Over on LinkedIn, the invaluable Lauren Pringle of the estimable Chancery Daily wrote of Delaware SB 21:
Make no mistake — this is regressive legislation that races us to the bottom. If you told someone forty years ago in all the “race to the bottom” debates that Delaware would be cribbing from the MBCA and that was nearly the least-bad aspect of proposed DGCL changes that had skipped out on the CLC process and were getting slammed through the legislature in a matter of weeks, no one ever would have believed you. And yet. Here we are.
I'm sort of ambivalent about the process by which SB 21 came to life. On the one hand, I get the argument that Delaware has a historic process that has served it well and has been bypassed here. On the other hand, Delaware's historic process consists of the state bar's corporation law council drafting legislation that the legislature then rubber-stamps. It's not exactly a paragon of democratic virtue.
In any case, I seriously doubt whether SB 21 is starting a race to the bottom. Let's assume that the bottom is Nevada (no offense to my Nevada friends, but it's true). Serious scholars like Michal Barzuza and Ofer Edlar have closely scrutinized Nevada law and come away concluding that it is "lax." See Michal Barzuza, Market Segmentation: The Rise of Nevada As A Liability-Free Jurisdiction, 98 Va. L. Rev. 935, 942 (2012) (“Nevada leverages its own competitive advantage by offering lax law.”); Ofer Eldar, Can Lax Corporate Law Increase Shareholder Value? Evidence from Nevada, 61 J.L. & Econs. 555, 556 (2018) (“The migration of firms to Nevada seems to be driven by the laxity of its corporate law with respect to managers . . ..”).
In 2001, for example, Nevada launched an especially aggressive attack on Delaware’s dominance, “as part of a plan to significantly raise franchise taxes for Nevada corporations,” by amending its corporation statute to offer substantially increased protection for managers against liability risk. Bruce H. Kobayashi & Larry E. Ribstein, Nevada and the Market for Corporate Law, 35 Seattle U.L. Rev. 1165, 1170 (2012).
At the time the amendments were adopted, one Nevada legislator objected that they would “protect some corporate crooks” and come “at a terrible price.” Dain C. Donelson & Christopher G. Yust, Litigation Risk and Agency Costs: Evidence from Nevada Corporate Law, 57 J.L. & Econs. 747, 753 (2014). Another complained that if the amendments were adopted “corporate officers and directors would be able to ‘commit virtually any act and get away with it and waste your money .... Scoundrels can move here.’” Id. Overall, critics predicted, the legislation would “impair shareholder litigation rights significantly, and facilitate self-dealing transactions, poor corporate governance practices, and managerial misconduct.” Michal Barzuza, Nevada v. Delaware: The New Market for Corporate Law 6 (Mar. 2024), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4746878.
Delaware has strong incentives not to race Nevada to the bottom. Unlike Nevada’s focus on a small firm market segment, Delaware caters to “larger firms that pay higher franchise fees.” Ofer Eldar & Lorenzo Magnolfi, Regulatory Competition and the Market for Corporate Law, 12(2) Am. Econ. J.: Microecon. 60, 81 (2020). Those firms face substantial pressure from large institutional investors who generally dislike Nevada-style liability protection for directors and officers. See Eldar & Magnolfi, supra, at 64 (“Nevada firms tend to be relatively small with low institutional shareholdings, and that Delaware firms tend to be larger and have significant institutional ownership”).
In addition to the constraining influence of institutional investors, venture capitalists reportedly prefer founders to incorporate in Delaware. See Jennifer Kay, Musk’s Tesla Threats Unlikely to Shake Delaware’s Dominance, Bloomberg News (Apr. 2, 2024), https://news.bloomberglaw.com/litigation/musks-tesla-threats-unlikely-to-shake-delawares-dominance (“Often it’s venture capital firms and other investors who push for Delaware incorporation . . ..”). Likewise, activist investors pressuring incumbent directors to improve firm performance reportedly often include reincorporation into Delaware among their demands. Eldar & Magnolfi, supra, at 65.
In order to placate such investors, firms with such investors are unlikely to opt for a Nevada-like regime. In turn, to placate such firms, Delaware is unlikely to increase the laxity of its laws to match Nevada.
Another important constraint on Delaware’s ability to pursue Nevada-style laxity is the risk of federal intervention. There is an emerging consensus that Delaware’s chief competition is no longer other states but rather the federal government. Although the federal government typically intervenes in corporate governance only in response to financial crises, Delaware is nevertheless highly aware of the threat of federal preemption. Former Delaware Chief Justice Norman Veasey, for example, has repeatedly warned that Congress may preempt Delaware law if Delaware courts fail to uphold its fiduciary duty standards.
Noting these developments, Professor Barzuza argues an effort by Delaware to compete with Nevada by weakening shareholder protections might trigger federal intervention. Barzuza, supra, at 967. Given Delaware’s reliance on maintaining its franchise tax revenue, Delaware cannot risk federal preemption. In contrast, because Nevada corporate law does receive the same level of attention as paid to Delaware law, Nevada’s laxity poses a much lower risk of triggering federal intervention.
This post draws on Bainbridge, Stephen Mark, DExit Drivers: Is Delaware's Dominance Threatened? (July 29, 2024). UCLA School of Law, Law-Econ Research Paper No. 24-04, Available at SSRN: https://ssrn.com/abstract=4909689
