TLDR:
A poison pill is a shareholder rights plan that makes a hostile takeover prohibitively expensive by allowing existing shareholders (except the acquirer) to buy additional shares at a discount when a large stake is acquired.
Poison Pill Evolution
The rights plan (poison pill) has evolved significantly since its invention by lawyer Martin Lipton in 1982. Early pills were designed to be permanent defenses; modern institutional investor norms have pushed boards toward time-limited pills (typically 1-3 years) that require shareholder reauthorization to continue. ‘Selective’ or ‘grandfathered’ poison pills can discriminate between shareholders — allowing a specific beneficial owner to hold above the trigger threshold while the pill remains in effect for other acquirers.
Proxy advisory firms have significant influence on shareholder votes regarding poison pill adoption and renewal. ISS and Glass Lewis’s poison pill guidelines set de facto governance standards that most large US public companies follow. For public company boards adopting pills in response to a specific takeover threat, obtaining a legal opinion on the pill’s validity, conducting a proper process for adoption, and preparing to defend the pill’s business justification to shareholders are all essential steps.
Poison Pill Variants
Common poison pill structures include: flip-in plans (existing shareholders other than the acquirer can buy shares at deep discount once a triggering threshold is crossed), flip-over plans (similar mechanism activated upon a back-end merger), dead-hand pills (only current directors can remove the pill, blocking acquirer-installed boards), and chewable pills (automatically expire under specified conditions). Most US public companies maintain “shelf” pills that can be deployed quickly in response to hostile bids. Pills have been controversial — proxy advisors generally recommend against them as entrenchment devices — but Delaware courts have upheld reasonably-tailored pills as valid defensive measures.