September 18, 2025 • 37 mins
If you look at prospectuses and earnings documents for almost any company, you're going to see a Delaware address. For more than a century, the state has been the place to go to if you're setting up a business. And in fact, Delaware has catered to these corporate clients, setting up an efficient chancery court to settle corporate disputes and producing a huge backlog of case law to act as reliable and efficient precedent. But suddenly, some companies are choosing to leave the state. Most prominent among them is Elon Musk's Tesla, which opted to re-incorporate in Texas after a Delaware judge invalidated his $56 billion pay package. States like Nevada and Texas are now also actively courting companies by enticing them with management-friendly laws. In this episode, we speak with Ann Lipton, University of Colorado law professor and Lawrence W. Demuth Chair, to find out what's at stake in the fight for incorporations and if there's a risk for a race to the bottom in terms of shareholder accountability.
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Episode Transcript
Available transcripts are automatically generated. Complete accuracy is not guaranteed.
Speaker 1 (00:02):
Bloomberg Audio Studios, Podcasts, radio News.
Speaker 2 (00:18):
Hello and welcome to another episode of the Authots podcast.
I'm Tracy Alloway and I'm Joe.
Speaker 3 (00:23):
Why isn't thal Joe?
Speaker 2 (00:24):
I have a fun fact for you? Go on? Are
you ready?
Speaker 1 (00:28):
Yeah?
Speaker 2 (00:28):
Okay, So Delaware has a population of about one point
h five million a little over a million. Okay, it's
one of the least populous states. Yeah, I think it
has fewer people than a lot of big cities in
the US for sure. However, Delaware has two point one
million businesses registered in the state, so basically two businesses
(00:50):
for every person.
Speaker 3 (00:51):
This is a legit fun fact. This is like a
legit I did not know this. I mean, I knew
that it was not a very big state population wise.
I know that so many corporations or businesses or whatever
incorporate in Delaware, but there's sort of two to one ratio.
Excellent fun fact tracing.
Speaker 2 (01:06):
Well done, Yes, for your next dinner party. You can
trot that one out. But I mean, obviously, maybe you
could argue that Delawareans are just phenomenally entrepreneurial. But as
you as you mentioned more.
Speaker 3 (01:17):
Than I'm not dismissing them. I just know that that's
not really what's going on, right.
Speaker 2 (01:21):
There's something else going on here, which is the Delaware
has become the de facto state for companies incorporating.
Speaker 3 (01:28):
Yeah, this is like the main thing that we know
about Delaware, and we don't really I mean the chickens, right,
not the chickens. But you don't hear much about Delaware
except typically when there is some sort of corporate fight
playing out in its courts. And of course it has
a dedicated court system for corporate fights and so forth,
and there's some prominent examples over the years where we
(01:50):
learn about what the chancery is and then I forget
what the chancery is or where that word comes from.
But people seem to like their simplistic, streamlined legal system
for things, and it seems to have paid off reasonably well.
Speaker 2 (02:02):
People seem to like it, but that might be changing.
So you mentioned corporate fights. We had a very prominent
example of this relatively recently when there was the court
fight over Elon Musk's compensation at Tesla, and eventually Elon
just said, you know, I'm going to pick up my
company and move it to Texas and incorporate there. And
(02:23):
in fact we are seeing a few examples of companies
choosing to move away from Delaware and two places like
Texas or Nevada. And I know this isn't maybe a
top of mind news development for many people right now.
There's a lot going on. Yeah, but I think it's
really interesting. It's kind of slow moving, and it does
have implications for shareholder rights totally.
Speaker 3 (02:45):
I actually think it's a very important relevant topic. And
I'll say this is the reason why, which is that
in this sense, a legal system is this network effect,
and people respect the legal system, and even if maybe
there are decisions that go against them, like okay, this
is a high qualt a legal system, it is very
hard to rebuild that somewhere else. It also is the
sort of thing that if there is some pole elsewhere,
(03:07):
then it's interesting to see what does it take to
pry entities away from this network where there is years
and years and thousands and thousands of decisions upon which
to build something resembling a shared law. And so, you know,
when I think about the United States, when I think
about these bigger questions about how do you move dollars,
how do you move entities, industries to other jurisdictions that
(03:29):
are maybe younger and don't have the same level of
historical jurisprudence. Maybe there is a microcosm a story to
be told about the Delaware history, how it built up,
and if there are any threats to it over the
medium term.
