For Optional Federal Incorporation
Dent, George W., Journal of Corporation Law
For decades, state chartering of public corporations and Delaware's domination of this activity have been criticized by many business law scholars.1 They believe, as Bill Cary put it, that Delaware has led a "race for the bottom" that has "watered the rights of shareholders . . . down to a thin gruel."2 To escape this "race for the bottom," some have urged mandatory federal chartering of public corporations.3 Even among critics of state chartering, this position has never commanded broad support for fear that mandatory federal incorporation would only make matters worse.4 Whatever the flaws of incorporation in Delaware, they cannot be too bad, or investors would flee Delaware corporations for companies chartered in other states. Because mandatory federal incorporation would preempt all competition, it threatens abuse with no means of escape.
This objection disappears, though, if federal incorporation were voluntary.5 The federal government then would simply offer a 51st option that would be elected only if superior to the other 50. If the choice were entrusted to shareholders, they could escape the status quo in which states compete for franchise fees primarily by appealing to corporate executives. Even if federal incorporation never became dominant, its potential appeal to investors would prod Delaware to pay them more heed.
Part I of this Article describes the current corporate governance problem and defects of state chartering. Part II explains why federal incorporation is likely to be superior. Part III weighs and rejects mandatory federal incorporation of public companies. Part IV argues for optional federal incorporation.
I.WHY FEDERAL INCORPORATION?
A. The Growing Corporate Governance Problem
Complaints about corporate governance have been voiced for as long as there have been public companies. The central problem was long ago identified as the separation of ownership and control-executives (especially the chief executive officer (CEO)) held sway and could run public companies to their own advantage and at the expense of the shareholders.6 In theory, a corporation is "managed by or under the direction of a board of directors."7 Also in theory, the directors are chosen by (and thus responsive to) the shareholders. The executives are hired hands who serve at the pleasure of the board. In practice, however, CEOs deeply influence, if not entirely dominate, their boards.
Recent developments show that the corporate governance problem has not abated and may indeed have worsened.8 Executive compensation at public companies has ballooned to wild excess.9 Worse, the compensation plans of many CEOs have little to do with the success of the company.10 Stock options are intended to motivate CEOs to raise the firm's stock price, but many boards back-date or "spring load" options so that CEOs profit even if the stock does not appreciate.11
The current economic downturn has revealed another facet of the problem. The compensation plans of many CEOs offer them lavish rewards if their companies prosper, but leave them unscathed if their companies flounder. In other words, managers and stockholders share in the good times, but in bad times the shareholders alone suffer all the losses.12 Not surprisingly, CEOs respond to these incentives by committing their companies to huge risks.13 This strategy disastrously exacerbated the damage to investors when the economy and the stock market collapsed. Obviously corporate boards were not protecting shareholders when they adopted these plans.
The flight of capital abroad has underscored America's corporate governance problem. Until recently the United States was unrivaled as an investment venue. Now many countries protect investors better than America does.14 As the Paulson Committee found, the resulting exodus of investors threatens to deprive American industry of the funds needed for robust growth.15 The costs of our poor corporate governance are large. …