Deference to Delaware Corporate Law Precedents and Shareholder Wealth: An Empirical Analysis

Abstract

Delaware is home to more than half of all public corporations, and its market share among initial public offerings is even higher. Not surprisingly, therefore, an extensive body of literature is dedicated to exploring the causes and consequences of Delaware's preeminence as a state of incorporation. There exists, however, a second and largely ignored dimension in which Delaware has come to dominate U.S. corporate law: the common law process. Courts in numerous other states now accord Delaware case law a previously unheard-of level of deference: many state judiciaries have declared explicitly that they will look to Delaware cases in deciding open legal questions. In this paper, I undertake an empirical analysis of Delaware's impact on the corporate common law of other states. Using a hand-collected dataset of state and federal cases, I gain a number of important insights. First, deference to Delaware may be driven in part by functional considerations. States that have based their law on the Model Business Corporation Act (MBCA) and can therefore rely on case law from other MBCA states are less likely to defer to Delaware precedents. Second, firms are more likely to incorporate locally if their home states' courts look to Delaware precedents in corporate law matters. Third, stocks of corporations that are incorporated in the deferring state tend to experience positive abnormal returns at the time of court decisions that introduce the principle of deferring to Delaware case law. Fourth, there is some, albeit mixed, evidence that that stock price reaction is substantially stronger for those firms where agency conflicts between managers and shareholders are more pronounced. This last finding is intuitive in the sense that well-governed firms, if they stood to benefit from the application of Delaware case law, might already have (re)incorporated in Delaware.