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 DoddFrank 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