Delaware Incorporation Research Articles

Governance and Success in U.S. Equity Crowdfunding

We propose three governance mechanisms pertinent to equity crowdfunding and campaign success through mitigating pronounced information asymmetries and agency problems. First, unlike IPOs for which the effect of Delaware incorporation has declined or disappeared over time, we propose Delaware incorporation matters a great deal for success in the new setting of equity crowdfunding. Second, we propose that security design is a critical tool for equity crowdfunding success and even more important than the limited 2-year financial statement disclosure. Third, we propose that platforms as intermediaries between entrepreneurs and investors play an important role in mitigating and sometimes exacerbating information asymmetries and agency problems. The population of equity crowdfunding campaigns from market inception in May 2016 to Q2, 2021 in the United States provides strong support for these propositions.

Startup Ltd.: Tax Planning and Initial Incorporation Location

Do startup firms consider taxes when they decide where to organize? This Article analyzes the incorporation decisions of relatively new, US-based private business enterprises with global ambitions. Such startup firms generally organize as US corporations. This Article theorizes this dominant structure and its exceptions, drawing from prior literature and illustrating with informal interview results. It identifies explanatory factors including limited tax benefits of non-US incorporation, legal benefits of US incorporation, startups’ liquidity and other resource constraints, and investor preferences.Part II explains the different treatment of US- and non-US-parented multinational corporations (MNCs) under US federal income tax law. Some non-US-parented MNC structures have tax advantages compared to US-parented MNC structures. This prompts the hypothesis that US-based startup corporations may incorporate outside the United States, for example in a tax haven jurisdiction, if the non-tax costs of a non-US incorporation decision are sufficiently low.Part III reports that available empirical work shows few examples of startup corporations headquartered in the United States and incorporated in tax haven jurisdictions. Prior work and informal interviews reported here support the conclusion that venture-backed Silicon Valley startups generally organize in the United States, form corporations rather than partnerships or LLCs, and prefer the state of Delaware as an incorporation jurisdiction. Available examples, drawn in large part from initial public offering (IPO) evidence, corroborate the conclusion that Delaware incorporation is the norm. The evidence also reveals exceptions to the general rule of US incorporation concentrated in particular industries, such as insurance and marine transportation. Part III also identifies several additional examples of US-based, non-US-incorporated firms, scattered among different industries.Part IV explores several possible reasons for the dominant structure of US incorporation for startup firms. One reason is the limited relative tax advantages of non-US incorporation. For example, US-parented MNCs can often obtain low tax rates on non-US income, sometimes access offshore cash without onerous US tax results, and erode their US taxable income base to some extent. Another reason is that a US-parented structure can provide corporate governance and other non-tax legal advantages

Governance and Success in U.S. Equity Crowdfunding

We propose three governance mechanisms pertinent to equity crowdfunding and campaign success through mitigating pronounced information asymmetries and agency problems. First, unlike IPOs for which the effect of Delaware incorporation has declined or disappeared over time, we propose Delaware incorporation matters a great deal for success in the new setting of equity crowdfunding. Second, we propose that security design is a critical tool for equity crowdfunding success and even more important than the limited 2-year financial statement disclosure. Third, we propose that platforms as intermediaries between entrepreneurs and investors play an important role in mitigating and sometimes exacerbating information asymmetries and agency problems. The population of equity crowdfunding campaigns from market inception in May 2016 to Q2, 2021 in the United States provides strong support for these propositions.

Is There a Delaware Effect for Controlled Firms?

The impact of Delaware incorporation on firm value remains a central question in corporate law. Despite the difficulty scholars have had in agreeing on an answer to this question, there is a consensus that Delaware has long enjoyed stable and important advantages in the expertise of its judiciary and its extensive case law. These advantages are believed to be particularly important for firms with a controlling shareholder. This Article attempts to empirically measure the effect of Delaware incorporation on these controlled firms and thus help us understand the market value of Delaware’s judiciary and caselaw. It finds, surprisingly, that controlled Delaware firms are actually slightly less valuable than similar companies incorporated elsewhere. This suggests that (1) Delaware does not create much if any premium in market value for controlled firms or (2) “lower quality” controlled firms—which would be less valuable regardless of where they incorporate—disproportionately pick Delaware. Either explanation runs counter to conventional wisdom in this literature. Finally, the results cast new light on the long-term effects of Delaware’s recent decisions weakening the doctrinal protection of minority shareholders embodied in M&F Worldwide and Synutra

Jurisdictional competition for corporate charters and firm value: a reexamination of the Delaware effect

In this paper, we analyze the Delaware incorporation effect on firm value to determine whether the positive association found by Daines (J Financ Econ 62(3):525–558, 2001) still holds. Analyzing a sample from 1997 to 2013, we find that the relationship between Delaware incorporation and firm value is no longer positive, as found by Daines, and is in fact negative and significantly different from zero. In addition, we find that this negative relationship holds even after controlling for the effects of Sarbanes–Oxley, the financial crisis, and foreign incorporations. We attribute this change to increasing charter competition, both within and outside of the US. However, in line with current governance trends, we propose that Delaware’s popularity may be rooted in director primacy arguments that support Delaware as a state where directors perceive they have autonomy and discretion through the Chancery Court system.

