Fear that more companies might follow Tesla and reincorporate outside Delaware has been roiling the corporate world, driven by recent court decisions that impose relatively stringent controls on controlling shareholders. In response, Delaware’s legislature is considering Senate Bill 21 (SB 21), which aims to reverse several of these rulings and dissuade Delaware corporations from leaving.
The threat of a corporate exodus that the legislation aims to address draws on a longstanding, widely accepted trope about the interjurisdictional dimension of U.S. corporate law: States compete with each other for incorporations, and a state that adopts unpopular rules risks losing this competition. In particular, the competition is seen as an important impediment to states adopting mandatory rules.
Yet this account of corporate law has long been criticized as an abstraction that does not perfectly translate into the real world. As commentators have argued, Delaware enjoys a de facto monopoly on incorporations and that competitive pressure is limited due to factors like potential federal intervention,[1] network effects,[2] and Delaware’s unique legal infrastructure, including its courts.[3] However, most of the existing literature is theoretical in nature.
In a new paper, I empirically investigate another moment when fears about a corporate exodus ran high. Nearly a decade ago, Delaware banned fee-shifting provisions in charters and bylaws just a year after the state’s Supreme Court approved them in ATP Tour, Inc. v. Deutscher Tennis Bund. Critics called the legislative ban a “self-inflicted wound”[4] and predicted that corporations would flee to jurisdictions friendlier to management, thereby harming Delaware’s competitive edge as the premier incorporation destination.
However, as my paper demonstrates, this predicted exodus never materialized. Companies did not leave Delaware in significant numbers following the ban on fee-shifting bylaws. Indeed, Delaware also maintained its dominance as the preferred jurisdiction for newly public companies. While these findings align with earlier critiques of traditional views of state competition, my empirical analysis reveals an additional, unexpected outcome: The adoption of fee-shifting provisions ceased nationwide, even in states without explicit bans.
This phenomenon indicates that Delaware’s legal interventions may have spillover effects on other jurisdictions. Importantly, insofar as these spillover effects—the “Other Delaware Effect,” distinct from the traditionally assumed positive effects of Delaware incorporation on shareholder value—exist, they further reduce the competitive pressure on Delaware. If the state’s actions influence corporations nationwide, reincorporating elsewhere will not necessarily help those corporations avoid the practical impact of Delaware’s laws.
My paper explores several mechanisms that might explain these spillover effects. For example, when Delaware outlawed fee-shifting provisions, law firms might have updated their standard governance advice to corporations everywhere—effectively taking these controversial provisions off the table even in states without explicit bans. Similarly, powerful institutional investors and proxy advisers, already skeptical of management-friendly terms, could have more credibly opposed fee-shifting bylaws once Delaware had outlawed them.
Of course, it remains uncertain how directly past experiences map onto the present moment. In particular, other jurisdictions like Texas might well offer controlling shareholders more leeway than Delaware currently does. Still, as Delaware debates rolling back judicial protections to prevent more corporations from following Tesla’s example, it is worth recalling how predictions of corporate flight have proven exaggerated in the past. The market for incorporations is stickier than sometimes assumed, supported by Delaware’s sophisticated legal infrastructure, network effects, and possibly the spillover effects identified in my paper.
Lawmakers and observers alike should thus keep cool heads when confronted with alarmist claims about the dire consequences of efforts to reign in managers and controlling stockholders. For SB 21, this counsels in favor of approaching the issue cautiously, assessing the measure’s pros and cons on their merits rather than acting hastily out of fear of an exodus that history suggests might be less likely than proponents of the reform assert. Delaware’s regulatory power and its ability to influence corporate governance norms might be stronger—and more far-reaching—than conventional wisdom seems to allow.
ENDNOTES
[1] Mark J. Roe, Delaware’s Competition, 117 Harv. L. Rev. 588 (2003).
[2] Michael Klausner, Corporations, Corporate Law, and Networks of Contracts, 81 Va. L. Rev. 757 (1995).
[3] Lucian Arye Bebchuk and Assaf Hamdani, Vigorous Race or Leisurely Walk: Reconsidering the Competition over Corporate Charters, 112 Yale L. J. 553 (2002); Marcel Kahan and Ehud Kamar, The Myth of State Competition in Corporate Law, 55 Stanford L. Rev. 679 (2002).
[4] Stephen M. Bainbridge, Fee-Shifting: Delaware’s Self-Inflicted Wound, 40 Del. J. Corp. L. 851 (2016).
This post comes to us from Professor Jens Frankenreiter at Washington University in St. Louis School of Law. It is based on his new paper, “The Other Delaware Effect,” available here.