CORPORATE CHARTERING AND FEDERALISM A NEW VIEW Ronald

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 Paul

Corporate Chartering in a Federal System • Three Approaches: – Real Seat Doctrine – Free Incorporation (Internal Affairs Rule) – Federal Chartering • Common assumption is that free incorporation promotes regulatory competition -- either: – Active Competition: states alter their corporation law to attract chartering business from other states or – Passive Competition: Firms obtain charters in states whose law they find congenial, without regard to states’ motives for establishing that law 2

Both Active and Passive Competition Are Assumed to Yield Legal HOMOGENEITY • Active competition: All states will adopt similar corporation law • Passive competition: All firms will incorporate in the same state • Academic debate then focuses on whether the winning body of corporate law is good or bad for overall social welfare • Those who like the resulting body of corporate law like free incorporation; others may prefer the real seat doctrine or federal chartering 3 3

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 law • We view firms as choosing between two strategies: – Those seeking MARKET-ORIENTED law • Open to market for corporate control • Imposes strong fiduciary duties on controlling shareholders and managers – Those seeking POLITICS-ORIENTED law • Companies have sufficient influence as to keep corporate (and other) law favorable to them 4

The U. S. Example • Delaware provides market-oriented law – Chosen by most U. S. exchange-listed companies • The other 49 states (except Nevada) provide politics-oriented law – They’re not actively competing for charters – Chosen by locally-headquartered firms seeking to maximize their influence on legal matters that affect them • Corporate law • Products liability • Building permits 5

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 marketoriented • Result: other states are relieved of pressure from local companies seeking market-oriented law. – Those companies have the opportunity of reincorporating in Delaware – So other states can favor local interests 6

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 influence • Notoriously, individual companies have induced state legislatures to amend corporation law quickly, against the wishes of shareholders. • The smaller states have the largest rate of instate incorporation 7

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 improvement – The disputes over Sarbanes-Oxley and Dodd. Frank reflect this 8

Europe • Centros (1999) replaced real seat doctrine with free incorporation – But little cross-border chartering resulted • Just enough for lowering minimum capital requirements – Difficult, for lack of a state like Delaware • EU has also failed at substantive federal-level “harmonization“ • EU now moving toward legislated regulatory dualism based on age and size of firms – Lets established firms retain politics-oriented old legal order – Allows 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 result – States and individual firms can choose exposure to hostile takeovers • Will probably extend life of entrenchment in many firms 9

Vertical Regulatory Dualism? • The Societas Europea offers choice of federal chartering – In theory an alternative market-oriented regime – But very little used Doesn’t offer either pole of regulatory dualism – No bond to market: • Subject to both home state and federal level politics – Yet little political influence for individual firms • Similar U. S. effort at choice of state or federal bank charters failed 10

Conclusion • Free 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 come 11

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 efficient • Regulatory 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