Speaker 2 (03:42):
Absolutely very well put. Thanks so I am happy to
say we have the perfect guest. We're going to be
speaking with professor Ann Lipton. She is a law professor
at the University of Colorado and Lawrence W. Dmouth Chair,
And thank you so much for joining us.
Speaker 4 (03:57):
Thank you so much for the invite.
Speaker 2 (03:59):
I'll start with the obvious question, which is how did
we end up with Delaware as the de facto place
for corporate incorporation? Why Delaware?
Speaker 4 (04:09):
Because Delaware actually strategized that it wanted to attract incorporations.
And this was back in all the late eighteen hundred's
early nineteen hundreds, a number of states actually thought that
they could make money by having corporations incorporate in their
state and pay fees. You could actually open a newspaper
at that time and see advertisements for come incorporate in
(04:29):
X state. And Delaware made a conscious decision to make
its state and its law friendly to corporations that wanted
to incorporate there So, among other things. At the time,
one of the main concerns of businesses was that corporate
law would be used politically, that the rules would change
to effectuate some kind of political policy. So Delaware adopted
(04:49):
a constitutional amendment that its judges would have to be
politically balanced, so you couldn't have more than half more
than a bare majority of one party or the other.
So for a seven member court, no more than four
can be a member of one party or another. They
also put a constitutional amendment that any change to the
corporate code required a two thirds vote of the legislature,
(05:09):
so trying to insulate their corporate law from political pressures.
And then they just made their corporate law very flexible
and very manager friendly. Managers could kind of do what
they wanted with it, and it just sort of took
off from there.
Speaker 3 (05:20):
This is really fascinating, this idea of creating the corporate
legal system in this sort of glass enclosure through which
the political system cannot break. And this is a theme
that seems to come up over and over again. We
talk about it when we talk about the Federal Reserve
and its nominal or de facto independence. This came up
when we talked to the Alaska Sovereign Wealth Fund guys
(05:43):
and the difficulty that the political system has in accessing
the corn seed, so to speak. Talk to us a
little bit more about the structures in place and how
strong they are to insulate the core system from politics,
and how durable and thick those a glass wall.
Speaker 4 (06:00):
Yeah, so they can't insulate the court from politics in
the sense of the legislature acting and so forth, and
that's actually what we've just been seeing, but they are
fairly insulated from partisan politics. Partisan politics doesn't play out
in the same way that we would understand it in
other parts of the country or other areas. But so
the idea here, well, first of all, I mean one
thing to note though, is that Delaware is obviously it's
(06:22):
very blue state voting behavior, and judges do things other
than decide corporate cases. We do forget that, but they
do in fact have other things to decide. But still
the judges are politically balanced in order to benefit this
corporate system. So what happens with the way laws made
in Delaware, corporate laws made, is that it actually doesn't
really come from the legislature, which really most of the
(06:43):
legislature isn't. They're not corporate experts, they don't know much
about corporate law necessarily, they're just legislators. So what happens
is there's the Delaware State Bar Association has a Corporation
Lost section and they actually generate the proposed statutes on
the theory that they can do it in a sort
of non partisan, very technocratic way, and then the legislature
(07:03):
tends to sort of rubber stamp the stuff that comes
out of the Corporation law section.
Speaker 2 (07:08):
So, you know, Joe mentioned that sort of network effect earlier,
and I think this is really important in law, especially
because a lot of legal battles are based on precedent, right,
and so we have Delaware as the de facto incorporation
state and decades and decades of precedent for judges and
(07:28):
lawyers to actually look at, how does that sort of
I guess precedent or first mover advantage help Delaware.
Speaker 4 (07:37):
Well, it's always been assumed that that would help Deltware
because you would have the statute and you have a
decades of precedent, so that companies would kind of know
how questions would be answered. If they came up. So
there are a lot of areas where other states you
just simply do not have information on, like how a
court would treat particular kinds of claims or particular kinds
(07:57):
of disputes. Some of the obvious things are things like
activist takeovers or our proxy contests and takeover defenses, because
we know how that looks in Delaware, because Delaware incorporates
most of the public companies where you have those kinds
of fights. We don't know how that looks in other
states because you don't tend to have as many activist
situations in those other states. So that's always thought to
(08:19):
be sort of an advantage of Delaware that everything plays
out there, and most other states they very often look
to Delaware when they're deciding their own corporate law. Sometimes
they contrast their corporate law with Delaware, but Delaware is
always kind of where they look to deal with these questions,
and that's always considered to be a real advantage of Delaware.
You at least know what's going to happen. But it
(08:40):
also means that because this is case law, it's mostly
not in the store, hasn't been mostly in the statute.
