Dead Hands-Poison Catalyst or Strength-Enhancing Megavitamin? An Analysis of the Benefits of Managerial Protection and the Detriments of Judicial Interference

Monday, January 1st, 2001 at 12:00 am by Mark Klock
Mark Klock, Dead Hands-Poison Catalyst or Strength-Enhancing Megavitamin? An Analysis of the Benefits of Managerial Protection and the Detriments of Judicial Interference, 2001 Colum. Bus. L. Rev. 67

The addition of dead hand provisions to poison pills is a fairly recent development which is spreading. Dead hand provisions defend against the aggressive hostile corporate takeover tactic of combining a proxy fight with a tender offer by creating a poison pill which can only be redeemed by continuing directors. Thus, ousted directors can continue to exert control with their ‘dead hands.‘ The dead hand defense can significantly strengthen management’s ability and incentives to maximize shareholder welfare, but critics argue that such a defense poisons shareholder protection.

The wave of hostile takeovers and attempts which occurred in the 1980’s resulted in the widespread adoption of many takeover defenses as well as much anti-takeover legislation at the state level. These events resulted in a great deal of debate about the legality and desirability of these developments. While much has previously been written on the topic, there are two reasons why more analysis is desirable. First, dead hand provisions in poison pills and their variations have resulted in a new wave of commentary. This wave has not yet crested as appellate courts have yet to decide a case involving dead hand pills, and the trial courts in different states continue to handle these provisions differently. Thus, important opinions expanding or contracting shareholders’ rights to tenure managers still are inevitable.

Second, the analysis to date has tended to be unbalanced and based on static models which are slanted in one direction or another. The analysis presented here is based on a dynamic model which incorporates complex responses to changes in rules and provides a policy prescription which recognizes that pills can serve different purposes in different enterprises and that courts can not and should not police the appropriateness of pill defenses. Essentially, the view presented is that the explanations given for poison pills are not mutually exclusive, but the appropriate policy prescription in any case–accounting for dynamic effects–is for minimal judicial interference with poison pills and, absent fraud or theft, deference to the business judgment rule.

The first contribution of this article is to bring relevant and modern economic theory pertaining to employment contracts into the debate over dead hand poison pills. This literature offers several insights as to why shareholders can benefit from granting tenure to management. Indeed, empirical evidence complementing the theory suggests that shareholders have not been injured by the development of potent takeover defenses. The second contribution is to offer insights as to how enhanced scrutiny of these provisions by courts can be harmful.

A simple summary of the polar viewpoints over poison pills–and the recent dead hand embellishment–is that one camp considers these devices to be management entrenching tools which work against shareholder wealth maximization, while the other camp considers these devices to be a lever which management can use to better protect shareholder interests (or alternatively to protect nonshareholder corporate constituencies).

In a recent twist, one commentator brought modern portfolio theory from the field of finance into the debate to support dead hand provisions in poison pills with the argument that shareholders can diversify away the risk associated with adoption of a dead hand poison pill. While it is true that finance theory provides some support for the commentator’s argument, the argument is too simplistic. If dead hand provisions serve solely to entrench shirking managers, and all boards adopt them, then investors cannot diversify away the ill-effects. The analysis provided in this Article explains the beneficial effects of dead hand provisions, and further explains why improper dead hand provisions are not likely to become widespread and why courts should not second-guess the motives underlying them. The cornerstone of the analysis is drawn from the economics literature on optimal contracting.

Author Information

Professor of Finance, The George Washington University