Delaware's shrinking half-life.

• Author: Roe, Mark J.
• Position: Competition in corporation law

INTRODUCTION I. DELAWARE AS MONOPOLY II. DELAWARE'S CONSTRAINTS I: BUSINESS DYNAMISM AND DELAWARE'S HALF-LIFE A. In flow and Expiration 1. The incorporation rate 2. Changing reincorporation rates 3. Mergers as a source of flow 4. The inflow's composition B. Increasing Flow; Shrinking Installed Base C. The Tax Rate III. CONSTRAINT II: A CONTESTABLE MARKET A. What Is a Contestable Market? B. Who Would Instigate? C. Contestable Markets for 1980s Merger Law D. Contestable Markets in the Dakotas: Credit Cards Charters E. Toeholds IV. CONSTRAINT III: IT'S NOT JUST STATES A. The Federal Overlay 1. Regulatory competence 2. Actions that annoy Delaware's' two major interest groups B. Delaware Moves: Shareholder Access as Contestability on Two Fronts V. YARDSTICK COMPETITION AND PROFESSIONALISM CONCLUSION TABLE OF TABLES Table 1. Exit from and entry into Delaware Table 2. Examples of major reincorporations into Delaware Table 3. Franchise tax payments in 2008, by year incorporated into Delaware Table 4. Franchise tax payments in 1996, by year incorporated into Delaware Table 5. Aging in 2008 of Delaware's 1679 maximum franchise tax payers Table 6. The shortening half-life of Delaware's franchise tax base INTRODUCTION

Corporate law academics have long sought to fully understand the process of state corporate lawmaking. Do states compete to issue corporate charters? Do they compete in a race to the top that hones an efficient law, or one to the bottom, by states currying favor with corporate insiders? For decades the debate was premised upon strong, ongoing state-to-state competition, with sharp disagreement on the directionality of that competition. In this decade, however, a powerful revisionist perspective has emerged that states do not compete, leaving Delaware alone with a monopoly in the interstate charter market. Marcel Kahan and Ehud Kamar showed in their influential The Myth of State Competition in Corporate Law in the Stanford Law Review that no state other than Delaware actively seeks chartering revenues and concluded, as the title indicates, that states just do not compete. (1) Their perspective has proven to be convincing. Ronald Gilson said in describing the coalescing consensus to a European corporate audience, "Kahan and Kamar ha[ve] demonstrated [that] there is no[] competition for corporate charters in the U.S. [and] no competition among states for the revenue from incorporation...." (2) Others offer similar views, sometimes with differing analytics. (3)

Now that we know that ongoing franchise tax competition is weak, we need to reframe the inquiry to examine the constraints that Delaware does face. No state is poised to take franchise revenues away from Delaware. If that kind of state competition just isn't in play, does Delaware have unlimited discretion? If not, where do those limits come from?

First, Delaware faces a unique constraint that hasn't yet been analyzed, perhaps because it historically was weak. Even if no other state actively competes for chartering revenue, Delaware itself must vie to sell new charters because it needs to draw reincorporations from other states, as its own charters disappear as firms merge and disappear. Conceptually, this is clear. The question, then, is one of degree. When business turnover was slow, this competitive channel was not particularly important. But as corporate restructurings, spin-offs, mergers, and turnover have accelerated, this competitive channel has become increasingly important for Delaware. Indeed, it has squeezed the half-life of its tax base down from a quarter century to a decade.

Second, another state, North Dakota, actively entered the market for corporate charters, drawing intense attention from Delaware and increasing attention from corporate dealmakers and corporate law academic analyses. It's captured few reincorporations yet--and, hence, little in franchise fees--but the potential can constrain Delaware.

And, third, Washington, D.C. has always been a corporate governance player. Moreover, in the scandals of the early part of this decade and the economic turmoil of the latter part, its persistent role, and its potential to displace and sometimes affect state lawmaking, has become increasingly vivid.

The first channel deserves further attention. Typically, we lack data on the intensity of any competition and its growth or decline. But below I describe data the Delaware Secretary of State's office provided that show flow and turnover of Delaware's tax base to be substantial in the past decade. Although ongoing state-to-state competition for chartering revenues is somnolent, as has been shown, competition in American business--in the real economy--is not. The dynamism of the real economy interacts with the structure of the chartering market to create a major arena where Delaware must continually vie for charters.

