repurchases its own shares from a specific shareholder at a premium price. This defensive strategy aims to prevent an unwelcome takeover bid or to protect existing management and corporate control from external challenges.
What is Greenmail
Greenmail involves a company paying a premium to a corporate raider to halt a hostile takeover attempt. This payment acts as an incentive for the raider to abandon their bid and often includes an agreement not to acquire further shares for a specified period. The core concept involves the target company buying back its stock at a price significantly above the current market value, removing the threat posed by the large shareholder.
The term “greenmail” combines “greenback” and “blackmail,” highlighting the transaction’s coercive nature. This financial tactic became particularly frequent and controversial during the 1980s, an era marked by intense merger and acquisition activity.
How Greenmail Transactions Operate
A greenmail transaction begins when a corporate raider, also known as the “greenmailer,” accumulates a substantial stake in a target company’s stock. Once a significant position is established, the raider signals or explicitly threatens a hostile takeover, or seeks to influence management through their considerable ownership.
Following this threat, a negotiation phase commences between the target company’s management and the corporate raider. The process concludes with the target company agreeing to repurchase the raider’s shares at a price substantially higher than the prevailing market value.
Key Participants in Greenmail
The primary parties involved in a greenmail scenario are the greenmailer, the target company, and other shareholders.
The Greenmailer
The “greenmailer” is a corporate raider or an activist investor who acquires a significant block of shares in a company. This individual or entity aims to either take over the company or pressure management into buying back their shares at a premium. Their motivation is often to profit from the substantial premium paid for their shares.
The Target Company
The “target company” is the corporation whose shares are being accumulated and whose management is defending against the potential takeover. Management initiates the greenmail payment to prevent a change in control and to protect their positions. This involves using company funds to repurchase shares, which impacts the company’s cash reserves and balance sheet.
Other Shareholders
Other shareholders, those not involved in the greenmail transaction, are also impacted. They do not receive the premium price for their shares that the greenmailer does. This can lead to a perceived inequity, as the company’s funds are used to benefit a single large shareholder, potentially at the expense of other investors. The financial strain from the repurchase can also affect the company’s ability to invest in growth or pay dividends to other shareholders.
Legal and Ethical Perspectives
Greenmail is not illegal under federal law, though it is a controversial practice. However, certain state corporate governance rules and regulations may impose restrictions on share repurchases. For example, some state laws require that premium share repurchases be approved by the board of directors and sometimes by a majority of shareholders, excluding the greenmailer. These laws aim to ensure repurchases are made for a legitimate business purpose and do not solely benefit management at the expense of broader shareholder interests.
A significant legal deterrent to greenmail in the United States is the federal excise tax. In 1987, the Internal Revenue Service (IRS) introduced an excise tax equal to 50% of any gain or income received from greenmail. This substantial tax aims to reduce the profitability of greenmail transactions.
Ethically, greenmail is widely debated. Critics often view it as a form of corporate extortion, where a raider profits by threatening a company, providing no value in return. This prioritizes short-term gains for the raider over the company’s long-term health and value creation. However, some argue it can be a legitimate market tactic, allowing investors to pressure management to improve company performance or unlock undervalued assets.