Greenmail, in the context of finance, refers to a controversial practice wherein a hostile corporate raider or an outside investor
acquires a significant stake in a target company and then threatens to launch a takeover bid. The raider or investor uses this leverage to coerce the target company's management into repurchasing their shares
at a premium, effectively buying them out at an inflated price. This practice is often seen as a form of blackmail, hence the term "greenmail."
The term "greenmail" is derived from the words "green" and "blackmail." "Green" refers to the substantial profit
or financial gain that the hostile raider or investor seeks to achieve through this strategy, while "blackmail" alludes to the coercive nature of the tactic. Greenmail is typically employed as a means to extract short-term financial gains rather than to create long-term value for the target company and its shareholders.
The process of greenmail typically unfolds as follows: First, the hostile raider or investor accumulates a significant stake in the target company's shares, often through open market
purchases or private negotiations. Once a substantial position is established, the raider approaches the target company's management and threatens to launch a takeover bid, which could potentially result in a change of control or management. This threat puts pressure on the target company's management to negotiate with the raider and find a resolution that avoids a hostile takeover
To avoid the potential disruption and uncertainty associated with a hostile takeover, the target company's management may agree to repurchase the raider's shares at a premium above their market value
. This premium compensates the raider for their investment and provides them with a quick profit. The repurchase is typically financed using the target company's own resources, which can deplete its cash reserves or increase its debt burden.
Greenmail has been widely criticized for several reasons. Firstly, it is seen as an unfair practice that allows hostile raiders or investors to profit at the expense of the target company and its shareholders. The inflated repurchase price paid to the raider represents a transfer of wealth from the target company's existing shareholders to the raider, without creating any real value for the company.
Secondly, greenmail can create a moral hazard
by incentivizing raiders to engage in short-term profit-seeking behavior rather than focusing on the long-term growth and success of the target company. This can lead to a misallocation of resources and undermine the target company's ability to invest in its future growth and development.
In response to the negative consequences associated with greenmail, regulatory authorities have implemented various measures to discourage or prevent its use. These measures include implementing stricter disclosure
requirements for large shareholders, imposing restrictions on repurchasing shares at a premium, and adopting takeover defenses such as poison pills to deter hostile takeovers.
In conclusion, greenmail is a controversial practice in finance whereby a hostile raider or investor acquires a significant stake in a target company and then coerces the company's management into repurchasing their shares at an inflated price. This practice is widely criticized for its unfairness and potential negative impact on the target company's long-term prospects. Regulatory measures have been put in place to mitigate the use of greenmail and protect the interests of shareholders and companies involved.