I am a little late, but I wanted to put my oar in on the debate over Delaware incorporation. Steve Bainbridge wrote about it here; the Corp Law Blog wrote about it here; and Lucian Bebchuk wrote about it here. Truth be told (and it always is told on this site!), I usually find this debate a little tiresome, partly because I have formulated my view and don’t want to be bothered by those who disagree with me. Nevertheless, these recent arguments deserve some attention.
First a step back in time. When I was starting my career as an academic — fresh off three years of practicing as a Delaware corporate lawyer — I encountered Roberta Romano’s short book, The Genius of American Corporate Law. Romano argues that federalism is the secret sauce in American corporate law, and that law is shaped favorably by the competition among states for corporate charters. Delaware wins that competition because it has an emormous investment in attracting and retaining incorporations.
Since Romano’s book was published, we have seen an enormous outpouring of scholarship on this question. The question is usually framed as follows: Is corporate law the product of a “race to the top” or “race to the bottom”? Notice the fundamental assumption: that the content of law is the thing that distinguishes one state from another. In my view, this assumption is flawed.
Now, I will concede that law matters, but I don’t believe that it matters much in the incorporation debate. Simply stated, Delaware corporate law is not very distinctive. If it were distinctive, it could easily be copied by so-called competitors (witness, for example, the adoption of statutory exculpation provisions following Smith v. Van Gorkom).
Corp Law Blog falls into the trap by suggesting that the key to Delaware’s success is “predictability.” The claim is based on the observation that Delaware has more cases than anyone else. It storehouse of judicial opinions provide answers for practicing lawyers. This must be wrong. Even if we believe that judicial opinions provide ready answers (in my experience, each opinion tends to generate more questions than answers), this competitive advantage could be easily appropriated. Just at the United States relied on English common law decisions for many years after the Revolution, so do many states refer to Delaware cases when a novel issue arises. In this sense, Delaware is creating a public good, and it cannot use the public good for competitive advantage.
Steve Bainbridge offers another content-driven explanation for Delaware. His purpose is not so much to explain Delaware as to explain why not California (as if the recent recall election isn’t reason enough!), but his argument rests on assumptions about the importance of content. He writes provacatively: “California can indulge the luxury of allowing its corporation laws to reflect the overall anti-business/anti-capitalist leanings of the state’s dominant left-liberal political elites. In other words, California doesn’t retain so few incorporations because it has no antitakeover statute; California has no antitakeover statute because it retains so few incorporations … and doesn’t care.” One problem with this argument is that takeover laws do not seem to be an important determinant in the incorporation decision. (See Rob Daines’ recent work on this.) Another, more serious, problem is that it does not explain the relative lack of success of all 48 other states in the hunt for corporate charters. Most of those states have anti-takeover statutes — indeed, most have statutes much more protective of managers than Delaware’s — and still they fail to attract firms from outside their state.
Bottom line: the content of law is not what drives Delaware.
Perhaps it is the manner in which corporate law is administered? People often observe that the Delaware judges are experts in corporate law (at least relative to their counterparts in other states), but this is not the explanation for Delaware’s popularity. Those who drive the incorporation decision — mostly transactional lawyers — are not thinking about litigation. What they are thinking about is the ease with which they can interact with Delaware when the company engages in corporate transactions. In other words, it’s about the bureaucrats. And Delaware has the best in the business.
I will concede one point to those who think the incorporation “competition” is content-driven: because of Delaware’s unique reliance on corporate franchise taxes (30% of the state budget according to Bebchuk), the consumers of corporate law can rest assured that neither the Delaware legislature nor the Delaware courts will embark on a sustained march down an insane path. In other words, we can be very confident that Delaware will pursue conservative strategies in corporate lawmaking over the long run. That assurance is essential in attracting business (and, I should add, it is one thing that California cannot offer).