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Vanderbilt Conference: Comments on Bebchuk and Cohen Firms’ Decisions Where to Incorporate

A perennial topic in academic corporate law is whether the evolution of state corporate law is better described as a race to the top or a race to the bottom. According to the "race to the bottom" hypothesis, states compete in granting corporate charters. After all, the more charters (certificates of incorporation) the state grants, the more franchise and other taxes it collects. Because it is corporate managers who decide on the state of incorporation, states compete by adopting statutes allowing corporate managers to exploit shareholders.

Many legal scholars reject the race to the bottom hypothesis. According to a standard account, investors will not purchase, or at least not pay as much for, securities of firms incorporated in states that cater too excessively to management. Lenders will not make loans to such firms without compensation for the risks posed by management's lack of accountability. As a result, those firms' cost of capital will rise, while their earnings will fall. Among other things, such firms thereby become more vulnerable to a hostile takeover and subsequent management purges. Corporate managers therefore have strong incentives to incorporate the business in a state offering rules preferred by investors. Competition for corporate charters thus should deter states from adopting excessively pro management statutes. The bulk of the empirical research appears to bear out this view of state competition, suggesting that efficient solutions to corporate law problems win out over time.

Lucian Bebchuk and Alma Cohen have made an important recent contribution to the debate in an empirical paper entitled Firms’ Decisions Where to Incorporate. Bebchuk and Cohen claim two key empirical findings:

[First, their] study has … produced findings that cast substantial doubt on the proposition that there is a vigorous competition among states over corporate charters. ... The overwhelming majority of non-Delaware companies are simply incorporated in the states where their headquarters are based.

[Second, their] findings indicate that the incorporation market rewards states that amass antitakeover statutes. ... At one end of the spectrum, states with no antitakeover statutes, such as California, do poorly and retain a relatively small fraction of the companies located in them. At the other end of the spectrum, states that amass most or all standard antitakeover statutes are the ones most successful both in retaining in-state companies and in attracting out-of-state companies.

In other words, the market for state competition in corporate charters is not perfect, and (2) agency costs affect management decisionmaking. Neither result will surprise any informed observer of the corporation law scene. The question is what, if anything, does confirming those points prove? Bebchuk clearly intends it to be one more nail in Delaware’s coffin. Does it succeed in slaying the race to the top beast?