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In today’s startup culture, establishing a new business is straightforward, thanks to the simple qualifying and documentation criteria set by the government. But staying afloat in the market with growing competition is difficult. Even if the newly launched company or any vintage business is doing well in the market and meeting customers’ expectations, chances are high that some giant company from the same domain will try to acquire it to lower the competition or maintain a market monopoly.
Companies often use different anti-takeover measures to ward off such scenarios. One of the many mechanisms available is the dead hand provision. Let’s learn about this actionable measure in detail.
What is Dead Hand Provision?
A dead-hand provision is a defensive strategy that a company uses to protect its business from hostile takeovers. This provision activates when an unwanted bidder attempts to acquire a significant portion of the company’s shares, typically between 15% and 20%.
Once triggered, the provision allows the issuance of new shares to all shareholders except the hostile bidder. This dilutes the acquirer’s stake and makes gaining control of the company more expensive and challenging.
The term ‘dead hand’ signifies that only the directors who put the provision in place can revoke it. It cannot be undone by any new directors who may come into power after a takeover bid succeeds. This makes it particularly difficult for the acquirer to remove the provision by electing a new board through a proxy fight.
Dead Hand Provision Example
Suppose there is a company named AquaPure. It specialises in water purification technology. AquaPure has been performing well, but a larger competitor, HydroHealth, sees an opportunity to expand its market share by acquiring it.
HydroHealth starts buying AquaPure’s shares in the open market to proceed with a hostile takeover. To defend itself, AquaPure’s board implements a dead-hand provision. This provision allows the current board to issue new shares at a discount.
If HydroHealth acquires 15% of AquaPure’s shares, the provision triggers, and all shareholders except HydroHealth can buy new shares at half the price. This move diluted HydroHealth’s stake and made the takeover bid more expensive and less attractive.
HydroHealth now faces a dilemma. It can either abandon the takeover attempt or fight a costly legal battle to remove the dead-hand provision. Meanwhile, AquaPure’s shareholders are in a tight spot. They cannot elect a new board that could negotiate better terms or remove the provision because only the current board has that power.
This situation creates tension between shareholder rights and management’s desire to fend off takeovers. While the dead hand provision protects AquaPure from immediate threats, it also limits shareholders’ ability to make decisions that could enhance the company’s value.
Dead Hand Provision Effects
While dead-hand provisions can effectively maintain current management, they have several downsides. Here are some:
1. Shareholder Disempowerment
Deadhand provisions can significantly limit shareholder rights. By preventing new directors from rescinding the provision, shareholders are stuck with the current board, even if they prefer a change in management.
2. Inhibits Positive Change
These provisions can block takeovers that benefit the company and its shareholders. A potential acquirer might have the resources and strategies to improve company performance, but a dead-hand provision can halt such opportunities.
3. Legal Challenges
Dead hand provisions often face legal scrutiny. Courts may view them as excessively entrenching current management and not in the best interests of shareholders. The result is costly and time-consuming litigation.
4. Market Skepticism
The market may react negatively to implementing a dead-hand provision. They may see it as a sign of weakness or fear of competition. This can lead to a decrease in stock prices.
5. Reduces Negotiation Power
While intended to be a defence mechanism, these provisions can actually weaken a company’s position in negotiations by signalling that the company is not open to any takeover attempts, even friendly ones.
What are Some Other Anti-Takeover Measures?
Similar to dead-hand provision, other anti-takeover measures are detailed below.
- Golden Parachutes: The target company guarantees attractive benefits to executives who lose their jobs due to a takeover, making the acquisition more costly.
- Staggered Board: This strategy involves having different classes of directors with staggered terms. It makes it difficult for an acquiring company to gain board control quickly.
- Shark Repellents: The target company makes amendments to its charter or bylaws designed to make it less attractive to potential acquirers.
- White Knight: A friendly company that offers to acquire the target company on more favourable terms than the hostile bidder.
- Pac-Man Defense: The target company turns the tables by attempting to acquire the hostile bidder.
- Crown Jewels: The company sells its most valuable assets to reduce its attractiveness to a potential acquirer.
- Leveraged Recapitalisation: The company increases its debt to fund special dividends or share buybacks, reducing its attractiveness.
- Greenmail: The company buys back shares at a premium from a potential acquirer, often with the agreement that they will not pursue the takeover.
- Dual-Class Stock Structure: The company issues different classes of stock with varying voting rights to maintain control within a select group.
- Standstill Agreements: Under this, the potential acquirer agrees to limit its holdings in the target company for a specified period.
Conclusion
A dead-hand provision is a defensive tactic companies use to thwart hostile takeovers. When triggered, it allows the issuing of new shares, diluting the hostile bidder’s stake. Once in place, the provision can only be removed by the current directors, making it hard for new management to undo it.
While it shields companies from immediate threats, it can disempower shareholders, inhibit positive change, spark legal battles, create market uncertainty, and weaken negotiation power. Therefore, while offering protection, dead-hand provisions have significant drawbacks that companies and shareholders must consider carefully.
Frequently Asked Questions
A Dead Hand Provision is an anti-takeover strategy where a company issues new shares to all shareholders except the hostile bidder. This dilutes the bidder’s ownership and makes a takeover more difficult and expensive.
Critics of the Dead Hand Provision argue that it entrenches current management, potentially disenfranchises shareholders, and can prevent beneficial takeover offers. It is seen as a coercive tactic that may limit shareholder rights and harm shareholder value by blocking unsolicited offers irrespective of shareholder preferences.
Yes, hostile bidders can challenge it legally or win a proxy fight to elect a new board that can redeem the provision.
It is termed ‘Dead Hand’ because it can only be revoked by the directors who implemented it, not by any subsequent board.
They are not as common as other anti-takeover measures due to the controversy and legal scrutiny they attract. However, many companies still use it as a defence strategy.