September 30, 2011 14:25 Age: 3 yrs

Weighing Jurisdictional Competition in Corporate Law

William J. Carney

Charles Howard Candler Professor of Law
BA, Yale University, 1959
LLB, Yale University, 1962

Scholarly interests: business associations, securities regulation, corporate law

Continuing Emory’s tradition of law and economics scholarship in corporate law, William J. Carney has produced more than 50 articles and book chapters, several books, and two market-leading casebooks. Corporate Finance: Principles and Practice is in its second edition (Foundation 2010); this year saw the third edition of Mergers and Acquisitions: Cases and Materials (Foundation 2011).

As reporter for the Corporate Code Revision Committee of the State Bar of Georgia, Carney realized that corporate laws were essentially uniform across the United States. Studying the process of making corporate laws throughout the nation, however, he wondered why U.S. laws differ so much from their more restrictive European counterparts.

“Our jurisdictional competition explained the difference,” Carney says. “To attract chartering business and the resulting franchise taxes, a state had to provide laws attractive to investors. European laws, without jurisdictional competition, included provisions apparently influenced by political pressures from labor unions and creditors. Jurisdictional competition, far from being a race to the bottom, is much more efficient than lawmaking by a single monopolistic legislator, subject to interest group pressures.”

American corporate law, however, hasn’t won Carney’s unqualified approval. In other work, including his 2010 article “Delaware Corporate Law: Failing Law, Failing Markets” (with Emory Law colleagues Joanna Shepherd Bailey and George Shepherd), Carney has shown how American interjurisdictional competition sometimes has fallen short, resulting in suboptimal corporate law.

Exploring why Delaware continues to dominate the competition for chartering business, the three authors focused on lawyers who advise on these choices: “Our study showed that lawyers  suffer from bounded rationality,” Carney says. “All they know is Delaware law and their own state’s law.”

SELECTED PUBLICATIONS

Books

  • Mergers and Acquisitions: Cases and Materials (3rd ed., Foundation 2011)
  • Corporate Finance: Principles and Practice (2nd ed., Foundation 2010)
  • Mergers and Acquisitions: The Essentials (Aspen 2009)

Book Chapters

  • Delaware Corporate Law: Failing Law, Failing Markets, in The Law and Economics of Corporate Governance: Changing Perspectives (Alessio M. Pacces ed.)(Elsevier 2010) (with Joanna Shepherd Bailey & George B. Shepherd)
  • Venture Capital Financing and Documentation, in Technological Innovation: Generating Economic Results (Marie Thursby ed.) (Elsevier 2007)
  • Will Choice of Corporate Law Become Trivial?, in Balancing of Interests: Liber Amicorum Peter Hay 73 (H.E. Rasmussen-Bonne, R. Freer, W. Lüke, & W. Weitnauer eds., 2005)

Articles

  • Lawyers, Ignorance, and the Dominance of Delaware Corporate Law, Harvard Business Law Review (forthcoming 2011) (with Joanna Shepherd Bailey & George B. Shepherd)
  • The Mystery of Delaware Law’s Continuing Success, 2009 University of Illinois Law Review 1 (with George B. Shepherd)
  • The Costs of Being Public After Sarbanes-Oxley: The Irony of “Going Dark,” 55 Emory Law Journal 141 (2005)
  • Appraising the Non-Existent: The Courts’ Struggles with Control Premiums, 152 University of Pennsylvania Law Review 845 (2003) (with M. Heimendinger)
  • The Illusory Protections of the Poison Pill, 79 Notre Dame Law Review 101 (2003) (with L. Silverstein)
  • Jurisdictional Choice in Securities Regulation, 41 Virginia Journal of International Law 717 (2001)

 

Excerpt: “Why Delaware Continues to Dominate the Competition for Chartering Business”

Two of us have previously reviewed the history of the competition for corporate chartering business. This competition was possible because virtually all American states followed the English choice of law rule, the “Internal Affairs Rule,” which applies the law of the incorporating jurisdiction to the governance of the corporation, rather than Europe’s “Real Seat Rule,” which required incorporation at the location of the corporation’s real headquarters.    

When New Jersey, the first mover in the American chartering competition, relinquished its advantage in a misguided movement at law reform in 1911, Delaware became the favored state for incorporation.

. . .

One author characterized Delaware’s preeminence as stemming from the “combination of its flexible corporate code, the responsiveness of its legislature, the wealth of legal precedent, its efficient and knowledgeable court system, and its business-like Secretary of State’s office.” Our previous work challenged the benefits of its corporate code, its legal precedent, and its court system. We argue that the principal feature of an efficient corporate law is to reduce transaction costs of organizing and operating a business entity. Romano’s pioneering work identified this as the primary motivator of changes in states of incorporation. Thus, from the perspective of corporate managers, this characteristic is the mark of good corporate law.

Our view of the statistical evidence of Delaware law’s superiority is that it is currently unpersuasive about the quality of law issues identified by Romano as critical. We agree with former Chancellor William Allen that “[b]y intruding on the protected space that the business judgment rule accords such decisions, courts create disincentives for businesses to engage in the risk-taking that is fundamental to a capitalist economy. Such intrusiveness also prolongs litigation without offsetting social utility.”

