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Beyond Competition for Incorporation UC Berkeley Law and Economics Workshop Title Beyond Competition for Incorporation Permalink https://escholarship.org/uc/item/8dx735c2 Author Kamar, Ehud Publication Date 2005-10-01 eScholarship.org Powered by the California Digital Library University of California BEYOND COMPETITION FOR INCORPORATIONS Ehud Kamar* October 2005 Forthcoming in the Georgetown Law Journal This Article documents and analyzes a powerful form of regulatory competi- tion — competition for investments — that has transformed national corpo- rate laws in the European Union in recent years. Unlike the competition for incorporations that shapes Delaware corporate law and, by some accounts, the corporate laws of other American states as well, competition for invest- ments sparks innovation in corporate law when firms cannot incorporate outside the jurisdiction in which they operate, and is designed to attract in- vestments in local businesses rather than incorporations by foreign busi- nesses. The high political payoffs that await successful participants in the competition for investments enable them to overcome opposition that could stifle competition for incorporations. And, together with the fact that no single jurisdiction in the European Union can dominate the market for in- vestments, these payoffs drive multiple jurisdictions, including large ones, to compete. Allowing firms to incorporate outside the jurisdiction in which they operate, as a recent series of European Court of Justice rulings re- quires, may or may not breed competition for incorporations. Either way, however, as long as the competition for investments does not lose its steam, the effect on firms will be quite the same. Judging from the reforms that the competition for investments has fueled so far, the effect will be positive. * Visiting Professor, New York University School of Law; Associate Professor, Uni- versity of Southern California Law School; [email protected]. I would like to thank Scott Altman, Jennifer Arlen, Oren Bar-Gill, Lily Batchelder, Stephen Choi, Guido Ferrarini, Ronald Garet, Elizabeth Garrett, Jeffrey Gordon, Gillian Hadfield, Ernst Hirsch Ballin, Marcel Kahan, Gregory Keating, Daniel Klerman, Marja Lutsep, Ruth Mason, Edward McCaffery, Arkadiusz Radwan, Brian Raphael, Nicolai Schwarz-Gondek, John Steines, Eric Talley, Mark Weinstein, and workshop participants at the Harvard Law School and Swiss Institute of Technology Conference on Corporate Lawmaking in the European Union held on October 29-30, 2004, the 2005 Annual Meeting of the American Law and Economics Association, and the law schools of Fordham University, New York University, Southwest- ern University, University of Southern California, and University of Texas for helpful comments. TABLE OF CONTENTS Introduction .............................................................................................2 I. Competition for Investments.............................................................. 8 A. The Old Way: Tax Incentives .................................................. 8 B. The New Way: Corporate Law................................................ 11 II. The Incentives to Compete...............................................................27 A. Benefits .................................................................................. 28 1. Competition for Incorporations........................................ 28 2. Competition for Investments............................................. 31 B. Costs....................................................................................... 38 1. Competition for Incorporations........................................ 38 2. Competition for Investments.............................................45 III. Normative Implications................................................................. 49 A. Competition for Investments and Competition for Incorporations Compared..................................................... 50 1. Who Competes and How .................................................. 50 2. Firms Whose Costs of Incorporating Abroad Are Low .....53 3. Firms Whose Costs of Incorporating Abroad Are High ....54 B. The Effects of Firm Choice on the Competition for Investments ............................................................................57 1. The Incentives to Compete ................................................57 2. The Effects on Firms ......................................................... 62 3. Competition for Incorporations as a Complement............63 Conclusion............................................................................................. 