The influence of antitakeover statutes on incorporation choice: evidence on the "race" debate and antitakeover overreaching.

AuthorSubramanian, Guhan
PositionRace to the bottom

Commentators have long debated whether competition among states for corporate charters represents a race to the top or a race to the bottom. Race-to-the-top advocates recently have gained ground in this debate on the basis of the general corporate migration to Delaware in the 1990s and empirical evidence suggesting that Delaware incorporation increases shareholder wealth. This Article uses second-generation state antitakeover statutes to shed additional light on this debate. I use a new database of reincorporations from the 1990s to show that managers generally migrate to (and fail to migrate away from) typical antitakeover statutes. Given the robust econometric evidence that these statutes increase managerial agency costs and reduce shareholder wealth, my results are generally consistent with the race-to-the-bottom view. However, I also find some evidence that managers migrate away from the more severe antitakeover statutes in Massachusetts, Ohio, and Pennsylvania, through incorporation choice and opt-out from these statutes. This finding introduces the possibility of "overreaching" in the corporate charter marketplace and suggests potential limits on the race to the bottom. The results have implications for recent developments in corporate charter competition in both the United States and the European Union.

INTRODUCTION

One of the most important questions in U.S. corporate law is whether competition in the corporate charter market represents a "race to the top" or a "race to the bottom." The answer has implications for whether and to what extent federal legislation should pre-empt state corporate law. Ralph Winter, (1) Frank Easterbrook, (2) Daniel Fischel, (3) and Roberta Romano (4) have argued that states compete against each other to offer laws that maximize shareholder value, resulting in a race to the top. William Cary, (5) Lucian Bebchuk, (6) Alma Cohen, (7) Alien Ferrell, (8) and (in the political arena) Ralph Nader (9) have argued that states cater to managers, whose self-interest often can diverge from the interests of shareholders, resulting in a race to the bottom at least with respect to certain issues.

Commentators on both sides of the debate have noted that their opposing views in fact share fundamental assumptions about the social welfare goal (maximization of shareholder wealth), the states' objective (maximization of incorporation revenue), and managers' decision rule (pursuit of self-interest). (10) The two views differ only in their assessment of managers' ability to pursue private benefits of control. Race-to-the-top proponents argue that managers are to a large extent prevented from pursuing their self-interest to the detriment of shareholders by marketplace discipline--notably the capital market, the product market, and the market for corporate control. Race-to-the-bottom proponents argue that these forces do not effectively constrain managers.

In the 1970s, the race-to-the-bottom view held sway. In 1976, for example, Richard Jennings stated that the race-to-the-bottom view was "common knowledge," (11) and a year later Winter stated that "[i]t is almost universally the opinion of academic commentators that state corporation codes do not impose sufficiently stringent controls on corporate management and are lax in protecting shareholders." (12) Yet in the 1980s and 1990s commentators documented the many benefits of Delaware incorporation and argued that the growing tide of reincorporations to Delaware was evidence against a race to the bottom. (13) This argument gained empirical validation through the recent work of Robert Daines, who provided evidence that Delaware firms have higher Tobin's Qs than non-Delaware firms. (14) By the mid-to-late 1990s the conventional wisdom among academic commentators had shifted to the race-to-the-top view. In 1995, Michael Klausner stated that "there is broad consensus that state competition to produce corporate law is a race to (or at least toward) the top." (15) In 2000, Jill Fisch reported that "[m]ost corporate law scholars ... align themselves with Winter." (16) This consensus represents a dramatic turn from the "almost universal[]" endorsement of the race-to-the-bottom view two decades earlier. (17)

Along with contemporaneous work by Bebchuk and Cohen, (18) this Article takes a new approach to assess the nature of competition in the corporate charter marketplace. The starting point for the analysis is the wave of antitakeover statutes that were passed by a majority of states in the late 1980s and early 1990s. Econometric analyses of these statutes consistently find that they reduce shareholder wealth; the most common explanation is the expectation (whether correct or not) (19) that such statutes reduce the likelihood of a takeover and hence reduce the likelihood of a takeover premium for shareholders. Antitakeover statutes also seem to increase managerial agency costs at an operational level. (20)

These findings from the financial economics literature provide the opportunity for a relatively clean empirical test: do managers migrate to or away from antitakeover statutes? Race-to-the-top theorists predict that managers will migrate away from such statutes. (21) Race-to-the-bottom theorists predict that managers will migrate to such statutes. (22) Examining managers' response to antitakeover statutes, then, focuses squarely on the critical question--the question on which the debate turns--as to whether managers can pursue private benefits of control to the detriment of shareholders.

