I recently presented Does Delaware Compete? at the Law and Economics seminar here at Harvard Law School. The paper focuses on a long-standing academic inquiry into the nature of state-to-state competition for chartering revenues and the making of corporate law. While the existence of state competition has long been posited — with the controversy being over its nature — recent work has shown that in fact few states try to make money in corporate franchising and only one — Delaware — is very successful at it.
In this paper, I analyze three arenas in which Delaware competes, even if no other state is a strong player today. First and importantly, it must attract firms to reincorporate away from their home states. The dynamism of American business interacts with even a lackluster state-based corporate chartering market to create a broad avenue of chartering competition, as Delaware’s business base is persistently eroding as firms merge, close and restructure. The “half-life” of Delaware’s franchise tax base is surprisingly short. If it fails to be attractive enough to obtain a steady flow of reincorporating firms, that base will erode. Even if no other state is trying, Delaware has to try. Second, an awakening of a dormant competitor is not impossible. I outline what might motivate one or the other. Although the odds of that happening at any one time are small, small does not mean zero. Analysis should focus not primarily on the incentives of states and their legislatures — where most of the focus has been — but on the incentives of businesses and their lawyers. Entrepreneurial lawyers, with clients who want a different corporate law, would be the likely source of state innovation in making corporate law, not the state legislature directly. Similarly, and third, Delaware has reason to consider the risk of a federalization of core elements of its corporate law even if no other state actively competes for charters. A reputation for bad decision-making (or bad decision-makers) could impel Congress to displace Delaware, in whole or, more likely, in part, perhaps as an excuse during an economic downturn or after a scandal. While the odds of full displacement are low, Sarbanes-Oxley shows us that the odds of substantial partial displacement are not.
I then draw parallels between these ideas and those in the industrial organization, antitrust literature on contestable markets: in contestable market analysis, a single producer can dominate a market, but, depending on the nature of its technology and its market, it could lose market share overnight or suddenly face a new entrant if the incumbent missteps badly. To the extent the chartering market is contestable, Delaware competes, even if that’s a weak form of competition. And, once we see Delaware as in a contestable market with other states, we see that Washington could erode Delaware’s dominance just as another state can. In other words, Delaware could face catastrophic loss in two dimensions: the traditional horizontal one of a competing state, and the vertical one of federal displacement. To fully understand the structure of American corporate lawmaking, we must also see the importance of the Delaware-Washington interaction, actual and potential.
The full paper is available for download here.
In another paper entitled Delaware’s Competition, I make the case that over the 20th century, the most important alternative to Delaware in making corporate governance law was not the other states, but Washington, D.C. That paper is available for download here. In a second related paper, entitled Delaware’s Politics, I focus on the political economy of the Delaware-Washington structure: Managers and shareholders are the primary players in Delaware; a much wider set of interests and policies is brought into play when corporate issues move to Washington. That paper is available for download here.