It's judged by judge decisions, and that can also mean
that sometimes it's sort of hard to penetrate because it's
really you've got to read this decision, well, don't forget
this other decision, and don't forget this decision too, and
that can be sort of hard to figure out if
you're just looking at it the first time.
Speaker 3 (09:01):
Yeah, I'm really interested in this tension, right because in theory, okay,
you write down laws on paper and they're all visible
and say, okay, this is consistent. We know what's going
to happen. But also decisions are made by judges and
people dispute them. Otherwise they wouldn't have to have cases
in the first part, if if judges didn't have to
exercise some sort of agency, how do the judges feel
(09:22):
about their own responsibility when deciding these cases to think
about consistency or the underlying deep principles of Delaware corporate
law and the long term implications for the state of
Delaware and for the state when they make their decisions.
Speaker 4 (09:39):
Yeah, so there's a tension there. So you just identified,
like attention, a tension between the state of Delaware versus
general corporate theory and corporate law and I think you
don't become a judge and you don't go into this
area unless you really do appreciate the law and enjoy it.
And I mean the Delaware judges are extremely thoughtful about
corporate law and what the right answer is and how
corporations should work. They don't always have exactly the same theories,
(10:02):
but they definitely have a point of view and they
care very much about how corporate law operates. But and
this is where some of the tension is today. If
corporate boards are unhappy with their decisions over and over
and over again, then Delaware may lose incorporations to other states.
And how that plays out between sort of fidelity to
(10:22):
a vision of what corporate law should be couple with
the straight up reality that if managers are unhappy and
incorporate elsewhere, Delaware doesn't have doesn't get to do much anymore.
That's a tension that's been playing out for just as
long as Delaware has been incorporating companies.
Speaker 5 (10:37):
I mean, that's.
Speaker 4 (10:37):
Always I don't think judges are usually consciously making that
decisions based on that, or they're certainly trying not to,
but that tension is always present and has been present
in the past.
Speaker 2 (10:48):
Before we get to why companies some companies seem unhappy
with Delaware at the moment, I'm going to go ahead
and ask Joe's classic question whenever this comes up, which
is what is a chancery.
Speaker 4 (11:02):
Well, it's just the name for the Delaware courts that
here corporate cases, So I mean the fun This is
a very technical legal point, but historically there were two
types of courts in the world. There were the courts
of law and the courts of equity. The courts of
law followed sort of these stringent rules, and the courts
of equity were literally sort of about fairness and dealing
(11:22):
with what's the right answer and doing justice as opposed
to according to technical rules that were laid down. And
so there was two separate courts, and that was from England,
and that was true in the United States, and then
the United States in the thirties or so melded the
two courts at the federal level, and most states did
the same, so there would just be one court that
heard all the cases law cases and equity cases. But
(11:44):
Delaware never did that, so it still has this separate
court of law and the Court of equity, which is
the chancery court. So its historical origins are essentially rooted
in this idea of fairness and commanding people to take
the proper actions. And it doesn't sit with a jury.
The cases are heard just by the judges. The judges
(12:05):
find facts. Would otherwise juries would do that, but the
judges find facts in the Delaware Court of Chancery, they're
very expert. They are, you know, they're all drawn from
corporate practice before they get on the bench, and that's
what they do. I mean, they hear other things besides
corporate cases. Other things fall into this category of equity.
But the main thing, obviously is the corporate cases.
Speaker 3 (12:40):
So I want to eventually get into the Elon paid
case and maybe get you read on it, et cetera.
But before we do that, you mentioned that this is
nothing new. Some of these there are these long standing
questions about the Delaware and its persistence. Can you give
us a little history or what are you know? What
were the Elon cases pre the Elon cases that sort
(13:00):
of maybe had people questioning the sort of durability of
the Delaware system the.
Speaker 2 (13:06):
Long, long, long ago before Elon Elon l.
Speaker 4 (13:10):
Lepe It's in the eighties. It was that long ago.
