Dead Hand Provision

An an anti-takeover method in which additional shares are issued to everyone except the hostile bidder trying to purchase the firm

A dead hand provision is an anti-takeover method in which additional shares are issued to everyone except the hostile bidder trying to purchase the firm. It helps to dilute the value of the shares previously acquired by the acquirer. 

Dead Hand Provision

A dead hand provision, sometimes known as a dead hand poison pill, is used by a target corporation to resist hostile takeover attempts.

Once the hostile acquirer has acquired a specific number of shares, fresh ones are immediately granted to every other existing shareholder, causing the aspiring owner's stock holdings, or percentage of ownership in the firm, to be severely diluted.

The action dilutes the acquirer's stake, making the takeover effort unappealing and costly. To invalidate the poison pill and proceed with the takeover, the acquirer can either seek judicial intervention or launch a proxy to elect a new board of directors.

To do this, the board of directors adopts a poison pill that the current management can only redeem. Any succeeding board of directors cannot invalidate the pill.These safeguards kick in when the hostile bidder purchases a certain percentage of the target company's stock, often between 15% and 20%. 

Company's Stocks

The target firm issues many additional shares, and the bidder's stock holdings are diluted as stock is issued to all other shareholders except the bidder.

When a firm realizes that the unwanted acquirer has bought enough of its shares from the secondary market, it issues new shares in large quantities, causing the shares acquired by the unwanted acquirer to be enormously diluted. 

Understanding the Dead Hand Provision (DHP)

It is like when you sleep incorrectly and cut off circulation to your hand, and when you wake up, you can't feel or move it and have to flop it around like dead weight until the blood returns. Hand. Dead. 

Dead Hand on Finance

In financial terms, picture something similar happening to your stock's voting power. It suddenly becomes nearly unusable. That's a dead hand clause. For example, your vote doesn't mean much if something awful happens.

Acquisitions are a vital part of a normal business cycle where companies that are not doing well tend to look for a better company to acquire and save the business.

It permits present executives to keep their jobs, receive salaries, and access additional cash via the acquisition amount. However, some organizations that are fundamentally strong and wish to grow to try to buy direct competitors.

When such target firms refuse the purchase offer, a hostile takeover may be launched. Although aggressive takeovers are discouraged, purchasing shares on the secondary market is entirely lawful. 

If a firm rejects an acquirer, it may utilize the secondary market route to purchase enough shares to have a major position in the company and influence its decision-making.

Buying stocks

If hostile takeover offers are made, a company's management may choose to deploy controversial techniques such as the poison pill, the crown-jewel defense, or a golden parachute to protect its position. 

These methods differ in type, but they all have one thing in common: they are meant to discourage buyers by making the acquisition less appealing. Like other poison pills, a dead hand clause serves to make an aggressive takeover prohibitively costly. 

When a hostile bidder purchases a certain percentage of the target company's shares, often between 15% and 20%, new stock is issued, allowing only eligible members of the Board of Directors to purchase these recent issued shares at discounted rates.

Board of Directors

The dead hand clause would make a bidder's takeover attempts prohibitively expensive. In addition, the action bans shareholders or a freshly elected board of directors from accepting hostile acquisition proposals. 

In the event of a normal poison pill, the defensive mechanism can be circumvented if a hostile bidder starts a proxy contest demanding that a new board of directors is elected in a target business.

However, dead hand measures can also protect against replacing the present board of directors. In some instances, dead hand poison pills have been challenged because of the controversy surrounding their use.

Effects of DHP

Most firms that use poison pills can avoid hostile takeover attempts, allowing them to preserve their independence.

Poison Pills

Here are some of the consequences of the dead hand provision on businesses:

1. Used as a negotiating tool.

In some instances, the dead hand poison pill is employed as a negotiation weapon to obtain the best conditions from bidders. 

By incorporating a clause that grants incumbent directors the ability to redeem the pill, management's negotiating position is enhanced, and freshly elected directors cannot override them. 

In the absence of a poison pill, shareholders would elect a new board of directors to approve any transactions that increase shareholder value

In a corporate climate where opportunistic bidders start hostile takeover offers against struggling or undervalued enterprises, management may also employ the dead hand clause to exert control over the company's destiny.

Business Struggle

2. Protect the shareholders

Since the board of directors activates the dead hand clause, they can utilize the proposal to abuse their position and ensure their term is prolonged even if the shareholders disagree.

 As a result, active shareholders may request to adopt the DHP clause before the board of directors may begin the procedure. This improves the protection of shareholder interests.

The clause is coercive since it requires shareholders to keep the current directors even if they want to be represented by a new board.

In certain cases, activist shareholders attempt to prevent such an abuse of power by introducing a motion requiring shareholder approval before the board of directors may put a new poison pill in the corporate charter.

If implemented, such a strategy would protect the company's independence while preventing deteriorating productivity and inefficiencies caused by poor management.

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Example of Dead Hand Provision

A business called XYZ is attempting to buy a company called PQR through a hostile takeover procedure. It purchases 1,00,000 shares at the present price of USD $50, accounting for 10% of the firm. 

Business meeting

PQR, on the other hand, does not want XYZ to purchase but cannot prevent XYZ from purchasing its secondary market shares. As a result, it is aware that XYZ will own 10% of the firm, entitling it to voting rights and influence over corporate decision-making. 

PQR utilizes the DHP tactic to block the hostile acquisition and issues 1,000,000 additional shares, increasing the company's total outstanding shares. Since supply has grown while demand has remained constant, the share price falls, and the voting power of each share is diluted.

If XYZ wishes to reclaim 10% voting power, it must purchase 100,000 additional shares, which is costly. Because XYZ will not want to invest extra money to maintain the same ownership, the hostile takeover plan fails, allowing PQR to escape the hostile takeover.

Criticism of a Dead Hand Provision

A normal poison pill can be defeated by conducting a proxy contest and electing a new board of directors to revoke it. However, that is not the case with DHPs.

Shareholders

DHP in shareholder rights plans prevents anybody other than the directors who enacted them from canceling them. 

In other words, current directors can prohibit an unsolicited offer from being accepted, regardless of the shareholders' intentions or the opinions of the newly elected directors.

Placing this authority in the hands of the present board of directors has sparked many debates. 

The dead hand clause can be used to extend the term of incompetent and undesirable directors and to prevent the majority of voting shareholders from having a voice in whether an acquisition should proceed or not.

Such discoveries have led to the legalization of dead hand poison pills in various jurisdictions, notably the popular business-friendly state of Delaware.

The Delaware Supreme Court determined in 1998 that dead-hand redemption clauses in stockholder rights agreements are unconstitutional defensive measures because they disenfranchise stockholders unjustly.

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Researched and authored by Jash Shah | LinkedIn

Reviewed and edited by James Fazeli-Sinaki | LinkedIn

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