What is the Scorched-Earth Defense?

The scorched-earth defense is employed by a takeover target to reduce its attractiveness to a hostile bidder. The name comes from a military application, where a country being invaded would destroy its farmland and homes, so that an invading force could not live off the land.

Scorched-Earth Tactics

There are several tactics that may be used to construct a scorched earth defense against a hostile acquirer. Some of the more common tactics are as follows:

Acquire another business. The target company could conduct its own acquisition, buying another business that the hostile acquirer does not want. A further advantage of this approach is that the target company can take on debt to fund the acquisition, which the hostile acquirer will need to pay off.
Sell assets. The target company can sell off its most valuable assets in order to reduce its value. If enough assets are sold, the hostile acquirer will have no further reason to buy the firm.
Take on debt. The target company may take on a substantial amount of debt, or add a clause to its debt repayment schedules, mandating that the debt be paid in full immediately after a hostile takeover. This would require the hostile acquirer to come up with a substantial amount of cash to pay off the debt.

By taking these actions, the target company hopes to remain independent.

Disadvantages of the Scorched-Earth Defense

Even when the scorched-earth defense succeeds, it may seriously impair the long-term competitiveness and earning ability of the target company, which reduces the value of the business for its shareholders. A possible outcome is that the company eventually goes bankrupt, or is later sold off at a reduced price.