Dead hand and no hand pills are a type of precommitment strategy. Individuals and entities use precommitment strategies all the time. In The Odyssey, for example, Homer tells a classic story of using a precommitment strategy to achieve a desired goal. Circe warned Odysseus that his course would lead him past the Sirens, whose song famously enchanted all who passed near them. Once trapped, the passerby would be warbled to death by the sweetness of their song. Following Crice’s advice, Odysseus adopted a plan by which he would be able to hear the Sirens’ song but still escape their trap. Odysseus charged his men to lash him to the mast of their boat and not to release him until they were far beyond the Sirens. Odysseus then stopped up his sailor’s ears with beeswax, so they could hear nothing. As his ship passed the Sirens, their song overwhelmed Odysseus’ will power and he tried desperately to get his men to approach the Sirens. Unable to hear the song, and thus being free of its enchantment, however, his men merely tied him even more tightly to the mast and sailed on. Only once they were safely past the Sirens did they release Odysseus.
Homer’s tale illustrates the use of a precommitment strategy to solve the problems known to behavioral economists as time inconsistent discount rates and multiple selves. The discount rate an individual applies when making net present value calculations often declines as the date of the reward recedes. Professors Korobkin and Ulen offer the following example: “Suppose that an individual is to choose between Project A, which will mature in nine years, and Project B, which will mature in ten years. Suppose, further, that an individual who compares the two projects across all their different dimensions prefers Project B to A. Now suppose that we bring the dates of maturity of the two projects forward while maintaining the one-year difference in their maturity dates. Because discount rates increase as maturity dates get closer, it is possible that the individual’s preference will switch from Project B to Project A as the dates of maturity decline (but preserving the one-year difference).” Russell B. Korobkin and Thomas S. Ulen, Law and Behavioral Science: Removing the Rationality Assumption from Law and Economics, 88 Cal. L. Rev. 1051 (2000). One effect of time inconsistent discount rates is that people “always consume more in the present than called for by their previous plans.” Richard H. Thaler, The Winner’s Curse 98 (1992).
The somewhat related multiple selves phenomenon posits that individuals do not have a single utility function, but rather multiple competing utility functions. Because each “self” orders preferences differently, there is an ever-present risk that the self predominating at a given moment may make decisions not in the complete individual’s best interest. Again, Korobkin and Ulen explain: “A stiff tax on cigarettes, to take an obvious example, can be viewed as aiding the future-oriented self in its battle with a more present-oriented self that values immediate gratification over long-term health. . . . Today’s self can attempt to make commitments that either will completely bind tomorrow’s self or, at least, raise the cost of taking action that today’s self wishes to avoid.” In Homer’s tale, Odysseus had himself lashed to the mast precisely so that his present-oriented self could not satisfy its desire to prolong exposure to the Sirens’ song. Being lashed to the mast was a precommitment strategy by which he avoided making an unwise decision in the future. Hence, Odysseus privileged the desires of his farsighted “planner” self, who was concerned with lifetime utility, over those of his myopic and selfish “doer” self. Bank Christmas Clubs are predicated on the same idea. By prohibiting the withdrawal of funds until late November, Christmas Clubs prevent people from acting on hyperbolic discounting proclivities, and assure the future availability of funds to pay for Christmas presents. In general, precommitment strategies are desirable because they disempower the myopic “doer” self. As such, “people rationally chose to impose constraints on their own behavior.” See generally Richard H. Thaler & H.M. Shefrin, An Economic Theory of Self-Control, 89 J. Pol. Econ. 392 (1981).
Accordingly, there are many situations in which both individuals and organizations make enforceable precommitments. Such precommitments are beneficial because they protect ourselves against passion and time inconsistency. In using contractual devices to make a precommitment, the incumbent board likewise binds itself—and future boards—to a particular strategy. In striking down the dead hand and no hand poison pills on authority grounds, the Delaware courts seemingly have limited the use of such precommitment strategies by adopting a broad principle that boards have an ongoing duty to constantly re-evaluate their decisions.
Boards commonly enter into contracts limiting their future authority to varying degrees. Bond indentures commit the board to long-term obligations that will continue to bind future boards for many years. To be sure, the constraint on the authority of future boards is relatively modest, as such boards could always choose to breach the contractual obligations imposed by the indenture, but it nevertheless remains the case that their authority has been constrained.
Merger agreements likewise commonly contain provisions by which the board of directors binds itself to particular courses of conduct. A best efforts clause, for example, obliges the target’s board to use its “best efforts” to consummate the transaction. No shop clauses prohibit the target corporation from soliciting a competing offer from any other prospective bidders. The no negotiation covenant, a variant on the no shop theme, goes further to prohibits negotiations with unsolicited bidders.
Fair price shark repellents commonly include continuing director provisions. Like the dead hand pill, the continuing director provision of a fair price shark repellent allows a bid to go forward only if approved by those members of the board of directors who were on the board when the acquirer first triggered the defensive provision. If the fair price shark repellent was included in the articles of incorporation, rather than the bylaws, it might satisfy the supreme court’s view that “any limitation on the board’s authority be set out in the” articles of incorporation. Query, however, whether a typical fair price provision would contain language explicitly authorizing a limitation of the board’s authority and whether the Delaware courts would require an explicit statement to that effect.
All such corporate actions would be vulnerable to an authority-based challenge if the supreme court’s reference to “any limitation on the board’s authority” is to be taken literally. Yet, if the word “any” is not to be taken literally, where is the firebreak between permissible and impermissible limitations?
If there is no firebreak, what should the Delaware supreme court have done? Instead of creating a novel doctrine based on statutory authority, the court should have relied on the well-established principles outlined in Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946 (Del. 1985), and its progeny. Dead hand and no hand pills unquestionably raise very serious issues of target director fiduciary duty. The market for corporate control and, in particular, the unsolicited tender offer are critical accountability mechanisms by which agency costs are constrained in the corporate setting. Director action that impedes unsolicited bids therefore is tainted by a conflict of interest, as Unocal recognized. Indeed, it is difficult to imagine a legally cognizable threat sufficiently severe for a dead hand pill to pass muster under the proportionality prong of Unocal. Binding someone else’s hands, as the dead hand pill does, does seem more problematic than binding one’s own. Such concerns become even more pronounced, when the decision to disable another is tainted by a conflict of interest situation.
Yet, never before had the Delaware supreme court adopted a prophylactic prohibition in response to that taint. To the contrary, the court rejected just such an approach when it rejected academic calls for a rule mandating director passivity in the face of an unsolicited bid. Moreover, Delaware courts have employed even Unocal cautiously. They recognize the danger “that courts—in exercising some element of substantive judgment—will too readily seek to assert the primacy of their own view on a question upon which reasonable, completely disinterested minds might differ.” City Capital Assoc. Ltd. Partnership v. Interco, Inc., 551 A.2d 787, 796 (Del. Ch. 1988).
The Delaware supreme court should acknowledge that both self-disablement by the board of directors and disablement by the board of other constituencies are legitimate and accepted corporate governance practices. It then should emphasize that such self-disablement raises issues of fiduciary duty, especially when tainted by the sort of potential conflict of interest inherent in takeover defense decisions.
References:
Corporation Law and Economics at 685-90.
Dead Hand and No Hand Pills: Precommitment Strategies in Corporate Law