It was the eighties. There were two big incidents. So
one case of like these are the basic law cases
that you learn if you're in any kind of basic
corporate law class. So one case was called Ben Gorkum. Basically,
a company was selling itself and they settled on a price,
and shareholders sued, claiming that the board didn't take proper
(13:31):
care and setting this price. Nobody suggested they were acting
in bad faith, but they just didn't take the time
to make sure that they got the best price. And
the Delaware Supreme Court agreed, and it held that the
directors could be held personally liable for damages for essentially
not getting the right price for the company. And that
terrified boards because these boards could be acting in good
faith and still could be I mean, not selling the
(13:54):
company for enough. That's serious money damages. So Delaware amended
its corporated so that companies can now add a provision
to their charter that says directors will not be held
liable for monetary damages for negligence, and that really also
boosted companies incorporating in Delaware after that, and by now
(14:15):
every state has adopted a similar thing. But at the
time that was done essentially because they knew that they
had just scared the Jesus out of boards. And another
issue that came up, this is also in the eighties,
was during the hostile takeover era. This was like you know,
the deal decade. There were lots and lots of hostile
takeover attempts, and when there's a hostile takeover attempt, boards
put up barriers, usually shareholder rights plants poison pills to
(14:36):
prevent hostile takeovers. And there was a real question as
to how far boards could go to fend off a
hostile acquirer, even if the shareholders wanted this deal. And
at first the Delaware courts were pretty strict about it.
They after a certain point they were saying, look, you
got to let shareholders decide. The board can't just block
beneficial proposals to buy the company if the shareholders want it.
(14:59):
And once again there were threats to that companies would leave,
they would leave Delaware so that they could protect against
hostile takeover attempts, and at that point the Delaware Supreme
Court backed off. It adopted new standards that allow much
more deference to boards when they are fighting off hostile
takeover attempts.
Speaker 2 (15:17):
So fast forward to today. I just want to make
sure we have our priors correct.
Speaker 6 (15:22):
We love, we love establishing our priors on this podcast,
but you know those examples aside, does it feel like
nowadays there is perhaps more discussion of alternatives to Delaware
or more companies that seem to be moving away.
Speaker 4 (15:36):
Yeah, so I don't know if statistically the numbers really
move the needle. We've seen definitely some high profile announcements
of companies planning to move, but we just don't have
enough data right now to see whether this is a
serious like actual exodus. But there's definitely a lot more discussion,
and there's definitely a lot more boards thinking, our lawyers
(15:56):
thinking they have to counsel boards whether you want to
incorporate in Delaware, when before that one wouldn't even have
been a question. So that's definitely something that's happening.
Speaker 3 (16:03):
Well, why so, what is it if a lawyer is
counseling boards? Don't just because you know, I've known people
who have launched startups at times and the idea of
incorporation in Delaware that was just obviously what you did
right You just did it right away. So what is
it that a lawyer might say, well, maybe take a
few beats and think about this. What has actually changed
(16:24):
that's caused that.
Speaker 4 (16:25):
Well, Delaware understands fought back, and it's changed its law
very recently to sort of fight this off. But essentially
the issue, most of the issue is shareholder liability or
liability to shareholders and vulnerability to a shareholder lawsuit. And
most of that vulnerability is vulnerability to a shareholder lawsuit
over conflicted transactions. That's the main headline thing. There are
(16:46):
a few other issues that have come up, but the
main headline thing is boards feeling as though Delaware has
made it too easy for shareholders to sue over conflicted transaction.
Speaker 3 (16:57):
What's a conflicted transaction? Just so we know these terms.
What is an example of one, either figurative or actual.
Speaker 4 (17:03):
Actual Tesla buying Solar City. Elon Musk was on both
sides of that transaction. He's on the board of Tesla
and he's on the board of and running Solar City,
and so Tesla is using its resources to buy out
Elon Musk company. So that's a classic conflict transaction.
Speaker 2 (17:18):
That actually reminds me just speaking of Elon, but how
big a deal was Tesla moving from Delaware to Texas
because we talk about this network effect. Is it the
case that one high profile company moves and suddenly all
these other companies are like, we're going to do that too.
Speaker 5 (17:34):
Yeah.
Speaker 4 (17:34):
I think it's a big deal. I mean, first of all,
you know, we all know that it was inspired by
the that move was inspired by the pay package case.
But I think some of the grumblings about Delaware are broader.
But I think that was a big deal. If for
no other reason, then Elon Musk is very admired by
a lot of CEOs, a lot of venture capitalists, a
lot of Silicon Valley. They look to him as a
real role model. And so when he publicly announces that
(17:57):
he's had it with Delaware and shows that it's possible
to take a pub company and gets shareholder support for
moving out of Delaware, even if he is as special
and he has a particular relationship with the shareholders that
may not be shared by other companies, I think that's
the kind of thing that has boards thinking putting it
on the table.