The Delaware Trap: An Empirical Study of Incorporation Decisions

One of the most enduring debates in corporate law centers on why Delaware has become the dominant state in the market for corporate charters. Traditionally, two perspectives dominated the debate, the “race to the top” perspective that sees competition among states as driving legal rules toward efficiency and the “race to the bottom” perspective that sees competition among states as driving legal rules toward the interests of corporate managers. The two dominant perspectives have struggled to explain why approximately half of companies incorporate in Delaware, while the other half incorporate in their home states. Whether the choices are attributable to the quality of state law or to characteristics of the companies themselves or both has given rise to a large, but inconclusive empirical literature.This Article uses a large dataset of corporate financings to shed new light on this mystery and uncovers strong evidence that some of the strongest factors in incorporation choice are factors unrelated to either the quality of state law or the characteristics of individual companies. Instead, the data strongly suggest that demographic markers of sophistication, such as choice of law firm and headquarters location, predict the jurisdictional choice about as well as state law or the business attributes of companies. Companies with more demographic markers of sophistication tend to choose Delaware incorporation, and companies with fewer demographic markers of sophistication tend to choose home-state incorporation. The finding persists even when other attributes of the company are controlled for, such as its industry classification, the amount of money raised, or whether the company is public or private. Indeed, the sophistication factors arguably predict Delaware incorporation as well or better than any factors documented in the vast literature on state competition for corporate charters.The findings have important implications for the state “race-to-the-top” debate in corporate law. At a minimum the results in this Article make it clear that the choice of legal representation is an important missing variable in models of incorporation decisions. The fact that the choice of law firms drives the jurisdictional choice has far broader implications. If law firms drive the jurisdictional choice they may steer companies toward states that serve the law firms’ own interests without regard to the quality of legal rules or the needs of the client. When the state chosen is Delaware, as it often is, there are few alternative jurisdictions that shareholders and managers can agree on. As a result, companies inadvertently fall into a “governance trap” from which reincorporation out of state is nearly impossible. This interpretation would suggest that Delaware’s carefully calibrated positioning in the charter market has largely eliminated meaningful competition among the states for the quality of corporate law.

Delaware Incorporation and Managerial Entrenchment

Critics have charged that state competition in corporate law, which Delaware dominates, leads to a “race to the bottom” making management unaccountable. One metric of management accountability is forced CEO turnover, which we use to test the race-to-the-bottom hypothesis. We find that Delaware CEOs are more likely to be forced out relative to firms incorporated in other jurisdictions. After controlling for differences in firm characteristics, we find that firms incorporated in Delaware are still more likely to terminate CEOs, but that termination decision is less sensitive to poor performance.

INCORPORATION CHOICE AND IMPLIED COST OF EQUITY

Prior studies document a Delaware incorporation effect on firm valuation, generally using Tobin’s Q, but the directional effects are mixed and inconclusive. Our study uses implied cost of equity to assess valuation, and we find consistent evidence that firms incorporated outside of their home state, either in Delaware or in other states, have a cost of equity that is 40 to 100 basis points higher than firms incorporated in their home state (depending on the model). Importantly, there is no statistical difference between Delaware incorporation and other non-home states of incorporation, which suggest the more important distinction is home state versus non-home state, rather than a Delaware effect. These findings are robust to controls for risk factors that affect the cost of equity including market beta, market value of equity, book to market ratio, analyst forecast dispersion, long-term growth in earnings, and industry membership. Results are consistent in yearly estimations for the sample period 1990-2006, and robust across the spectrum of firm size, different measures of cost of equity, and to control for endogeneity of the firms’ incorporation choice.

U.S. State Chartering Competition: Evidence of Director Primacy in Corporate Governance?

Utilizing concepts from agency theory as well as director and shareholder primacy models, this study examines U.S. state chartering competition and the debate about whether Delaware incorporation provides additional firm value for shareholders. In a longitudinal study of firms with data from 1996-2013, we found that on the surface, in line with shareholder primacy goals, Delaware incorporated firms appear to have less debt, and a higher Tobin's Q than similar firms in other states, suggesting that they are managed well for shareholder returns and supporting race to the top arguments. However, when taking into account fixed effects, and expanding the sample to include those companies that are publicly traded in the U.S. but incorporated overseas, the effect of Delaware incorporation is negligible to shareholder wealth. Foreign incorporated firms provide significantly more value for shareholders over longer periods of time than do Delaware corporations. This suggests that the popularity of Delaware incorpor...