. . .

All of the preceding [empirical] literature, with minor exceptions, treats corporate law as a black box that generates more or less efficient outcomes for firms and investors. Lawyers have quite another perspective—that content, detail, and certainty are important. We offer another explanation that attempts to synthesize Subramanian’s work and Romano’s earlier results: reincorporations of public companies occur when management is contemplating a major transaction, where litigation costs and uncertainty become important. If managers and their advisors are aware of the present difficulties with Delaware law governing important transactions, that may influence a move to other states. The rush to Delaware for IPOs during the same period becomes more puzzling in view of the evidence of its less dominant performance in the market for reincorporations. One possible explanation borrows from Coates’ observations about adoption of antitakeover defenses by IPO firms. It may be that at least some groups of lawyers advising issuers on IPOs are less familiar with the difficulties of Delaware law involving mergers and acquisitions, if they are not specialists in those areas. We explore the evidence in Parts IV and V.

Delaware’s Indeterminacy Problem

There is much about Delaware corporate law that is efficient and attractive.

Corporate law is largely about default rules, and in that sense can be considered trivial. All other state laws share very much the same sets of rules, and we do not propose to discuss them here. The interesting rules, from our perspective are the mandatory rules, mostly involving fiduciary duties, that seem difficult if not impossible to contract around. The dominant phenomenon present in recent Delaware judicial decisions is loss of the faith of the courts in the good faith of directors and a significant erosion of the deference formerly granted under the business judgment rule. Thus the set of decisions now contestable in the Delaware courts has grown exponentially. This is not to say that directors’ risk of personal liability has increased at the same rate, because most if not all Delaware corporations have availed themselves of the liability shield offered by Section 102(b)(7). It was only after the first intrusion into the directors’ domain, and a dramatic reaction in insurance markets and the market for directors that the Delaware legislature felt compelled to adopt this statute and provide liability protection against unpredictable intrusions into directors’ judgments. But since that adoption the Delaware courts have recharacterized some director actions that one would have thought of as involving protected breaches of the duty of care as breaches of the duty of good faith, for which neither exculpation nor indemnification is available. The first two cases involved charges that directors had failed to create adequate systems to monitor lower-level employees for illegal activities, and since the directors won both cases, created only minor concerns about personal liability. But recently a vice chancellor characterized a board’s acceptance of an attractive purchase offer that was on a take-it-or-leave it basis as a breach of the duty of good faith, because the board neither shopped for alternatives in the seven days it was given to accept, nor reserved the right to test the market after signing the agreement, over the absolute refusal of the buyer to grant such a right. While the Delaware Supreme Court has taken the extraordinary step of granting an interlocutory appeal on this issue, it illustrates the uncertainty and potentially enormous increase in director liability possible under Delaware law.
One of the notable features of Delaware law has been its respect for the bright lines between separate sections of the statute, a rule of “independent legal significance.” This allowed managers to choose the most advantageous method for accomplishing a desired result without worrying about complying with another and more restrictive statutory provision that would also allow one to reach the same result. Recent commentators have noted the gradual erosion of the doctrine of independent legal significance over the past ten years. These authors note that the courts have attempted to distinguish the cases disregarding the doctrine by claiming that it only “applies to exercise of legal power. It does not apply to fiduciary review.” Unfortunately, that rationalization does not apply to the Chancellor’s most recent departure, which only involved the availability of appraisal rights, which did not address breaches of fiduciary duties. There the Chancellor recharacterized a planned dividend as part of the consideration for a merger, thus subjecting the transaction to different rules.

. . .

Delaware law is so indeterminate that Delaware appellate and trial judges disagree on its application with relative frequency, their specialized expertise notwithstanding. In some cases the appellate decisions are sufficiently surprising that they generate considerable commentary by both academics and practitioners. Many of these decisions involved changes in Delaware’s law, and they occurred in areas involving review of important transactions, such as mergers and acquisitions. The important observation here is not that the rules are difficult to discern once announced, but that new rules have been announced with remarkable regularity. These rules represent surprises for those who have recently completed transactions that are now subject to challenge in an unexpected way, and new risks of liability for participants. To the extent they are fact-intensive, they make prediction more difficult for planners of transactions. They have been characterized as standards, and in one sense the notions of care, good faith and loyalty covered by fiduciary obligations are that, but they have devolved into a series of min-standards that could fairly be described as rules, as we shall demonstrate. The frequency of litigation in Delaware, often described as a blessing, might as easily be a handicap. As with viruses, the frequency of their replication creates the probability of every possible mutation occurring within a day, increasing the probability that some mutations will be drug resistant. So in Delaware, multiple decisions involving closely related fact patterns can lead to unfortunate results.

— from Delaware Corporate Law: Failing Law, Failing Markets, in The Law and Economics of Corporate Governance: Changing Perspectives (Alessio M. Pacces ed.) (Elsevier 2010) (with Joanna Shepherd Bailey & George B. Shepherd)

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