Speaker 3 (18:12):
Let's talk about the pay package deal. I don't know, Like, look,
I really don't know much about the law or anything
about this stuff at all. But I say when I say, hey,
this was the compensation package she agreed to. Who is
this judge to say that he can't get paid? Intuitively,
to me, it's he was outrageous. Why is this judge
(18:32):
canceling his pay package? But this is my dumb guy
just reading ahead. I didn't even read the article probably,
so what I'm being honest here? So why don't you
tell me, as someone who actually understands this stuff, how
we should read what that case was all about?
Speaker 4 (18:46):
Okay, So remember the issue here is conflicted transactions. Yeah,
Musk's pay was a standard conflicted transaction in the sense
that the board was deciding what it was going to
pay at CEO, which is very much well with the
the board discretion. But the board included Elon Musk and
his brother, So therefore this was your classic conflict transaction.
Speaker 3 (19:08):
It was a board, but a lot of CEOs are
on their board.
Speaker 4 (19:11):
Yes, okay, So under Delaware law, the general rule is
a conflicted transaction will get close scrutiny by a court
unless it's cleansed. And how do you cleanse it? You
put an independent decision maker in the mix, and then
the court will say, well, I'll just defer to the
independent decision maker. And you have two options for an
independent decision maker, the unconflicted board members or the shareholders.
(19:34):
And usually, I mean, this doesn't happen. You have to
understand how unusual a case was. Usually that's more than sufficient.
You have the unconflicted board members decide the pay, or
you have the disinterested shareholders vote on the pay. And
at that point Delaware says, I'm out, you guys, god bless.
The problem here was that the unconflicted board members were
(19:55):
not unconflicted. So they were all like he stocks Tesla's
board with people who were basically his bestest buds. And
they created a committee that was supposed to be the
independent members of the committee, and the committee still had
close ties to Musk. And then the committee formed a
working group that would really do the compensation package, and
they picked the people with the closest ties to Musk
to put in the working group. And there were all
(20:17):
these facts about how he interfered with the committee's deliberations
and they just deferred to him. So given that the
court felt that like they didn't put actual independent decision
makers at the board level, so then they took it
to the shareholders and the mayde a shareholder vote, but
there was not full disclosure in the proxy statement. The
shareholders were not fully informed, and for obvious reasons, shareholders
can't cleanse anything unless they have full information. So left
(20:40):
with the situation where the board was not independent of
Musk and the shareholders were not fully informed. That's why
the court felt, well, I have to evaluate the pay
package because no independent decision maker was put in the mix,
and then from there she decided it was too much.
Speaker 2 (20:58):
So this might be a tough question ask. But since
we're talking, you know, this discussion or debate centers on
shareholder liability. As you've laid out, do we have any
research that actually tells us what happens to share prices
and stocks when a company's signals that it's going to
move away from Delaware or when it actually does it.
Speaker 4 (21:20):
We have incredibly mixed evidence. The fact is that scholars
have been fighting about this forever whether it makes a difference,
and some have found that maybe it's beneficial depending on
the type of company, Like, I mean, Delaware is expensive.
I mean the whole point of Delaware having this chartering
business is that's how the state funds itself. It gets
twenty five percent of revenues from incorporation fees. No other
(21:40):
state does anything like that. So for smaller companies with
less resources, it can be beneficial to move away from Delaware.
But mostly this is something where different scholars will come
up with different things. We just don't know for sure,
and that's probably because Delaware has been dominating for so long,
at least for public companies, that it's hard to tell
if there's a serious movement away.
Speaker 5 (21:59):
Now now it's.
Speaker 3 (22:00):
Interesting, so let's talk about the allure of, say, reincorporating
in Texas. You know, I could see just sort of
for vibes in vague ideological things. Elon wants to go
to Texas. I'm not surprised, and they're probably the politicians
or yeah, Elon, come on down. The shareholders are like,
we're going to get away from those blue states that
(22:22):
impost communism on you by not letting you get your
billion dollar pay package or whatever. All that being said,
the goal, it seems to me, or why people like
Delaware is right, this idea of balance, because while there
may be an Elon must cult that loves to hand
him money, and not every shareholder wants to have that
relationship with their CEO where they're just working over a
(22:45):
lot of money. And so it seems to me that Okay,
maybe Texas is a good fit for Elon and his shareholders,
but that's still in many cases, some sort of court
system that imposes maintains a balance of power between the CEO,
the board and the outside share holders is still what's
going to be desirable for most companies.
