Scorched Earth Policy - Explained
What is a Scorched Earth Policy?
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What is a Scorched-Earth Policy?
Scorched earth policy is a termed derived from military language which refers to an act by retreating soldiers where they focused on destroying crops and plants to prevent the attackers from getting enough resources to survive in the pursuit. In business management, scorched earth policy also takes the same form, but there's no crop in this case. Rather, a firm that is on the verge of an acquisition or takeover does everything within its power to incur bad debts and spoil its image, so that it'd be less attractive to hostile bidders. For this to happen, target firms will be willing to sell off machinery and other assets, as well as engage in bad credits which could cause a hole in the pocket of any acquirer. In some cases, a scorched earth policy might reach the point of a suicide pill.
Back To: BUSINESS ENTITIES, CORPORATE GOVERNANCE, & OWNERSHIP
How is a Scorched Earth Policy Used?
Like we stated before, the scorched earth policy has military origins, and it has become the last line of defense for firms that want to resist hostile bidders and acquisition. However, the target company should be careful when plotting the possible steps to take to look unattractive, as they might suffer a substantial irreversible loss if the acquisition doesn't occur anymore. To avoid the possibility of this loss, firms have now decided to make provisions that will increase CEOs salaries well beyond normal if new management were to be enacted. This way, they wouldn't lose anything if a takeover fails to occur. Just like other business policies, there is a chance that a scorched earth policy might fail. This mostly occurs if the hostile bidder or acquirer seeks injunction over the targets defensive actions, as this injunction can prevent the board members of the target firm unable to stall or reject takeovers. Let us illustrate this using the furniture industry. Now, let us imagine that Firm CSX threatens to sue Firm D, who is their primary manufacturer of nails and nuts. Now, if Firm D creates low-quality materials, CSX might choose to acquire it to improve the potentials of the firm. Using the scorched earth policy, the target firm (Firm D) will look for different liabilities to incur so as to make itself undesirable to CSX. To prevent this, though, CSX might obtain a court order which prevents the target firm from incurring liability or making any absurd investment.
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