Among my great pieces of good fortune during my time in law school at the University of Virginia was to meet and befriend – and to co-author several papers with – Adam Pritchard, now a professor at the University of Michigan School of Law, specializing in securities law. (Adam and I haven’t written anything together in many years, but I hope that that’ll change soon.) I look forward to reading this new working paper that he co-authored with Murali Jagannatha; it’s entitled “Does Delaware Entrench Management?” I’m not surprised by the finding about Delaware, but I am surprised by the finding on the apparent lack of correlation between the strength of state anti-takeover legislation and management entrenchment. Here’s the abstract:
Critics have charged that state competition in corporate law, which Delaware clearly dominates, leads to a “race to the bottom” promoting management entrenchment at shareholders’ expense. We present evidence here inconsistent with this hypothesis. Measures of director quality and governance mechanisms are higher in Delaware. Delaware’s directors hire higher quality CEOs and they are more likely to terminate CEOs.
Tenures of Delaware directors and CEOs are both lower than their counterparts in other states. In addition, contrary to claims that anti-takeover laws promote management entrenchment, we find that states that provide the greatest anti-takeover protection – Ohio, Pennsylvania, Massachusetts, and Maryland – do not have significantly different turnover rates from California, the state that arguably offers the least anti-takeover protection.
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The key sentence seems to me to be on the bottom of page 26; it states that takeovers and terminations [of CEOs] may be substitute disciplinary mechanisms. I'd say that not only "may" this be the case, but it is certainly the case.
As a practitioner of Delaware corporate law, I've noticed this for years. The reason, based on my own observations, is that Delaware doesn't have a lot of powerful native industries (du Pont notwithstanding). Instead, a huge part of the state's economy, and of the state government's revenues, is based on the state's ability to attract entities. Delaware is selling a legal regime. Now, many have reasoned this far and then concluded that Delaware therefore caters to management. But the legal regime governing an entity must be attractive to more than just management — it must be attractive also to the investors that management plans to draw. Thus, Delaware corporate law has for decades pursued a balance between directors'/managers' authority to run the business and investors' authority to protect their stake. Delaware corporate law is a product shaped by the wants of the people buying it — both managers and investors.
JP,
Very clear post, thanks. I wonder why other states don't simply look at Delaware law and copy it.
If I were losing the competition I'd want to know what I was competing against and how to meet or better it.
There's just no explaining the way the world works sometimes.
vidyohs — Thanks! Some other states have in fact copied Delaware's corporate law (Nevada is the most aggressive example). However, they have not been able to make much of a dent in Delaware's market share for three reasons:
First, Delaware has about a century's worth of court decisions expanding upon its corporate law and how it applies in different factual situations. This makes it much easier to predict how Delaware law will be interpreted and applied when one is trying to decide on a course of action. Other states can (and sometimes do) SAY they will follow Delaware law, including its court decisions, but people will have a lot more certainty that Delaware law will be applied as expected by a Delaware court than by a court in another state. (In other words, you might as well go to the source, as long as the source is not charging too much in taxes and fees.)
Second, Delaware has an excellent judiciary. All Delaware judges are appointed, not elected, and the bar and governor realize how important it is that smart, knowledgeable practitioners be on the bench. Moreover, unlike most states, Delaware has a court of chancery that (1) does not use juries, (2) is willing to move quickly on important matters (such a whether to prevent an impending merger), and (3) focuses on business litigation (i.e., very little family-law cases, no criminal cases, no products liability / personal injury cases). The Chancellor and Vice Chancellors in Delaware are almost all distinguished former corporate-law practitioners.
Third, the state government derives so much of its revenue from corporations formed in Delaware that it is motivated to make its systems as user-friendly as possible. You can file papers by fax, you can get same-day service, the rules are easy to understand and follow, etc. Most other states are Kafka-esque by comparison.
(As I guess you can tell, this is one of my favorite topics.)
JP,
When you're doing something you like, it ain't work. Good on ya. BTW, thanks for the exspansion of information on your state's attitude towards its own laws and administration. I think we all can get something from that.
An excellent article on the evolution of American corporate law is by Henry N. Butler, "Nineteenth-Century Jurisdictional Competition in the Granting of Corporate Privileges," in Vol. 14 of the Journal of Legal Studies (1985).
Thanks, Don. I will look for it.