Whither Delaware? Limited Commitment and the Financial Value of Corporate Law

This paper provides novel evidence concerning the association between firm value and state corporate laws, focusing on (re)incorporations in Delaware. As (re)incorporations are endogenous, we use plausibly exogenous variation in the state of incorporation at the IPO stage from the law firm identity, finding that Delaware incorporation is negatively related to firm value. Consistent with this, firms reincorporating into (out of) Delaware decrease (increase) in firm value in the time-series. These results seem incompatible with a managerial entrenchment explanation of the relationship between state corporate law and firm value, as reincorporations into Delaware are associated with increased takeover activity, suggesting that Delaware is relatively takeover-friendly. Rather, our results appear to be driven by firms where potential conflict of interests between shareholders and other stakeholders are likely to be more severe. This suggests that state corporate laws matters for firm value primarily by addressing the problem of shareholders’ limited commitment to long-term value creation.

Cronyism and Delaware Incorporation: An Examination on Excess Compensation

This paper investigates whether Delaware incorporation relates to cronyism by examining excess director and CEO compensation. I find that excess director compensation is significantly and positively related to excess CEO compensation in both Delaware and non-Delaware firms. However, excess CEO compensation in non-Delaware firms is negatively associated with firm performance. The result indicates that cronyism does exist in non-Delaware firms but not in Delaware firms. Therefore, Delaware incorporation does not favor managers at the expense of shareholders.

Does Delaware Incorporation Encourage Effective Monitoring? An Examination on Director Compensation

Delaware incorporation is popular among publicly traded firms in the United States. However, the question of whether Delaware incorporation favors shareholders is an on-going debate. This paper is the first attempt to examine director compensation by considering the role of state of incorporation. First, Delaware firms pay their directors more compensation than non-Delaware firms. Second, Delaware firms tend to hold more meetings per year than non-Delaware firms. Finally, among Delaware firms, the changes of director cash compensation, equity compensation, and total compensation are positively related to the change of shareholder wealth. The results not only indicate that Delaware incorporation appears to encourage effective board monitoring but also support the view of “race to the top” on Delaware incorporation.

The Market for Contracts

Legal scholars have focused much attention on the incorporation puzzle-why major firms so heavily favor Delaware as their chartering state. The choice of Delaware incorporation is effectively a decision to select Delaware law to control issues of corporate governance and (less reliably) to select Delaware courts to adjudicate disputes. In this sense the incorporation decision is similar to any contract in which parties select a governing law or designate a forum. This paper considers whether theories about Delaware corporate law apply to the broader market for commercial contracts. After describing how the preconditions for such a market were established during the last half of the Twentieth Century (through the increased enforceability of choice-of-law and forum selection clauses), the paper looks at empirical evidence about major commercial contracts. Although Delaware dominates the market for incorporations, New York is the leading supplier of law and forum in commercial contracts. The paper explores several explanations for New York's popularity. * * * * Corporate charters are contracts. 2 Unusual contracts, to be sure: they last a long time, are not negotiated at arm's length, are difficult to renegotiate, 3 include specialized mandatory terms, 4 and involve repeated transfers of rights (as shareholders buy and sell)

Does Delaware Incorporation Affect Executive Compensation? An Empirical Analysis

Motivated by agency theory, this study attempts to ascertain whether chief executive compensation is influenced by legal rules. In particular, we analyze whether Delaware law has an impact on CEO pay. Legal rules have been argued to impact agency conflicts. Agency costs, in turn, affect CEO compensation. Thus, we contend that Delaware law influences CEO pay through their associations with agency problems. The empirical evidence corroborates this hypothesis, showing that Delaware firms pay their CEOs significantly more generously than do non-Delaware firms (about 36% higher in total compensation). Furthermore, Delaware firms exhibit significantly lower pay-performance sensitivity (almost 50% lower), implying that the higher pay more likely reflects rent expropriation rather than shareholder wealth maximization.

