What is a Scorched Earth Policy?
A scorched earth policy is a series of actions taken by a business to discourage hostile takeover attempts. The goal is to make the company less appealing as a takeover target, but it may serve to end the business entirely if the scorched earth actions taken are severe enough.
In war, scorching the earth is a tactic used when retreating in which anything useful is destroyed as the retreating army moves through. The intention is to ensure the conquerors have little to no resources left to work with once they arrive on scene.
In business, the tactic is used in similar ways. A company that is being targeted for takeover may pile up debt, sell off valuable assets, and give management substantial severance package contracts.
Common scorched earth tactics
While tactics may vary somewhat, the most common approach is to employ tactics that make the company as unattractive to takeover as possible. Below are a few common scorched earth tactics a company may employ:
- Loading up on debt: By taking on extensive amounts of debt, the targeted company can make a takeover much less appealing. This tactic can have much more impact if the massive new debt is due soon after the expected takeover.
- Selling prized assets: When a takeover is happening primarily due to specific assets the company owns, selling those items often creates an immediate loss of appeal.
- Terminating valuable contracts: By terminating valuable contracts with management, contractors, or suppliers, the company may be able to reduce its appeal for takeover.
- Setting up lucrative severance packages: Often when new owners take over a company, they replace the existing management team with their own. If the targeted company sets up lucrative severance packages for those employees, it can deter the takeover by making it too costly for the new owners to cover.
Potential problems arising from a scorched earth policy
When a company decides to use scorched earth policy tactics, there are two potential outcomes, each with their own problems:
- They can successfully thwart the takeover
- They can still be taken over
If the company succeeds and thwarts the takeover attempt, it retains full ownership and control as it desired. Unfortunately, if the tactics used were extreme enough, they may have caused the company more problems than it is able to recover from.
If a publishing company sold the intellectual rights to its entire archives, for instance, and it was a major revenue stream for the company, it may not be able to replace that revenue soon enough to prevent bankruptcy. Likewise, if a retail chain severed ties with its most popular manufacturer, that company may have signed a new contract that prevents them from renewing those previous ties.
The second scenario is possible as well. The hostile takeover may move forward as planned despite all of the scorched earth tactics undertaken. The acquiring party may still want the company anyway. If they believe there is still enough value, or even if they simply desire to, the takeover may still happen despite the targeted company’s efforts.
Scorched earth policy tactics are extreme and often seen as a suicide move. Sometimes the hostile bidder is able to stop more extreme moves via a court order, and sometimes they simply stop attempting the acquisition.
When not prevented and taken to the extreme, some companies can never recover — whether the takeover succeeds or not. There are some companies, however, that have successfully enacted scorched earth policies and, with diligence and luck, recovered in the end.