Dead Hand Provision

What Is a Dead Hand Provision?

A dead hand provision, also known as a dead hand poison pill, is a strategy utilized by a target company to ward off the advances of a hostile takeover. Once a certain number of shares have been purchased by the unwanted acquirer, new ones are automatically issued to every other existing shareholder, leading the aspiring owner’s stock holdings, or percentage of ownership in the company, to become massively diluted.

Understanding a Dead Hand Provision

Acquisitions happen all the time, although not all of them are welcomed by company management. Sometimes the board of directors (B of D), those calling the shots, will reject an offer to be bought out. When faced with resistance, the interested party could either give up and move on or go directly to the company's shareholders to drum up enough support to replace management and potentially get the acquisition approved.

Should takeover advances turn hostile, a company's management might opt to employ controversial strategies, such as the poison pill, the crown-jewel defense, or a golden parachute, to safeguard its position. These measures vary in nature but all have one thing in common: Each of them is designed to put off the buyer by making the acquisition less attractive.

Like other poison pills, the job of a dead hand provision is to make the hostile takeover prohibitively expensive. Once a hostile bidder acquires a designated amount of the target company’s shares, typically between 15% to 20%, the dead hand provision kicks in, allowing only eligible members of the Board of Directors to buy newly issued shares at reduced prices.

A dead hand provision can be used to completely thwart the advances of a predator or, in other cases, as a bargaining tool to drive up the price of the acquisition. In the latter instance, it becomes a negotiation tool.

Suddenly, the stock held by the acquirer becomes less influential. Flooding the market with new shares dilutes the value of the shares it already purchased, reducing its percentage of ownership and making it harder and more costly to gain control.

Criticism of a Dead Hand Provision

A hostile bidder can overcome a regular poison pill by launching a proxy contest and then electing a new board of directors to redeem it. That’s not the case with dead hand provisions.

Dead hand provisions in shareholder rights plans bar anyone but the directors who adopted them from rescinding them. In other words, that means existing directors can prevent the acceptance of an unsolicited offer, regardless of the shareholders’ wishes or the views of the newly elected directors.

Placing all this power in the hands of the current board of directors has, perhaps understandably, generated a lot of controversies. The dead hand provision can serve as a way to prolong the tenure of unfit and unwanted directors, as well as prevent the majority of voting shareholders from having a say in whether they want an acquisition to go ahead or not.

Such observations have led dead hand poison pills to be challenged in some jurisdictions, including in the popular business-friendly state of Delaware. In 1998, the Delaware Supreme Court ruled that dead-hand redemption provisions in stockholder rights plans are invalid defensive measures because they unfairly disenfranchise shareholders.