What is Dead Hand Provision?

Key Highlights

• A dead-hand provision is a strategy for blocking takeovers by giving new shares to everyone except the hostile bidder who wants to buy the company.
• The value of shares that the acquirer already owns is diluted, and its percentage of ownership is reduced, making it more expensive to take over.
• Management cannot prohibit dead hand provisions because they can only be revoked by the approved board.

Understanding Dead Hand Provision Meaning

A dead-hand provision is a method businesses employ to respond to another that has started acquiring the former in a hostile manner. A dead hand provision and a requirement for new shares to be issued on the market is also a deadly poison pill. When a company knows that an unwanted acquirer has acquired enough of its shares from the secondary market, it issues new shares in a high volume, which dilutes the shares acquired by the unwanted acquirer. As a result of dilution, its holding in the unwanted acquirer will decrease below the specified amount so that it cannot obtain the company.

A dead-hand provision would make a takeover bid prohibitively expensive for the interested parties. This prevents potential acquirers from submitting an offer directly to shareholders or a newly elected board of directors. This would require the shareholders to retain their current management since it is they who can regain a poison pill.

Example of Dead Hand Provision

Using the hostile takeover procedure, a company called XYZ is trying to acquire a company called PQR. It's buying 1,00,000 shares at the current price of Rs. 500, which is 10% of the company. PQR has no intention of having XYZ acquire it but cannot prohibit its secondary market shares from being acquired. Therefore, it knew that XYZ had a 10% holding in the company and could exercise its voting rights and have an effect on the board's decisions.

PQR issues 1,000,000 new shares, bringing the company's total outstanding shares to 1,000,000 in an attempt to prevent a hostile acquisition. This is done by using the dead-hand provision approach. As the supply increases and demand remains the same, the share price falls. Now, if XYZ wants to get back to 10%, it's going to have to buy another 1,00,000 shares, which is going to be expensive. The hostile takeover plan fails, allowing PQR to avoid the hostile takeover because XYZ will not spend more to maintain the same ownership.

Effects of Dead Hand Provision

Most firms with poison pills tend to avoid hostile takeover bids, helping them maintain their independence. Below are some of the effects of Dead Hand Poison pills on enterprises.

1. Use as bargaining instruments

The dead hand poison pill is occasionally used to negotiate to obtain the best conditions from bidders. The management's negotiating position is strengthened, and freshly elected directors cannot override them, mainly due to the inclusion of a pill that grants the current directors the ability to redeem it. The shareholders could elect a new board of directors, approving any deal that increases the shareholder value, if no poison pill were available. In a business environment where opportunistic acquirers initiate hostile takeover bids against failing or undercapitalised companies, management may also use dead hands to manage the company's future.

2. The shareholders' approval before the poison pill can be activated

In most cases, directors abuse the poison pill by using it in order to extend their terms even when a majority of shareholders do not like them. The provision constitutes coercion because it requires shareholders to keep the existing board members despite their wishes that a new board be set up that would have all its statutory powers and act in the best interest of those shareholders.

Activist shareholders are attempting to prevent this abuse of power by submitting proposals requiring shareholder approval before the board is able to put a new poison pill into the company's charter. This proposal would ensure that the company remains independent and avoid a decline in productivity and inefficiencies caused by poor management if implemented.

Conclusion

The provision of dead hands, which ensures that an unwanted entity does not acquire a company, is considered to be the crown jewel of the business world. It guarantees that the acquisition is carried out in accordance with ideal and agreed-upon terms, giving maximum control to the company. In addition, shareholders are protected from the Board of Directors, which may abuse its powers for their benefit. In essence, the dead-hand provision is a controversial and ideal business strategy that enables companies to remain in control under worst-case scenarios.