CORPORATE CHARTERING AND FEDERALISM: A NEW VIEW - PowerPoint Presentation

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CORPORATE CHARTERING AND FEDERALISM: A NEW VIEW

Ronald J. Gilson

Columbia Law School

Stanford Law School

Henry Hansmann

Yale Law School

Mariana Pargendler

Fundação Getulio Vargas Law School at São PaulSlide2

Corporate Chartering in a Federal System

Three Approaches:

Real Seat Doctrine

Free Incorporation (Internal Affairs Rule)Federal CharteringCommon assumption is that free incorporation promotes regulatory competition -- either:Active Competition: states alter their corporation law to attract chartering business from other states orPassive Competition: Firms obtain charters in states whose law they find congenial, without regard to states’ motives for establishing that law

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Both Active and Passive Competition Are Assumed to Yield Legal HOMOGENEITY

Active

competition: All states will adopt similar corporation lawPassive competition: All firms will incorporate in the same stateAcademic debate then focuses on whether the winning body of corporate law is good or bad for overall social welfareThose who like the resulting body of corporate law like free incorporation; others may prefer the real seat doctrine or federal chartering33Slide4

We See a Different Dynamic

We have termed

this

dynamic REGULATORY DUALISM, in contrast with REGULATORY COMPETITION.In this interpretation, free incorporation creates pressure for HETEROGENEITY in corporate lawWe view firms as choosing between two strategies:Those seeking MARKET-ORIENTED lawOpen to market for corporate controlImposes strong fiduciary duties on controlling shareholders and managersThose seeking POLITICS-ORIENTED lawCompanies have sufficient influence as to keep corporate (and other) law favorable to them4Slide5

The U.S. Example

Delaware provides

market-oriented

lawChosen by most U.S. exchange-listed companiesThe other 49 states (except Nevada) provide politics-oriented law They’re not actively competing for chartersChosen by locally-headquartered firms seeking to maximize their influence on legal matters that affect themCorporate lawProducts liabilityBuilding permits5Slide6

Complementarity

Delaware is free of political pressure on its corporate law

Corporate constituencies aren’t resident in the state

So it can offer a regime that’s strongly market-orientedResult: other states are relieved of pressure from local companies seeking market-oriented law.Those companies have the opportunity of reincorporating in DelawareSo other states can favor local interests6Slide7

Some Evidence

Delaware law offers (somewhat) more protection to non-controlling shareholders from controlling shareholders and entrenched managers

Companies seek charters almost exclusively from either Delaware or their headquarters state.

A third state would yield little political influenceNotoriously, individual companies have induced state legislatures to amend corporation law quickly, against the wishes of shareholders.The smaller states have the largest rate of in-state incorporation 7Slide8

Federal Corporation Law Would Be a Compromise

It would need to be responsive both to those companies that favor market-oriented law and those that have some political influence (individually or in groups) on the federal government

We cannot say

a priori whether this would be a social welfare improvementThe disputes over Sarbanes-Oxley and Dodd-Frank reflect this8Slide9

Europe

Centros

(1999) replaced real seat doctrine with free incorporation

But little cross-border chartering resultedJust enough for lowering minimum capital requirementsDifficult, for lack of a state like DelawareEU has also failed at substantive federal-level “harmonization“EU now moving toward legislated regulatory dualism based on age and size of firmsLets established firms retain politics-oriented old legal orderAllows new and growing firms to enter a market-oriented regime.For example, under tax and cross-border merger regimes:Codetermination is effectively grandfathered Will probably last longer as a resultStates and individual firms can choose exposure to hostile takeoversWill probably extend life of entrenchment in many firms9Slide10

Vertical Regulatory Dualism?

The

Societas

Europea offers choice of federal charteringIn theory an alternative market-oriented regimeBut very little usedDoesn’t offer either pole of regulatory dualismNo bond to market:Subject to both home state and federal level politicsYet little political influence for individual firmsSimilar U.S. effort at choice of state or federal bank charters failed 10Slide11

ConclusionFree incorporation has potentially important, and frequently overlooked, consequences for the politics of law-making

It can isolate some of the political resistance to market-oriented law

But at the same time it can concentrate and prolong resistance to overall efficient reforms

It will be interesting to see these forces play out in Europe in the years to come11Slide12

Potential Dynamics Under Free Incorporation

Regulatory Diversification

: Corporations are heterogeneous in their need for corporate law

Regulatory Experimentation: Corporations may be homogeneous. It is unclear which legal regime(s) is most efficientRegulatory Competition: Corporations are homogeneous, but competition is needed to induce all jurisdictions to adopt it.Regulatory Dualism: Corporations are homogeneous, but a single body of law would frustrate the ability to offer firms a strongly market-oriented body of law THEY AREN’T MUTUALLY EXCLUSIVE