Advantages of Competition for Corporate Charters Roberta Romano Yale Law School and National Bureau of Economic Research Yale Law School International Symposium on: Assessing Corporate Law Reform in the Transatlantic Context Paris, October 21, 2003

Benefits of Competition Improved incentives for promoters Improved incentives for regulators Innovation and experimentation Bottom-up vs. top-down harmonization

How does the U.S. corporate charter market work? Firms choose a statutory domicile from among 50 states and District of Columbia Statutes are enabling Substantial uniformity in content: significant reforms diffuse across states Delaware is the dominant choice of public corporations

Reasons for Delaware’s success Responsive to corporate concerns (first or second in corporate law reform) Credible commitment to be responsive: 17% of total tax revenues from franchise fees Investment in corporate-law specific assets (legal capital) Constitutional requirement of supermajority to amend corporation code

Is the race to the bottom or the top? Evidence toward the top –Event studies report positive price effects on change in domicile –Higher Tobin’s Q for Delaware firms (Daines 2001) Evidence toward the bottom –Event studies of takeover statutes report negative price effects –Successful states have takeover statutes but Delaware is the exception Conclusion: on balance, shareholders have benefited from competition

Reincorporation Event Studies Hyman (1979)26 firms Significantly higher mean price change day -2, week of event and of meeting for DE reincorporations. (S&P index adjustment) Dodd and Leftwich (1980) 140 firms Significantly positive two years before event (monthly data) Romano (1985)150 firms Significantly positive 3-day and week around event, and month before event Peterson (1988)30 firms Positive significance at 10% for 16-firms not reincorporating for takeover defense purposes on days -1, +3 and +10 Bradley and Schipani (1989) 32 firms Significantly positive on event and one month before Netter and Poulsen (1989) 36 firms Positive significance at 10% one month around event Wang (1995)145 firms Significantly positive 3-day around event; DE subsample significantly positive 40 days before and positive significance at 10% 3-day interval around event Heron and Lewellen (1998) 364 firms Significantly positive 4-days post-event plus meeting date for 59 firms reincorporating to limit liability; significantly negative 4 days post-event plus meeting day for 45 firms reincorporating for takeover defense purposes and 168 firms reincorporating for takeover defense and other purposes

Selected Takeover Statute Event Studies: Multiple Statutes Karpoff and Malatesta (1989) 40 statutes, 30 states Significant negative CAR over 2-day press date Mahla (1991)49 statutes, 30 states Significant negative AR day 2 and 3 pre-1987 statutes; post-1987 significant at 10% Pugh and Jahera (1990) 5 statutes, 1 vetoed, 4 states Insignificant; negative CAR on introduction +2 days significant at 10%

Selected Takeover Statute Event Studies: Business Combination Statutes Karpoff and Malatesta (1989)Multiple statesSignificant negative CAR over 2-day press date Mahla (1991)Multiple statesSignificant negative AR event date Karpoff and Malatesta (1989)DelawareInsignificant Jahera and Pugh(1991)DelawareSignificant positive CAR over 8 2-day events Pugh and Jahera (1990)IndianaInsignificant Broner (1987)New JerseySignificant negative CAR 10 days around Senate Approval Margotta and Badrinath (1987) New JerseyInsignificant Pugh and Jahera (1990)New JerseyInsignificant Schumann (1988)New YorkSignificant negative CAR over 3 day legislative event Karpoff and Malatesta (1989)New YorkInsignificant Pugh and Jahera (1990)New YorkSignificant positive CAR between introduction and passage by first chamber

Effects of Domicile differences on Antitakeover Protection

Issues for Competition in the EU (raised by ECJ’s rejection of real seat rule) Development of incentives for nation states –Franchise fees –Competition among organizational forms –Tax on cross-border domicile changes –Concentrated ownership structures Harmonization impetus –Potential for changes in company law –Nonshareholder wealth- maximizing objectives in company laws

E.U. Company Law Directives compared to U.S. Corporate Codes Of 131 directive provisions, 95 in no U.S. states; 14 in all 50 states; rest random Higher mandatory content in directives (e.g. minimum capital) Rules long eliminated in U.S. (e.g. legal capital rules on distributions, par value) (Source: Carney 1996)

Conclusion State competition produces innovative, responsive corporation codes Best available evidence indicates that the product, for the most part, benefits investors –Race is to the top but non-linear (takeover statutes) – Short-run deviations face self-correcting pressure from competition, which would be absent in non- competitive context Expected changes in EU company laws (on some dimensions may come closer to US codes) in absence of harmonization efforts, should benefit shareholders