Democracy and the Dominance of Delaware in Corporate Law

Abstract:     
Among the grandest debates within corporate law is whether the dominance of Delaware is the result of a "race to the bottom" - toward a legal regime that benefits managers at the expense of the shareholders - or a "race to the top" - toward an efficient, shareholder-centric governance framework. This paper argues that this debate is largely beside the point. Even if Delaware's dominance is the result of a competition resulting in law that efficiently serves the interests of shareholders, it is nevertheless illegitimate. This is because the internal affairs doctrine, on which Delaware's preeminence depends, in effect allows corporations to choose the corporate governance laws that will apply to them, whether or not the state they choose has any other contact with the corporation. This is inefficient as an economic matter and illegitimate as a democratic matter.

Indeed, of the thousands of corporations with charters from Delaware, few have their headquarters or significant numbers of employees or shareholders there. Delaware law can therefore be crafted without attention to the political influence of any important stakeholder unless that influence can be transformed into market terms. Delaware law reaches beyond its borders to affect all the corporation's stakeholders even though they have no political influence over what the laws are. The internal affairs doctrine has allowed Delaware to externalize the costs of its rules on other stakeholders and indeed other states.

The central argument of this paper is that this practice of deferring to Delaware law is undemocratic. Indeed, if areas of the law can be evaluated on their susceptibility to democratic or political pressures, then corporate law must be among the least open to political influence. In a democracy, this should be seen as a serious flaw in the framework of corporate law.

Because the internal affairs doctrine is merely a special exception to conflict of laws principles, individual states can simply change it by asserting their own interests in the corporate governance of companies operating in their states. Typical conflicts of laws principles suggest that the state with the greatest interest in regulating the behavior in question should provide the governing law for the behavior. But the internal affairs doctrine allows a state that has little genuine interest in regulating the corporate behavior at issue to dictate the rules governing that behavior. Of all the areas of law that control and limit corporations, it is only corporate law that is left to the corporation itself to choose. From the standpoint of democratic legitimacy, it is no more justifiable to allow corporations to choose the state that provides the corporate governance laws to govern them than it is to allow such corporations to choose which state should provide the tort law or environmental law that governs them.

Keywords: Corporate governance, Delaware, race to the bottom, internal affairs, conflict of laws

Accepted Paper Series