First of all, I’d like to thank Jay for giving me the opportunity to blog here. I’ve been a big fan of this blog for a number of years, and I look forward to hopefully making some positive contributions. Given the name of the blog, I thought I’d start by addressing where I personally stand on the issue of whether the development of modern corporate law constitutes a race to the bottom or top.
The phrase “race to the bottom” is most commonly identified as tracing its roots to Justice Louis Brandeis in the 1933 case of Ligget Co. v. Lee:
The race was one not of diligence but of laxity. Incorporation under [competing state] laws was possible; and the great industrial States yielded in order not to lose wholly the prospect of the revenue and the control incident to domestic incorporation.
A fair starting point for the analysis is asking what we would expect to see if in fact the race for corporate charters constitutes a race to the bottom. One fair answer is that we would expect the evolving laws to more and more favor the individuals making the decision of where to incorporate—that is to say, management. And in fact, most commentators would agree that the state currently winning the race for corporate charters—Delaware—does in fact have what can fairly be described as manager-friendly law.
However, we clearly can’t end the analysis there because even though director-primacy looks suspiciously like what we would expect from a race to the bottom, it may in fact nonetheless also represent the most efficient allocation of power under corporate law. A strong argument in favor of this proposition is that the market would not support an inefficient allocation of power. That is to say, the cost of capital for managers incorporating in inefficient manager-friendly states should rise to the level of making incorporation there prohibitively costly.
The response of those who remain suspicious despite this rebuttal is often that markets simply aren’t efficient enough to impose the suggested sanctions. One might point to various cognitive biases that have been identified by the adherents of behavioral economics, and argue that the typical investor is going to be overly optimistic, for example, in assessing whether the corporate law of the particular state of incorporation warrants discounting the expected rate of return. One may add that this should be particularly so in the case of retail investors as opposed to sophisticated investors, since sophisticated investors are often in a much better position to contract around many of the “overly” manager-friendly default rules.
Proponents of a race-to-the-top view might then respond that even if there are inefficiencies in the market, they do not rise to the level of invalidating the status quo. That is to say, bluntly, do you have a proven better alternative? While the recent financial crisis has led at least some to respond with, “Anything is better than this,” the more recent struggles of more socialist regimes, and the historic collapses of various communist and totalitarian regimes, do make it a fair question. (I realize it’s a bit of a jump to go from director-primacy to socialism, but I hope you will take my meaning. If one views the various constituency statutes out there as a form of socialism, the criticism holds because it is hard to rebut the contention that those statutes do little more than provide additional cover for management.)
So, where does all this leave me? I guess I’m currently an agnostic believer in a race to the bottom. That is to say, I don’t claim to know as a matter of fact that the evolution of corporate law in the U.S. has left management with so much power as to be objectively inefficient, but my reading of the relevant cases (along with what I view as the excessive political influence of corporations and the ever-widening gap between rich and poor) makes me suspicious enough to happily come on board a blog called, “The Race to the Bottom.”