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Itís Time To Federalize Corporate Charters 
Delaware And Other States Arenít Tough Enough

Kent Greenfield is an Associate Professor at Boston College Law School and a corporate law scholar. He is an expert on the role of corporations in society, the legal obligations of corporate managers, and the responsibilities of corporations toward their employees.

Among the reforms proposed in response to the recent spate of corporate scandals, one that could make a real difference has not been mentioned: the idea that corporate governance should be a matter of federal rather than state law. Currently in the United States, the rules governing the internal management of corporations come not from the U.S. Congress but from the various states. Most of the largest U.S. corporations -- 60 percent of the Fortune 500 -- are incorporated in Delaware, mostly because it is protective of their managerial interests.

Because of a quirk in corporate law, the state that governs a company's management practices is not the state where the firm is headquartered, or even where it employs the most people. The laws of corporate governance come from the state where the company gets its corporate charter, which is easier to get than a driver's license. So managers can hunt around for the state that offers the most advantageous set of laws and incorporate there. The managers can then go back to Texas, California, Massachusetts, or wherever and act as if nothing is odd about having the firm be run according to a charter issued by a state that has little or no interest in the company. Their employees and creditors, not to mention the communities where they do business, have little to say about it.

States compete to issue these corporate charters, because incorporation fees can fatten what would otherwise be lean state budgets. It is no coincidence that the state that has won this competition, Delaware, has taken a largely laissez faire attitude to directorial oversight of everything from outlandish managerial compensation to companies' compliance with laws. Indeed, Delaware allows companies to include provisions in their charters that limit directors' potential liability if they fail to take their responsibilities seriously. Delaware has also refused to pass a "stakeholder statute," which would allow directors to consider the interests of employees and other stakeholders when important decisions are made.

Delaware courts have long been reluctant to disturb the decisions of corporate boards. It should be no surprise, then, when directors grow complacent and inattentive. Only when such docility costs shareholders billions do they notice that they have little recourse.

Many corporate law scholars applaud Delaware, saying that competition among states makes for more efficient laws. But that depends on what "efficiency" means. If another state wants to be more aggressive in fighting corporate crime or protecting shareholders, employees, or communities, it runs the risks that its companies will simply re-incorporate in Delaware. So most states end up mimicking Delaware law.

There has been a lot of talk from the Bush administration and Congress about what to do about the gladiatorial culture among the nation's business elite. Most of the proposed reforms focus on ensuring the truthfulness of companies' books, which is rightly seen as essential for a trustworthy securities market. But focusing on the securities market is like trying to stop the sale of rancid meat by regulating supermarkets. You have to go where the disease begins. With Enron, WorldCom and their ilk, the disease begins not with how they issue their stock but how they are managed. If the board does not provide meaningful oversight, if laws are disregarded in order to maximize profit, if the interests of shareholders, employees, communities, and society are ignored, then the disease will remain chronic.

Federal chartering has been a popular idea at various times in our history, most recently during the late 1970s. Corporate crime was in the headlines, then, too, as almost 400 firms admitted to bribing foreign or American officials or making illegal campaign contributions. The idea of federal charters was dropped after the Reagan victory of 1980, but it deserves resuscitation now.

If Bush and Congress are serious about reforming corporate behavior and protecting the public interest, they cannot leave Delaware or other states in charge of corporate chartering. The only way out of this mess is to have corporate law be federal law, and for Congress or the SEC to define the obligations of corporate managers and directors.



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Published: Jul 26 2002


 




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