Delaware's Competition

Abstract

One of corporate law's enduring issues has been the extent to which state-to-state competitive pressures on Delaware make for a race to the top or the bottom. States, or at least some of them, are said to compete with their corporate law to get corporate tax revenue and ancillary benefits. Delaware has "won" that race, with the overwhelming number of American large corporations chartering there. Here I argue that this long-standing debate is misconceived. Delaware's chief competitive pressure comes not from other states but from the federal government. When the issue is big, the federal government takes the issue or threatens to do so, or Delaware players are conscious that if they mis-step, Federal authorities could step in. These possibilities of ouster, threat, and consciousness have conditioned Delaware's behavior. Moreover, even if Delaware were oblivious to the Federal authorities, those authorities can, and do, overturn Delaware law. That which persists is tolerable to the Federal authorities. This reconception a) explains corporate law developments and data that neither theory of state competition can explain well, b) fits several developments in takeover law, going private transactions, and the rhetoric of corporate governance in Delaware, and c) can be detected in corporate law-making in Washington and Wilmington from the very beginning in the early 20th century "origins" of Delaware's dominance right up through last summer's Sarbanes-Oxley corporate governance law and the corporate governance failure in Enron and WorldCom.

This analysis upsets the long-standing analysis of state corporate law competition as a strong race (whether to the top or to the bottom) because when a corporate issue is important, the federal government takes it over, or threatens to do so, or Delaware fears federal action. As such, we cannot tell whether Delaware, if it indeed raced to the top, did so because of the looming federal "threat". Nor can we tell whether Delaware, if it raced to the bottom, a) did so because national politics meant that, had they taken the locally efficient path, Congress, subject to wider pressures than is Delaware, would have taken the issue away, or b) would have instead raced to the top on other, more important issues that directly affected the mechanisms of a race to the top, had the states fully controlled them. Nor can we tell if that which persists is that which the Federal players approved of, or at least found tolerable. Too many of the truly important decisions, the ones that could affect capital costs - the mechanism driving the race-the-top theory - are taken away from Delaware or are at risk of removal or the Delaware actors know could be taken away if they seriously damaged the national economy or riled powerful interests. That is not to say that what happens at the state level in corporate law is trivial, but that the results are ambiguous in terms of the race debate. If efficiency is the usual result, then the Federal vertical element could correspond to the strengths of other organizational structures (like separating proposals from ratification in decision-making, of the checks and balances in the M-form corporation). If inefficiency is the usual result, we do not know whether the states, if free to compete without a federal "veto" possibility, would have raced toward efficiency. When we add this "vertical," Federal-state competition atop the horizontal state competition in corporate law, the state race debate - one that has stretched across the 20th century from Brandeis to Cary and beyond - is rendered empirically and theoretically indeterminate.

Keywords: corporate law, fiduciary duties, inter-jurisdictional race, race-to-the-top, race-to-the-bottom, corporate law

JEL Classification: D21, G3, G18, G28, G30, G34, G38, H73, K4, K20, K22, K42, L21