Speaker 4 (23:02):
Yeah, so this is a complicated question. That is exactly
how Delaware has sold itself. Essentially that it maintained a balance,
that it mostly gave boards incredible amounts of flexibility and
incredible amounts of deference, but ultimately there was some basic
floor of protections for shareholders. The issue, well, there are
twofold issues. The first is that ultimately corporate managers are
(23:24):
the ones who make decisions about where to incorporate when
they do a startup. I mean, once you're actually publicly traded,
if you want to move, you need a shareholder vote,
But before then, you can pick any company you want
to And even if you need a shareholder vote once
you're publicly traded, as we saw with Tesla, if you're
a meta or where you have a controlling shareholder, the
shareholder vot'ess really easy. It's just what the controlling shareholder wants.
So moving is not hard, and so the only reason
(23:47):
essentially that you wouldn't do it is if you really
thought you were going to pay a price with shareholders.
It's not clear how much of a price shareholders are
going to inflict for being in a state with fewer protections.
So the theory is always been the cost of capital
will be higher if you're in a state with fewer protections,
but it's not clear how much that plays in. As
(24:07):
you just asked, like, is there really a shareholder of
value price for moving to a different state. It's not
clear shareholders really have the power to push back, and
Delaware also seeing this move, weakened a lot of the
shareholder protections that led to verdicts like the Musk pay
package case. So now we really don't know if there's
a difference.
Speaker 2 (24:41):
Why would a minority shareholder actually approve to move to
a jurisdiction where ostensibly they have fewer rights.
Speaker 4 (24:49):
Because remember ninety percent of this is about shareholder litigation.
There may be are and conflict transactions and suing over
conflict transactions. That is most of what this.
Speaker 5 (24:58):
Fight is about.
Speaker 4 (24:59):
It's not the only thing that's most of it. There
is a huge debate about whether shareholder litigation is in
fact the best way to handle this problem. I mean,
there are all kinds of concerns about strike suits. There
are concerns that this is just lawyer driven litigation. In
the Tornetti case that Elon must pay package. Remember the
shareholder there held nine shares, literally nine shares of Tesla stock.
(25:22):
So there's a real question about whether shareholder litigation is
in fact a game that's worth the candle. Unquestionably, there
are real problematic transactions, and shareholder litigation can win very
huge payouts for shareholders, but usually those payouts come from
the insurance that the company itself paid for in these settlements.
(25:44):
And whether or not that ultimately is the best way
to handle a conflict transaction situation is a very debated question.
So shareholders may very well think they can move to
a jurisdiction with fewer protections on the theory that ultimately
less litigation is better for the company.
Speaker 3 (26:00):
It is a very strange situation because essentially, again you
have this situation in which the shareholders were upset at
the state for not allowing more shareholder money to go
into the pocket of one person. That's a very strange situation,
et cetera. Shareholder lawsuits always strike me as a little
bit interesting field in general. I remember back twenty five
(26:21):
years ago and I sometimes used to buy and trade
individual stocks and a stock would miss earnings and then
suddenly you get an email it's like, this company is
filing suit. It's like, why do I want to take
a part in a lawsuit against this company that I
am a co owner of? Does this actually benefit me
or does this benefit anyone other than the lawyer. I've
never been totally clear on that either, just in general,
(26:43):
even setting aside sort of these conflict questions.
Speaker 4 (26:46):
Yeah, I mean that's it's a very debated question. But
for most of these suits, I mean, there is a
difference between a suit for fraud under the federal securities
laws and a state law suit for breach of fiduciary duty,
which is what Delaware handles. And there, I mean, when
there's a lawsuit like that, any payment is supposed to
come from the directors to the shareholders or to the company.
(27:07):
So that's that's the theoretical monitor benefit. But directors usually
don't pay out a pocket that got insurance, so if
they pay, it's the insurance. And guess who pays for
the insurance corporation does.
Speaker 2 (27:17):
Now you're going to think about shareholder lawsuits differently, Joe, or.
Speaker 3 (27:20):
Just yeah, I still don't Okay, keep going.
Speaker 2 (27:24):
All right, So you touched on this earlier, but Delaware
isn't exactly standing still while it sees companies move elsewhere.
Is this just going to result in a sort of
race to the bottom in terms of shareholder rights where
states are just like, well, if you drop your standards
or if you alter the balance here, I'm going to
do the same thing, and everyone just kind of races
(27:47):
to the bottom.
Speaker 4 (27:48):
I think that's what we're absolutely seeing. I mean, Nevada
and Texas are essentially selling their law as creating barriers
to shareholder lawsuits. And that's what Delaware did. It changed
its law to put up more barriers. Now it did
some more subtlely, which is exactly why I think they're
still like this race. Because Delaware didn't want to like
openly say now that's it, we're just barring shareholder lawsuits.
