Speaking of tactics that managers use thwart shareholder activists –

Sean Griffith and Natalia Reisel have posted a new paper to SSRN, Dead Hand Proxy Puts, Hedge Fund Activism, and the Cost of Capital, analyzing the effects of dead hand proxy puts.  These are loan covenants that allow the lender to require complete loan repayment in the event of a change of control that results from an actual or threatened proxy contest, and that cannot be waived by the borrower – i.e., the incumbent directors cannot settle with the dissident, give their blessing to the new directors, and thereby avoid the provisions (the “dead hand”).

Now my instinct on these provisions has always been that they improperly interfere with shareholder suffrage by insulating the incumbent board from the market for corporate control.  I wondered whether these provisions were in fact valued by lenders, or whether they were inserted at the behest of management to protect themselves from challenge, with lender acquiescence/indifference.

But the authors find that these provisions do, in fact, have value to lenders – and thus to corporations.  They are more likely to be adopted by firms that are potential targets of shareholder activists (unsurprising), and, critically, they lower the cost of the firm’s debt. 

The authors also find that though the provisions tend to be found in loan agreements – where they can be easily waived or modified if the lenders believe a change of control will not imperil the loan – their presence may be valued by bondholders, who cannot use such provisions as easily because it is more difficult for them to overcome collective action problems to modify them later.  (Question: is it likely activists would bargain with the lenders in advance, and make the lenders’ endorsement part of their platform when soliciting shareholders?  Is that a thing activists do?  I admit my ignorance.  If not – if the activist intends to bargain after gaining control – that would be a helluva risk for shareholders to take.) 

In any event, the upshot appears to be, directors can preempt a proxy fight and increase corporate value by adopting this kind of financial technology, which is different than the financial technology that activists would likely adopt, but – unlike typical activist tactics – benefits both shareholders and creditors.  

The critical question, then, is whether the value to shareholders generated by these provisions is equal to the value that would be generated by a shareholder activist.   The authors state that they will analyze this question in connection with an upcoming paper – and I look forward to seeing what they come up with.