The data reveal another trend: just as we corporate law academics were concluding that state chartering competition wasn't happening, this pressure on Delaware to maintain flow has increased. Briefly put: only a couple of decades ago, the half-life of Delaware's tax base was on the order of a quarter century. That posed a real consideration for Delaware, but was long enough not to be of immediate concern to the typical career state official, legislator, or Delaware lawyer. This pressure on Delaware has intensified, however--due to increasing pressures coming from the real economy interacting with the structure of Delaware's tax rules--to reduce the half-life of Delaware's tax base from a quarter century down to a decade.

Delaware must continually provide enough value to new firms arising in other states (and to their controlling decisionmakers) to induce them to reincorporate into Delaware. The current focus on whether state lawmakers are sufficiently dynamic and competitive is certainly warranted, but it's not the whole story. (4) Even if states are insufficiently dynamic and competitive, American business is dynamic. Firms arise, prosper, and merge; others arise, fail, and disappear. For Delaware's importance to persist over the decades, it must convince new and growing firms to reincorporate away from their home states.

Delaware faces other constraints. We can call those constraints competitive ones, if we expand our concept beyond ongoing competition for chartering revenue. Or we might just think of them as pressures and constraints on Delaware from being a fully free agent in its corporate decisionmaking. Delaware must be wary of making a major mistake, one that would not just induce the inflow to dry up, but that could induce a previously inactive state to enter the market, conceivably in a way that could irreversibly erode Delaware's existing base of charters if corporate America becomes unhappy with Delaware. Even states not actively seeking charters can potentially compete in this limited sense with Delaware. Such a concept has a parallel in the industrial organization literature on contestable markets: a single producer can putatively dominate a market, but it could lose its market share overnight. Hence, it acts like a competitor on some matters, or knows it must provide an overall package that is attractive to its primary customers. It has slack, but that slack is not unlimited, because its market, like Delaware's, is contestable.

In this dimension as well, the focus on slow state bureaucracies and uninterested state legislatures is justified but easy to overemphasize. The relevant actors are interests already in Delaware who become unhappy with Delaware corporate policy. These interests are not passive consumers, forced by the absence of another state purveying its own corporate law to accept whatever Delaware decides to offer. They can approach another state's lawmakers, ask for new law, offer that state the tax benefits of the law, and even do the needed legal drafting; they are the ones who would motivate and press Delaware to change. And, as if to demonstrate this possibility, shareholder activists, unhappy with Delaware law, went shopping for a friendly state in the past couple of years and found one--North Dakota--to put competitive pressure on Delaware. I discuss this entry and its precursors below.

Delaware, despite not facing the intense Economics 101 competition of many competing producers of corporate law, faces a contestable market, and that contestability limits the breadth of Delaware's discretion. Its position, hence, is contestable horizontally, subject to several powerful interstate pressures. And it is contestable vertically, subject to pressures from Washington. For example, Delaware legislation passed in March 2009 could change core parts of corporate law dealing with election contests and access to the company's proxy statement. That legislation is best understood as motivated by one or both of these dimensions to competition.

That Delaware competes in some (albeit possibly weak) sense seems indisputable: its principal lawmakers are active, involved, and energetic. A simple conversation with a Delaware judge or corporate lawyer, or an hour spent reading recent court opinions, would disabuse one of the notion that Delaware players are sloppy monopolists unconcerned about the professionalism of their product. Indeed, an astute inside commentator tells us that even if Delaware has won some race or another, "no one in Delaware is willing to play hare while some other state tortoise gains ground." (5)

Delaware players worry. The task I set out to accomplish in this Article is to better understand what they have to be worried about.

1. OUTLINE OF THE CASE THAT DELAWARE IS A MONOPOLY

   Consider first the raw numbers at the heart of the currently emerging consensus. Half of American public firms have Delaware charters. (6) Of those firms reincorporating from one state to another, 85%, the overwhelming majority, move to Delaware. (7) And recent analyses tell us that 97% of America's public firms...