The Mandatory Disclosure of State Corporate Law

• Publication year: 2021
• Citation: Vol. 86

86 Nebraska L. Rev. 795. The Mandatory Disclosure of State Corporate Law

795

Christopher Gulinello(fn*)

The Mandatory Disclosure of State Corporate Law

TABLE OF CONTENTS

I. Introduction ....................................................... 796
II. The Disclosure of State Corporate Law under Our
Current System .................................................... 800
III. The Importance of State Corporate Law to Investors in
Public Companies ................................................. 803
A. The "triviality" or irrelevance of corporate law .............. 804
B. Relying on voluntary disclosure as a proxy for
relevance ..................................................... 807
C. A substitute for disclosure of state corporate law?--
disclosure of firm-level rules ................................ 809
D. Evidence of the importance of state corporate law--
the debate on the competition for corporate
charters ...................................................... 811
E. Evidence of the importance of state corporate law--
empirical studies ............................................ 813
F. Preliminary conclusion ........................................ 815
IV. The Benefits of Mandatory Disclosure of State
Corporate Law ..................................................... 816
A. The efficient capital market hypothesis ("ECMH")............... 816
B. The ECMH and the disclosure of state corporate
law ............................................................ 818
C. The information costs of state corporate law ................... 819
D. Reducing information costs for investors through
mandatory disclosure ........................................... 820
E. Information costs for the company .............................. 822
F. The implications of substantial uniformity of state
corporate laws on information costs ............................ 823
G. Reducing the costs of unincorporated information ............... 826

826

H. "Piecemeal incorporation" of state corporate law
information .................................................... 829
I. Market solutions ............................................... 831
J. Preliminary conclusion ......................................... 832
V. The Costs of Mandatory Disclosure of State Corporate
Law ................................................................ 833
A. Administrative costs ............................................ 833
B. Liability costs ................................................. 833
C. Avoidance costs ................................................. 834
D. "Information overload" costs .................................... 835
E. Preliminary conclusion .......................................... 836
VI. Conclusion ........................................................ 836

I. INTRODUCTION

In the United States, the relationship between investors and the managers of public companies is governed by a combination of state and federal law. Traditionally, state corporate law(fn1) has provided the substantive rules that govern the relationship between management and investors. Federal law, on the other hand, has provided rules requiring public companies to provide investors with information. Although one may argue that the federal government has become more involved in providing substantive rules for the governance of public companies in recent years,(fn2) the distinction between how state law and federal law affect the governance of public companies remains true in most respects.(fn3)

Despite the central role state corporate law plays in the governance of public firms and despite the intense focus legal academia places on state corporate law (evidenced by the in-depth treatment of the subject in casebooks, legal hornbooks, and law review articles), public companies are not required to disclose information about the

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corporate law of their respective states of incorporation in their regular disclosures to the market (i.e., the disclosures companies first make when they first go public and the annual and quarterly disclosures they must make thereafter). The message to the investor is clear: If you want to know how state corporate law affects the public company, you must gather this information yourself.

Of course, gathering this information would be relatively simple if all public companies were subject to one corporate law. However, they are not. Although the State of Delaware may dominate the market for incorporation of public firms, roughly forty percent of public firms in the U.S. incorporate in states other than Delaware,(fn4) and nearly every jurisdiction in the United States is the state of incorporation for at least one public company.(fn5)

The implicit assumption of our current disclosure regime is that there is insufficient justification for requiring disclosure of state corporate law. In this Article, I challenge that assumption and question why we do not require public companies to disclose specific information on state corporate law. Indeed, because arguments against mandatory disclosure of state corporate law are not particularly strong, and because the market would receive significant benefits from such disclosures, I conclude that we should require public companies to disclose certain aspects of state corporate law as part of the regular disclosures they make to the market.

Requiring public companies to disclose any information is controversial. There has been strong opposition from some legal scholars to any kind of mandatory disclosure for public companies.(fn6) The scholars who call for the elimination of mandatory disclosure subscribe to the idea that regulators are in a relatively poor position to determine the scope and content of a socially optimal disclosure regime. They argue that if public companies desired to exploit the market for capital, they would provide the market with the information the market de

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manded.(fn7) For this group of scholars, a voluntary disclosure system would be the best way to achieve socially optimal disclosure.

Another group of scholars stops short of calling for the elimination of mandatory disclosure but argues the current system is in need of reform.(fn8) These scholars concede the need for mandatory disclosure rules but argue the federal government should not hold a monopoly on the authority to make these rules.(fn9) They propose that each of the various states should be allowed to regulate the disclosures of public companies.(fn10) A public company would choose the state it feels provides optimal disclosure rules by incorporating in that state and subjecting itself to that state's securities laws.(fn11) The proponents of this system, borrowing from the literature on the competition for corporate charters,(fn12) argue that competition between the states for incorporation revenues would result in a disclosure regime that at least fairly approximates a socially optimal one.(fn13)

Finally, there are scholars who support our current federal mandatory disclosure regime.(fn14) These scholars argue that eliminating mandatory disclosure rules altogether and relying on market forces ignores the real possibility of market failure.(fn15) They further argue that those who call for a competitive system of state disclosure regimes fail to recognize that the states may have little incentive to participate in such a competition and that the resulting disclosure regimes would have a bias towards underdisclosure.(fn16)

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In this Article, I do not take a position on the more general issue of the propriety of a federal mandatory disclosure regime for public companies. A federal mandatory disclosure regime is a fact of life in America, and, for now at least, public companies and scholars need to work within that rubric.(fn17) However, one clear lesson to be learned from the debate on mandatory disclosure is the importance of engaging in critical review of the content and scope of the information we require companies to disclose. Indeed, when regulators substitute their judgment for that of a competitive market, there needs to be frequent and robust debate on their decisions. The only hope for such a system to even come close to achieving socially optimal disclosure is through continual discussion and review of the scope and content of mandatory disclosure.(fn18) In this Article, I attempt to lay the groundwork for further discussion and debate on requiring public companies to disclose information about the corporate law of their respective states of incorporation.

The content of a public company's disclosures should provide investors with information that will aid them in determining whether to invest in the securities of a public company and, if they do invest, how much to pay for these securities. Using this information, investors can protect themselves from investment risks by either refusing to invest in a company or by adjusting the price they are willing to pay for the securities in order to accommodate for the risk.(fn19) When investors price securities based on certain information, they are not only protecting themselves--they are also helping to incorporate that information into the market price of the securities. When the market prices of securities reflect all relevant information, the economy as a whole benefits from a more efficient allocation of investment capital.(fn20)

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Mandatory disclosure plays an important role in this process by providing the market with the relevant information it needs.(fn21)

The information investors use to evaluate a company may be related to the future prospects of the company's main line of business, or it may be related to the possibility that the managers of the company will use their control over the company to expropriate benefits for themselves at the expense of the company and the shareholders. This...