Delaware Incorporation Matters for New Ventures: Evidence from Venture Capital Investment and the Going Public Process

In the United States, corporate actors choose their state of incorporation and are subject to the laws of the state in which they are incorporated. Incorporating in Delaware is a common move for most U.S. firms, especially those interested in attracting venture capital, as the state's corporation laws are clearer, more fully defined and business friendly, courts have more experience judging corporate cases, anti-takeover laws are less restrictive, and financing or merger deals are more quick and efficient than in most other states. Using a large sample of privately-held companies, we empirically investigate the implications of Delaware incorporation and examine its effect on access to venture capital financing and the process of going public. The results suggest that companies incorporated in Delaware receive more venture financing and attract more involvement from different venture capitalists than entrepreneurial firms incorporated elsewhere. In addition, we find that Delaware-incorporated venture-backed firms are more likely to reach the stage of going public, get to that stage faster, and generate more IPO proceeds or higher acquisition values than similar firms incorporated elsewhere. Overall, our study reveals the first empirical evidence about the importance of state laws to privately held, informationally opaque firms seeking venture capital support.

Delaware incorporation matters for new ventures: evidence from venture capital investment and the going public process

In the United States, corporate actors choose their state of incorporation and are subject to the laws of the state in which they are incorporated. Incorporating in Delaware is a common move for most US firms, especially those interested in attracting venture capital, as the state's corporation laws are clearer, more fully defined and business friendly, courts have more experience judging corporate cases, antitakeover laws are less restrictive, and financing or merger deals are more quick and efficient than in most other states. Using a large sample of privately held companies, we empirically investigate the implications of Delaware incorporation and examine its effect on access to VC financing and the process of going public. The results suggest that companies incorporated in Delaware receive more venture financing and attract more involvement from different venture capitalists than entrepreneurial firms incorporated elsewhere. In addition, we find that Delaware incorporated venture-backed firms are more likely to reach the stage of going public, get to that stage faster, and generate more IPO proceeds or higher acquisition values than similar firms incorporated elsewhere. Overall, our study reveals the first empirical evidence about the importance of state laws to privately held, informationally opaque firms seeking venture capital support.

How Does Delaware Incorporation Affect the Board of Directors?

This study investigates the impact of Delaware law on the composition and size of the board of directors. Our empirical evidence reveals that Delaware firms have smaller and more independent boards than their non-Delaware counterparts. Given that we find no value-premium for firms that incorporate in Delaware, we interpret our findings as being consistent with Delaware law benefiting managers. The more shareholder-friendly boards in Delaware exist to offset the benefits that managers derive from Delaware incorporation.

Delaware Incorporation and Earnings Management: An Empirical Analysis

Motivated by agency theory, this study examines whether the extent of earnings management significantly differs in firms incorporated in Delaware versus those incorporated elsewhere in the U.S. Delaware corporate law has been argued to affect agency costs. To the extent that shareholders make poor investment decisions based on managed accounting numbers, earnings management can be regarded as an agency cost. The evidence indicates that earnings management occurs to a lesser extent in Delaware firms. In addition, Delaware incorporation combined with a predominance of outside independent directors on the board, further constrains earnings management. Finally, the results suggest that earnings management is not diminished in Delaware firms that are controlled by founding families.

Creditor Protection Laws and the Cost of Debt

Abstract We examine the impact of state payout restrictions on firms' credit ratings and bond yields. Using publicly traded bond data for a sample of large firms, we find that firms incorporated in states with more restrictive payout statutes (for example, New York and California) have better credit ratings and significantly lower yield spreads (about 8.7 percent) than do firms incorporated in less restrictive states (for example, Delaware). These results suggest that incorporation in a more restrictive state provides a credible commitment mechanism for avoiding some of the moral hazard problems associated with long‐term debt. This commitment corresponds to an economically and statistically significant difference in market yields and firm‐financing costs and is robust to controls for ownership, governance, debt type, Delaware or non‐Delaware incorporation, and covenant usage. Overall, our results are consistent with the notion that Delaware incorporation has hidden costs for some firms.

The Disappearing Delaware Effect

Refining and extending the methodology introduced by Daines (2001), I present evidence that small Delaware firms were worth more than small non-Delaware firms during the period 1991--1996 but not afterwards. I also present evidence that larger firms, which comprise 98% of my sample by size, exhibit no Delaware effect for any year during the period 1991--2002. Thus the Delaware effect disappears when examined over time and when examined for firms that are economically meaningful. These new contours of the Delaware effect suggest that the benefit associated with Delaware incorporation was an order of magnitude smaller than estimated by Daines (2001) during the early 1990s, and nonexistent by the late 1990s. The trajectory of the Delaware effect further suggests that it cannot provide support for the race to the top view of regulatory competition, as some commentators have argued, and may in fact provide support for the race to the bottom view. Finally, the findings presented here identify two puzzles: (1) Why did small Delaware firms exhibit a positive Delaware effect during the early 1990s but larger firms did not? (2) Why did this effect disappear in the late 1990s? I identify doctrinal changes in Delaware corporate law in the mid-1990s, increased managerial incentives to sell during this period, and a cohort selection effect during the 1980s as potential explanations. Copyright 2004, Oxford University Press.