(28:09):
So they wrote a lot of words and their complex words,
but ultimately they may all come out to the same thing.
All three stays have made it much much harder, if
not virtually impossible, for anything, but in the most fraudulent
circumstances shareholders to bring claims. So I think we're at
that race. We're watching it right now.
Speaker 3 (28:25):
I could understand why a public company board or a
public company would say, Okay, we want to be in
a jurisdiction where it's much harder for shareholders to bring lawsuits,
et cetera. Is the calculus different depending on the maturity
of the company, And could you say, like an early
stage startup, like I said, I've known people in the
startup space, first, one of the first things they do
(28:46):
is incorporate in Delaware. In those situations, maybe from the
legal perspective, did the vcs own the company in a
more deep way than public company shareholders do, even though
nominally they're all just shareholders and there's a separate board.
Speaker 4 (29:02):
Yes, and a shareholder litigation. This kind of shareholder litigation
is extremely rare in VC back or smaller companies, and
that's because who the shareholders are. I mean, the shareholders
are largely insiders or friends of VC they don't want
to anger them. They may have signed arbitration agreements that
would prevent any kind of lawsuit anyway. So this issue
of litigation is much more of a public company problem.
(29:28):
That said, there were some issues that were really bugging
the startup community that Delaware fixed as well. For example,
a lot of startups like to have shareholder agreements where
one shareholder is given essentially governance rights, not because they're
a shareholder and they can vote their shares, but because
they have a contractual right to say, board, you're not
allowed to merge unless I approve. Board you're not allowed
(29:49):
to take on debt unless I approve. And Delaware a
couple of years ago a court decision, i think very
correctly under Delaware law at the time, said well, you
can't do that in a corporation. The board has to
run the company. You can't just hand over governance rights
to a shareholder by saying, well, here's your contract, you
get to approve all board decisions. That really scared the
VC community, and Delaware reacted immediately by authorizing those kinds
(30:11):
of shareholder agreements.
Speaker 3 (30:12):
Tracy, I think there's gonna be some very interesting questions
of corporate governance that come up. You know some of
these episodes that we've discussed where AI startups the company
gets ACQUI hired, and not all the value gets accrued
to shareholders or different class of shareholders depending on what
employee are. I bet there will be some very interesting
corporate governance law that comes out of this, for sure.
Speaker 2 (30:32):
And you know there's going to be some state that
tries to pitch itself as like the place to incorporate
AI start Yeah, okay, So speaking of startups, if Joe
and I were going to incorporate and become odd Lots,
I guess we'd be in LLC.
Speaker 5 (30:46):
Maybe not LAN, it probably would be yeah, okay.
Speaker 2 (30:48):
Odd Lots LLC. And you were our lawyer, our hypothetical
lawyer giving us legal advice, hypothetical what would you advise
us to do here? Where should we incorporate?
Speaker 4 (31:00):
Well, so, first of all, in LLC is not a corporation,
So I just want to you would not be incorporated,
you would be organizing in LLC. But actually I would
tell you not to go to Delaware, Nevada, Oro, or
Texas because Delaware dominates in public companies and these seedback
companies like professionalized startups, but it doesn't dominate in small
(31:20):
like you know, your average family business, your average local business.
It does not dominate there at all. And it's it's
not designed for that. So if you, I mean, you
guys are professionals, but you know, in a small relationship
back company, Delaware laws in some ways too ruthless. The
other states have a lot more protections for essentially non lawyer,
(31:41):
family ish friendish businesses. That might be more appropriate.
Speaker 1 (31:45):
Well, I don't know.
Speaker 3 (31:46):
We might, it might be we could be big, it
might be a professional operation. I guess have one more question.
How rare is the US for having this patchwork of
corporate systems, Like if we went to another country, is
there jurisdiction shopping the same way?
Speaker 4 (32:02):
No? Well, see, I understand we're like fifty different countries
in Europe. It's like, you know, so Europe, you used
to be that you couldn't do what we do in
the United States, where you incorporate in Delaware, but all
your business operations are somewhere else. It used to be
in Europe that essentially it was, but as country by country,
if you had your headquarters in a country, you were
(32:24):
supposed to organize in that country. And you couldn't mix
and match. Europe changed the law, but it's still so
that you could theoretically jurisdiction shop among European countries, you know,
or going to have your headquarters and all your operations
in one place and organized in another place, another country.
But they don't. They don't really have that norm. It's
just viewed as sort of weird. So for them, where
(32:45):
your operations are are largely going to be with the law,
the corporate law that governs your entity.
