What is a Scorched Earth Policy
A scorched earth policy is a strategy to prevent a takeover in which the target company seeks to make itself less attractive to hostile bidders. Tactics include selling off assets, taking on high levels of debt, and 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
The term has a military origin and describes a strategy in which a retreating army destroys crops and infrastructure to prevent their use by their attackers. Companies using a scorched earth policy are engaging in a last-ditch effort, and if the target company goes through with selling off important assets, it may wind up unable to recover if a hostile takeover falls through. As an alternative to selling assets or taking on debt, a company may instead enact provisions that provide senior management with substantial payouts, such as golden parachutes, if a new management team is brought on.
Scorched earth policies may not always be possible. The hostile company may seek an injunction against the company's defensive actions, and 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 for making poor quality parts. In this case, the target company would be seeking to purchase the future liabilities associated with any lawsuit settlement in an effort to burden the new, combined company with those liabilities, making it unattractive to hostile bidders. But a hostile bidder may be able to secure a court injunction to stop this acquisition.