Legal Commentary

Why don't non-profit firms reincorporate in other states?  We know, of course, that states compete to offer the most enticing set of corporate law rules (along with fees for incorporating) to for-profit firms, who can "charter" in any state.  There's a long-standing debate about what drives the competition  -- is it market pressure for efficient rules, producing a "race to the top" for the best state laws, or something else, such as self-serving managers?  I tend to agree with Bebchuk and others that the second story makes more sense, given available evidence. 

But how can we reconcile this result with the fact that (as OSU's Garry Jenkins described last year) non-profit firms do not appear to shop around for favorable state laws?  The efficient market hypothesis looks like a much better description of the non-profit sector.  After all, non-profit managers can be just as self-serving as managers in for-profit firms.   Unless there's something a lot different about the non-profit sector we're overlooking, it seems like the absence of charter competition undermines the managerial rents story.  Plus, n/p's aren't as subject to market pressures, so the absence of competition in that sector is consistent with the efficiency theory.  Of course, there are lots of other things that are unique to the n/p sector that could explain the difference.  More after the jump...    

1.  The supply side.  Maybe states don't bother producing attractive n/p law because, by definition, they cannot extract tax from the tax-exempt sector.  I'm not sure I buy this.  There's nothing that requires states to exempt n/p's from all taxes (and, for instance, lots of n/p's pay sales tax, fees, and the like).  If state law can add to firm value, why wouldn't a state try to get some of that value back?  But maybe, given the small revenues of many n/ps, the added value is small, so that the likely revenues would be smaller than the costs (including legislators' opportunity costs) of developing new laws.  Also, many legal innovations are easy for other jurisdictions to copy (about which, more next week); unless there are big returns, there might be little incentive for any one jurisdiction to innovate.  So perhaps races like the competition for charters are rarer and more fragile than we've thought.      

2.  The demand side.  Why don't n/p managers seem to seek out laws favorable to them, whatever the benefit to their firm?  If managers can offer large enough rents to officials, then their demand should generate an incentive to supply laws, too.  One possible answer here is that state n/p law is already almost meaningless.  Most states do not permit suits against managers and board members except by the board or the state attorney general.  (And there seems little market for more expansive standing rules, probably for the reasons I just mentioned above.)  AG's are notoriously disinterested enforcers.  So maybe the substantive law just doesn't matter often enough to be worth paying rents, and explaining transaction costs to other stakeholders.  Also, it's possible that federal tax law is the dog and state law the tail, or even just the fleas -- but there, too, enforcement is exceedingly rare. 

Bottom line, I think it's hard to say that the evidence from the n/p sector clearly tells us anything about the for-profit sector.  But these are testable hypotheses.  For instance, if the managerial rent-seeking theory is right, then n/p's should seek new charters  in those rare instances where the managers might plausibly face suit. 

Thoughts, anyone?