Corporate Governance

Delaware's Top Five Worst Shareholder Decisions for 2009 (Conclusion)

By J. Robert Brown

The system of corporate governance in the United States has many positive aspects.  The degree of disclosure in this country likely exceeds all others.  But there is one place where the development of the law has bordered on the irrational.  In a country of 300 million people, the substance of most aspects of corporate governance are determined by the State of Delaware, a tiny place geographically (save Rhode Island, it is the smallest state in the country) and demographically (the 45th smallest state based upon the 2000 census). 

It is also a state with a financial incentive to skew the law in a manner that maximizes revenue.  Foreign corporations allow Delaware to avoid charging a sales tax.  As we quoted in an earlier post:

• The revenue that the legal industry generates for the State of Delaware is also of vital importance to the First State and its residents as well. Over $709 million or 21.6 percent of all of the state's general fund revenue in fiscal year 2007 came from the corporate franchise tax and related fees. Corporations generated another $15 million in special fund revenue and about $10 million for local governments.

This represents only a portion of the economic benefits gained by the state.   Yet this is the state that determines the standards for board behavior in the largest companies in the country (and the world). 

The results are predictable.  Incorporation in Delaware usually means reincorporation.  Reincorporation is ordinarily done through a merger.  Under the laws of all 50 states, a merger can only be initiated by the board of directors.  States that want to attract corporations (and their tax dollars) must appeal to management.  Delaware does that with a law that is extraordinarily pro-management in its orientation. 

This can be seen from the cases decided in 2009.  The cases selected as the worst have a decidedly pro-management flavor.  They reaffirmed the ostrich approach, permitting management to remain unaware of critical matters within the corporation, including those that affect the voting rights of shareholdes or the solvency of the company.  They continued to deny shareholders the right to information on matters of clear importance to owners.  Finally, they continued to diminish the role of the duty of loyalty, despite clear circumstances suggesting a conflict of interest. 

The cases explain why the process of creeping preemption of corporate governance continues.  Bills in the House and the Senate would once again preempt Delaware law in connection with compensation committees, compensation consultants, and, if the Senate Bill gets adopted, with respect to the test for excessive compensation.  A review of the worst five decisions for 2009 illustrates why this is occurring. 

Full post as published by The Race to the Bottom on January 08, 2010 (boomark / email).