Next week I'll be speaking at a Vanderbilt law school conference on corporation law, where I'll be commenting on Firm's Decisions Where to Incorporate, by Lucian Bebchuk and Alma Cohen. I'll be posting my remarks after the conference, but in the meanwhile I thought this finding was particularly blogworthy: Bebchuk and Cohen examine whether firms located in a given state (say, California) choose to incorporate in that state or to incorporate elsewhere (say, Delaware).1 They find that California does especially poorly at retaining local business incorporations: California retains the incorporations of only 22% of businesses located within it. What explains California's lag? (2)
Bebchuk and Cohen's paper contains a variety of possible explanations, but the one I found most telling was this observation:
It is interesting to note that, in all three regressions, states that are strongly Democratic are less successful (at 99% confidence) in retaining local firms. For any given set of statutory corporate provisions, judges in states that are strongly Democratic might be expected to be more willing to intervene, which might be unattractive to those making incorporation decisions.(24)
To be sure, Bebchuk and Cohen lay more stress on the fact that California has no antitakeover statute, which is consistent with their larger thesis that the presence or absence of a takeover statute is what drives management decisions as to where to incorporate. Yet, my guess is that the absence of a takeover statute in California itself can be explained by the state's liberal legal culture. California gets a very small share of state revenues from incorporation-related taxes. (I don't have the exact figures, because franchise taxes -- as opposed to the corporate income tax -- are such a small share of the state's receipts that they don't even show up on the state's cash flow analysis.) A key tenet of the race to the top hypothesis is that states compete to attract incorporations so as to collect the franchise taxes firms pay for the privilege of incorporating within that state. Delaware profits hugely from this competition, as Bebchuk and Cohen elsewhere observe: "Delaware's annual revenues from franchise taxes are on the order of $3,000 for each household of four in the state, and they constitute about 30% of the state's budget." This gives Delaware a strong incentive to offer corporation laws that attract entrepreneurs looking for a place to incorporate their business. In contrast, California generates such a small percentage of its revenues from incorporation-related fees, that California has very little incentive to draft corporation laws attractive to entrepreneurs and managers. Instead, California can indulge the luxury of allowing its corporation laws to reflect the overall anti-business/anti-capitalist leanings of the state's dominant left-liberal political elites. In other words, California doesn't retain so few incorporations because it has no antitakeover statute; California has no antitakeover statute because it retains so few incorporations ... and doesn't care.2
UPDATE: Larry Ribstein (of the UIUC law school and the BusFilm blog) sends the following email:
See my Lawyers as Lawmakers paper. My theory in that paper predicts that states where transactional lawyers are powerful (e.g., Delaware) are likely to have efficient laws in areas where ex ante choice of law is viable, as with corporate governance. So maybe the problem in California is that the trial lawyers are more powerful than the transactional lawyers. Obviously the message that lawyers can be good is not one that is likely to captivate public opinion
UPDATE 2: The Corp Law Blog weighs in with an encomium of Delaware's judiciary and its well-established body of precedent. It's sufficiently important that I will be blogging on it separately. Stay tuned.
1 Note that this is a different question than the one that got so much play during the recall. In the debate over California's business climate, the question was whether businesses were moving their physical location out of the state. Bebchuk and Cohen are looking at business that remain physically within, say, California but pick another state in which to incorporate the business. Hence, issues like worker's compensation costs that drive businesses to physically leave California are irrelevant to this issue, because incorporating outside California doesn't eliminate those costs.
2 In other words, California is neither racing to the top nor racing to the bottom. It is doing its own quirky thing. In contrast, the states that lean Democratic but have adopted antitakeover statutes are participating in the race (whether it is to the top or the bottom).
And, in response to a reader's query, I'm not intending to suggest that California is shareholder-friendly -- although the political significance of CalPers and other state pension funds may incline the state in that direction -- so much as saying that it is anti-management.
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