Why No Poison Pill in China?

By: Li Wenbo   King & Wood’s  International Trade Group

Last month, Mr. Martin Lipton, of Wachtell, Lipton, Rosen & Katz, honored King & Wood with a speech on the implications of the “poison pill” in legal practice.  Mr. Lipton is noted for hisinnovative "rights plan", a series of defensive measures taken by the board of a target company in a hostile takeover.  The “rights plan” is meant to ward off hostile offers that substantially underestimate the value of the target’s shares.  The rights plan was later referred to as the "poison pill" by Wall Street bankers whose attempts at hostile takeover below fair value were frequently frustrated by the "rights plan."

Mr. Lipton’s speech inspired me to ponder the question of how defensive measures work in China’s corporate governance.  I then googled the word "poison pill" and "company" in Chinese, but found no instances of companies utilizing the poison pill within China.  So why is there no poison pill in China?
 

In a typical tender offer, a potential disagreement or disagreement between the shareholders and the board exists.  The shareholders may be lured by the offer of an investor and therefore intend to sell their equity in the target company at the price offered by the potential acquirer.  The board may believe the offer underestimates the value of the target company and refuses to approve the offer.  Diversified ownership structure means individual shareholder(s) cannot exercise decisive influence on the board.  Such ownership structures give management more independence.  When confronted by a hostile tender offer, the board of the target company often takes defensive measures by adopting resolutions or amending the bylaws of the target company, e.g. to control the timing of special shareholder meetings, control the procedure to replace directors, or to adopt the poison pill, etc.  Some shareholders who wish to sell may file derivative actions seeking injunctive relief, e.g. to declare the defensive measure illegal.  If the derivative action fails, the potential acquirer has to raise the price, or retreat.

In a typical tender offer, a potential disagreement or disagreement between the shareholders and the board exists. The shareholders may be lured by the offer of an investor and therefore intend to sell their equity in the target company at the price offered by the potential acquirer. The board may believe the offer underestimates the value of the target company and refuses to approve the offer. Diversified ownership structure means individual shareholder(s) cannot exercise decisive influence on the board. Such ownership structures give management more independence. When confronted by a hostile tender offer, the board of the target company often takes defensive measures by adopting resolutions or amending the bylaws of the target company, e.g. to control the timing of special shareholder meetings, control the procedure to replace directors, or to adopt the poison pill, etc. Some shareholders who wish to sell may file derivative actions seeking injunctive relief, e.g. to declare the defensive measure illegal. If the derivative action fails, the potential acquirer has to raise the price, or retreat.

The above scenario typically requires the following factors to initiate a hostile tender offer: (i) diversified ownership (which frees the management from individual or several shareholders’ control), (ii) an interventionist judiciary (willing to make determinations of whether defensive measures are lawful), and (iii) a set of relatively clear rules governing director’s actions (that are applicable guidelines directors follow). From a more general perspective, flourishing privately owned enterprises and a market economy create fertile ground for hostile takeovers. Further relevant factors may be a legal environment that clearly defines corporate governance and a business culture of relatively transparent corporate governance.

n China, company ownership is rarely diversified. This difference stems from a difference in corporate structuring and checks on corporate governance. Private enterprises in China are often closely held companies, in which the shareholders have firm control of the board; while state owned enterprises are usually under the influence of administrative order. Thus directors do not serve as a “goal keeper” against hostile takeovers because the shareholders of the company will have already said “yes” to any offer. Furthermore, Chinese courts and legislators have not yet come to the question of the poison pill’s legality under Chinese law.

One explanation is an alternative deterrent to hostile takeovers in China. In lieu of the poison pill, most Chinese companies prevent hostile takeovers by using a “white knight”, i.e., another buyer who agrees to offer a higher price or better conditions. In fact, this mechanism has proven quite effective against hostile takeovers. In a Chinese limited liability company, the board has to abide by the articles of association and cannot amend the bylaws or articles of association to create a defensive measure without government approval. At the same time, the board consists of directors who represent the shareholders directly. Therefore, there is rarely a disagreement between the shareholders and the board of directors. As such, a situation that gives rise to a hostile takeover in the west does not exist to quite the same extent. However, with the development of the Chinese economy and greater flexibility in corporate governance, China may someday look to an alternative mechanism such as the poison pill.