DEFINITION of 'Scorched Earth Policy'
A takeover prevention strategy in which the target company seeks to make itself less attractive to hostile bidders by selling off assets, taking on high levels of debt or initiating other activities that may damage the company if it is purchased. In extreme cases, a scorched earth policy might end up being a “suicide pill.”
BREAKING DOWN 'Scorched Earth Policy'
Companies using a scorched earth policy are engaging in a last ditch effort. The policy is similar to how a retreating army may destroy crops and infrastructure to prevent their use by invaders. If the target company goes through with selling off important assets, it may wind up unable to recover if a hostile takeover falls through. Rather than sell assets or take on debt today, the company may instead enact provisions that provide senior management with substantial payouts, such as golden parachutes, if a new management team is brought on.
If a takeover is imminent, the board of directors may not be able to go through with a scorched earth policy if it is not in the best interest of shareholders. The hostile company may look for an injunction against the board’s activities, and in some jurisdictions may be able to prevent the board from stopping the takeover bid. For example, a steel company may threaten to purchase a manufacturer embroiled in lawsuits from making poor quality parts. In this case, the target company is purchasing the future liabilities associated with any lawsuit settlement.