64 INTRODUCTION The notion that jurisdictions may compete for incorporations by tailoring their corporate laws to the preferences of corporate decision- makers has long fascinated legal commentators. It is easy to see why. The competition paradigm provides a powerful analytical tool for evaluating the entire body of corporate law without needing to ponder the merits of every detail. All one needs to do is examine the prefer- ences of those who make incorporation decisions. As long as corporate decisionmakers prefer laws that maximize the value of the firm, jurisdictions will produce such laws. Nearly half a century of legal scholarship has produced scores of articles explaining state corporate laws in the United States as a 2 product of just such competition. The basic facts are undisputed. First, firms in the United States are free to incorporate in any one of fifty states and the District of Columbia regardless of where they conduct their business. Second, states introduce legal innovations and copy from each other. And third, the state that innovates and copies more than any other — Delaware — prospers by attracting the most incorporations. These facts leave no doubt that Delaware competes for incorporations. Commentators only disagree over whether other states also compete,1 and whether corporate decisionmakers push the compe- tition in a desirable direction.2 From here it is a small step to apply the same analysis to other parts of the world, with the European Union as a natural place to start.3 Only the European Union does not meet a necessary condition for a market of incorporations to evolve. Unlike American states, most member states in the European Union follow the so-called real-seat rule, which prevents companies operating in these member states from 1 Compare Marcel Kahan & Ehud Kamar, The Myth of State Competition in Corpo- rate Law, 55 Stan. L. Rev. 679 (2002) (arguing that no American state but Delaware is actively pursuing incorporations), Lucian Bebchuk & Assaf Hamdani, Vigorous Race or Leisurely Walk: Reconsidering the Debate on State Competition over Corporate Charter, 112 Yale L.J. 553 (2002) (same), Ronald Gilson, Presentation at the American Law Institute and the European Corporate Governance Institute Conference on Regulatory Competition and Subsidiarity in Corporate Governance in a Transatlantic Perspective, http://www.ecgi.org/ tcgd/launch/gilson_speech.php (Jul. 12, 2004) (same), Melvin Eisenberg, Presentation at the American Law Institute and the European Corporate Governance Institute Conference on Regulatory Competition and Subsidiarity in Corporate Governance in a Transatlantic Perspective, http://www.ecgi.org/tcgd/launch/eisenberg_speech.php (Jul. 12, 2004) (same), and Mark J. Roe, Delaware’s Competition, 117 Harv. L. Rev. 588 (2003) (arguing that Delaware’s real competition is the federal regulator), with Roberta Romano, Is Regulatory Competition a Problem or Irrelevant for Corporate Governance?, 21 Oxford Rev. Econ. Pol. 221 (2005) (arguing that all American states pursue incorporations). 2 Compare Roberta Romano, Law as a Product: Some Pieces of the Incorporation Puzzle, 1 J.L. Econ. & Org. 225 (1985) (arguing that competition produces efficient law), Daniel R. Fischel, The “Race to the Bottom” Revisited: Reflections on Recent Developments in Delaware’s Corporation Law, 76 Nw. U. L. Rev. 913 (1982) (same), Ralph K. Winter, Jr., Shareholder Protection, and the Theory of the Corporation, 6 J. Legal Stud. 251 (1977) (same), with William L. Cary, Federalism and the Corporation: Reflections upon Delaware, 83 Yale L.J. 663 (1974), and Lucian Arye Bebchuk, Federalism and the Corporation: The Desirable Limits on State competition in Corporate Law, 105 Harv. L. Rev. 1435 (1992). 3 The theory of competition for incorporations has also been applied to Canadian provinces. See Jeffrey G. MacIntosh & Douglas Cumming, The Role of Interjurisdictional Competition in Shaping Canadian Corporate Law, 20 Int’l Rev. L. & Econ. 141 (2000); Ronald J. Daniels, Should Provinces Compete? The Case for a Competitive Corporate Law Market, 36 McGill L.J. 130 (1990). 3 incorporating abroad.4 If this rule were to change, commentators have argued, intense competition for incorporations would immediately follow.5 This moment of truth has arrived. In fact, it arrived several years ago, when the first in a series of decisions by the European Court of Justice required member states to recognize companies incorporated in other member states and to refrain from imposing local corporate law on them.6 Will the new freedom to choose where to incorporate unleash a fierce race among member states to win incorporations? Probably not. There is no reason to believe that European countries 4 See Eddy Wymeersch, The Transfer of the Company’s Seat in European Company Law, 40 Common Mkt. L. Rev. 661, 666-73 (2003) (reviewing legal barriers to incorporation abroad). 5 See Brian Cheffins,
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