Using a large sample of U.S. public companies, I find evidence that managers generally migrate to antitakeover statutes. Specifically, I find that managers of public companies are 26% more likely to remain in their headquarters state (instead of incorporating in Delaware or in a third state) if the headquarters state has a control share acquisition statute, a business combination statute, and a pill validation statute, the three statutes often thought to be the most important among the typical "second generation" state antitakeover statutes. I also find that fair price statutes, which do not seem to reduce shareholder value, also do not seem to influence the incorporation decision. Thus, managers migrate to antitakeover statues that are generally thought to reduce shareholder value, and are not influenced by antitakeover statutes that do not. These results continue to hold when I examine the flow of reincorporations from the 1990s rather than the stock of incorporations in 2000. Viewed as a whole, these results are generally consistent with the race-to-the-bottom view.

However, closer analysis of the most potent antitakeover statutes--in Pennsylvania, Massachusetts, and Ohio--suggests limits on this view. I find some evidence that managers migrate away from these statutes, both through their incorporation decisions and through opt-out. This finding suggests potential limitations on managers' ability to entrench themselves, perhaps due to the emergence of institutional shareholder activism in the 1990s, and suggests that these three states may have "overreached" in the corporate charter marketplace.

In general, these results support the view that the federal government should play a greater role in providing corporate law for U.S. public companies. (23) They also suggest that recent movements in the European Union toward greater competition for corporate charters among member states may be misguided. Finally, these results have counterintuitive implications for one specific development in the U.S. corporate charter marketplace. Race-to-the-bottom theorists point to Maryland's Unsolicited Takeover Act of 1999--by far the most potent antitakeover statute that has appeared to date--as the latest and most extreme manifestation of their view. Yet the empirical evidence from the experience in Pennsylvania, Ohio, and Massachusetts suggests that Maryland may have overreached.

The remainder of this Article proceeds as follows. Part I provides background information on the corporate charter marketplace and reviews the prior literature. Part II presents basic descriptive statistics. Part III presents the methodology and results from the empirical tests. Part IV examines the experience of Pennsylvania, Ohio, and Massachusetts, three states with potent antitakeover statutes. Part V provides implications of these results for recent developments in the United States and in the European Union.

  1. BACKGROUND

    1. Competition in the Corporate Charter Market

      U.S. corporations are governed by their state of incorporation, regardless of the location of their headquarters or where they conduct their business. Corporations are not constrained by their headquarters, location of manufacturing facilities, place of business, or other operational factors in deciding where to incorporate. (24) Moreover, reincorporation from one state to another is relatively inexpensive, (25) and typically qualifies as a tax-free reorganization under [section] 368(a) of the U.S. tax code. (26) The most important constraint on reincorporations is procedural rather than economic: because corporations generally reincorporate by merging into a new company that is incorporated in the destination state, and because mergers generally require board authorization and shareholder approval, (27) managers (and the board) cannot reincorporate on their own, nor can shareholders propose reincorporations on their own.

      States compete to have companies incorporated within their boundaries in order to maximize their corporate charter revenues. (28) New Jersey was the original leader in this market, (29) but lost its lead to Delaware after making restrictive amendments to its corporate law in 1913. (30) Delaware quickly gained a dominant share and never looked back: by 1965, 35% of companies listed on the New York Stock Exchange (NYSE) were Delaware companies; (31) by 1973 this number had risen to 40%; (32) and by 2000...

To continue reading

Request your trial

VLEX uses login cookies to provide you with a better browsing experience. If you click on 'Accept' or continue browsing this site we consider that you accept our cookie policy. ACCEPT