Itís Time To Federalize Corporate
Delaware And Other
States Arenít Tough Enough
|Kent Greenfield is an Associate
Professor at Boston College Law School and a corporate law
scholar. He is an expert on the role of corporations in
society, the legal obligations of corporate managers, and the
responsibilities of corporations toward their
Among the reforms proposed in response to
the recent spate of corporate scandals, one that could make a real
difference has not been mentioned: the idea that corporate
governance should be a matter of federal rather than state law.
Currently in the United States, the rules governing the internal
management of corporations come not from the U.S. Congress but from
the various states. Most of the largest U.S. corporations -- 60
percent of the Fortune 500 -- are incorporated in Delaware, mostly
because it is protective of their managerial interests.
Because of a quirk in corporate law, the state that governs a
company's management practices is not the state where the firm is
headquartered, or even where it employs the most people. The laws of
corporate governance come from the state where the company gets its
corporate charter, which is easier to get than a driver's license.
So managers can hunt around for the state that offers the most
advantageous set of laws and incorporate there. The managers can
then go back to Texas, California, Massachusetts, or wherever and
act as if nothing is odd about having the firm be run according to a
charter issued by a state that has little or no interest in the
company. Their employees and creditors, not to mention the
communities where they do business, have little to say about it.
States compete to issue these corporate charters, because
incorporation fees can fatten what would otherwise be lean state
budgets. It is no coincidence that the state that has won this
competition, Delaware, has taken a largely laissez faire attitude to
directorial oversight of everything from outlandish managerial
compensation to companies' compliance with laws. Indeed, Delaware
allows companies to include provisions in their charters that limit
directors' potential liability if they fail to take their
responsibilities seriously. Delaware has also refused to pass a
"stakeholder statute," which would allow directors to consider the
interests of employees and other stakeholders when important
decisions are made.
Delaware courts have long been reluctant to disturb the decisions
of corporate boards. It should be no surprise, then, when directors
grow complacent and inattentive. Only when such docility costs
shareholders billions do they notice that they have little recourse.
Many corporate law scholars applaud Delaware, saying that
competition among states makes for more efficient laws. But that
depends on what "efficiency" means. If another state wants to be
more aggressive in fighting corporate crime or protecting
shareholders, employees, or communities, it runs the risks that its
companies will simply re-incorporate in Delaware. So most states end
up mimicking Delaware law.
There has been a lot of talk from the Bush administration and
Congress about what to do about the gladiatorial culture among the
nation's business elite. Most of the proposed reforms focus on
ensuring the truthfulness of companies' books, which is rightly seen
as essential for a trustworthy securities market. But focusing on
the securities market is like trying to stop the sale of rancid meat
by regulating supermarkets. You have to go where the disease begins.
With Enron, WorldCom and their ilk, the disease begins not with how
they issue their stock but how they are managed. If the board does
not provide meaningful oversight, if laws are disregarded in order
to maximize profit, if the interests of shareholders, employees,
communities, and society are ignored, then the disease will remain
Federal chartering has been a popular idea at various times in
our history, most recently during the late 1970s. Corporate crime
was in the headlines, then, too, as almost 400 firms admitted to
bribing foreign or American officials or making illegal campaign
contributions. The idea of federal charters was dropped after the
Reagan victory of 1980, but it deserves resuscitation now.
If Bush and Congress are serious about reforming corporate
behavior and protecting the public interest, they cannot leave
Delaware or other states in charge of corporate chartering. The only
way out of this mess is to have corporate law be federal law, and
for Congress or the SEC to define the obligations of corporate
managers and directors.
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Published: Jul 26 2002