Academic journal article Law and Contemporary Problems

Democracy and the Dominance of Delaware in Corporate Law

Academic journal article Law and Contemporary Problems

Democracy and the Dominance of Delaware in Corporate Law

Article excerpt

I

INTRODUCTION

Delaware has a population less than one-third of one percent of the nation, but it is the state of incorporation for more than fifty percent of U.S. public companies and more than sixty percent of the Fortune 500. (1) Delaware's resulting dominance over the terms of corporate governance in the United States has been the subject of one of the grandest and most persistent debates within corporate law scholarship. Still the question remains whether Delaware's dominance has been the result of, in William Cary's famous phraseology, a "race to the bottom"--toward a legal regime that benefits managers at the expense of the shareholders (2)--or a "race to the top"--toward an efficient, shareholder-centric governance framework. (3) The conventional wisdom is that if the result is a race to the bottom, then Delaware's dominance is illegitimate and a federal chartering statute is appropriate. If the result is instead a race to the top, its dominance simply flows from its success in providing the best, most efficient set of governance laws available. Delaware's dominance is, in other words, a laudable result of the "genius of American corporate law." (4)

This essay will argue that this debate, as popular and notable as it is, is largely beside the point. Even if Delaware's dominance is a race to the top resulting in a corporate law framework that efficiently serves the interests of shareholders, it is still illegitimate. This is because Delaware's ability to define the rules of corporate governance depends on the so-called "internal affairs" doctrine, which provides that the rules governing the internal affairs of a corporation (that is, the rules of corporate governance) originate from the state in which the corporation is chartered. This is in contrast with conflict-of-laws principles that apply in all other areas of law. Typically, the state with the greatest interest in regulating the behavior in question provides the governing law. But under modern incorporation statutes, a corporate charter is extremely easy to obtain, and there is no requirement of any meaningful contact whatsoever with the chartering state. Thus, corporations can, in effect, choose which corporate governance laws will apply to them, regardless of whether they have any other contact with the state whose laws they choose. This ability of corporations to elect their governance law is illegitimate as a democratic matter and inefficient as an economic matter.

A. Delaware's Dominance

Delaware's dominance is staggering. Over 300,000 companies are incorporated there, including nearly three hundred of the Fortune 500. In contrast, the state incorporating the second largest number of Fortune 500 companies (New York) has only twenty-five. In fact, so many companies incorporate in Delaware that incorporation and franchise fees provide one-quarter of total state revenues. (5)

But Delaware has little contact with these corporations besides being the jurisdiction that provides the corporate charter. Of the thousands of corporations incorporated there, only a few have significant numbers of employees or shareholders in the state. Only two Fortune 500 companies, DuPont and MBNA, are headquartered in Delaware. (6) More importantly, even though Delaware has less than 820,000 citizens, (7) its corporate governance rules govern companies with millions of employees. The three hundred largest companies incorporated in Delaware employ over 15 million people, only an infinitesimal fraction of whom actually reside there. The number of employees at Wal-Mart, the largest company incorporated in Delaware, is fifty percent larger than the population of the entire state. (8) Furthermore, Wal-Mart's total net sales in their last fiscal year, $244.5 billion, (9) were more than six times the entire Gross State Product of Delaware. (10)

B. The Internal Affairs Doctrine

Perhaps this would not be so striking if "internal affairs" meant only the narrow relationship between managers and the company. …

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