Speaker 2 (32:51):
Is there transnational jurisdiction shopping? Could you get you know,
like a foreign company that wants to incorporate in the US.
Speaker 4 (32:58):
Well, yes, but it's much more lucky that a US
company wants to incorporate outside the country in Ireland. Yes,
for other kinds of you know, tat that used to
be a big deal for tax reasons and so forth.
Speaker 2 (33:10):
All right, and Lifton, thank you so much for coming on.
Odd lots really appreciate it. That was great.
Speaker 5 (33:15):
Thank you for having me, Joe.
Speaker 2 (33:30):
That was so interesting. I really think I think business
journalism in general or financial journalism doesn't cover legal stuff enough.
Speaker 3 (33:38):
Well, Matt Levine has proved it, because there's a huge
demand for his newsletter precisely because he's one of the
few destinations that actually talks about the chancery and all
this stuff. But to your point, right, this proves the point.
Speaker 2 (33:48):
He's the exception that proves the point the entire point,
and accounting as well, and insurance insurance. Okay, wait, I'm
not going to just criticize our colleagues in financial journalism. No,
that was fascinating. I do find the whole race to
the bottom idea a little bit concerning for obvious reasons.
And I guess like it's sort of that network effect
(34:11):
that you were discussing earlier, But once the ball gets
rolling in that direction, it just seems really hard to stop.
Speaker 3 (34:19):
It's just I agree, and I think this is something
very The sheer influence that Elon has and all the
people who look to him and see him as the
model is very interesting. On the other hand, you know,
there are not many CEOs out there for whom the
cult is so strong that people thirst to give him money.
(34:40):
And so the question of whether shareholders of other companies
want to be incorporated in states, whether they would actually,
unlike the current research, inflict some sort of cost of
capital penalty for non Delaware Incorporated States is going to
be an interesting question. But the ball is rolling, that's
going to be so interesting.
Speaker 2 (34:58):
Once the sample size it's a little bigger and you
can see like the actual impact on stock prices. So
I take your point, But there are shareholders who potentially
would say, well, if a company doesn't have to deal
with a lawsuit from like a shareholder who has nine shares,
maybe that's a good thing, and that's like a trade
off worth making.
Speaker 3 (35:19):
Yeah, I don't know. I mean nine shares and he
had this pay package. She was like, he signed a deal.
Could you imagine? Could you imagine how annoyed you would
be if your pay package got canceled because of some
shareholder with nine shares.
Speaker 2 (35:36):
I can't pay package of millions. I would be annoyed.
Speaker 3 (35:39):
It doesn't matter how rich I am. I would cannot
imagine my fury. I would be the richest person of
the world. I would be so annoyed by that.
Speaker 2 (35:45):
Okay, So now that we've annoyed Joe, shall we leave
it there?
Speaker 3 (35:48):
Let's leave it there.
Speaker 5 (35:49):
Okay.
Speaker 2 (35:49):
This has been another episode of the All Thoughts podcast.
I'm Tracy Alloway. You can follow me at Tracy Alloway.
Speaker 3 (35:55):
And I'm Joe Wisenthal. You can follow me at the Stalwart,
follow our producers Kerman rode Is at Carman armand dash
Ol Bennett at dashbot at, Kilee Brooks at Kilbrooks. From
our Odd Lots content, go to Bloomberg dot com slash
odd Loads were a daily newsletter, and all of our episodes,
and you can chat about all of these topics twenty
four to seven in our discord Discord dot gg slash odd.
Speaker 2 (36:16):
Lots And if you enjoy odd Lots, if you like
it when we dig into legalities in the US legal system,
then please leave us a positive review on your favorite
podcast platform. And remember, if you are a Bloomberg subscriber,
you can listen to all of our episodes absolutely ad free.
All you need to do is find the Bloomberg channel
on Apple Podcasts and follow the instructions there. Thanks for listening.
Speaker 4 (37:04):
E
Bloomberg Audio Studios, Podcasts, radio News.
Speaker 2 (00:18):
Hello and welcome to another episode of the Authots podcast.
I'm Tracy Alloway and I'm Joe.
Speaker 3 (00:23):
Why isn't thal Joe?
Speaker 2 (00:24):
I have a fun fact for you? Go on? Are
you ready?
Speaker 1 (00:28):
Yeah?
Speaker 2 (00:28):
Okay, So Delaware has a population of about one point
h five million a little over a million. Okay, it's
one of the least populous states. Yeah, I think it
has fewer people than a lot of big cities in
the US for sure. However, Delaware has two point one
million businesses registered in the state, so basically two businesses
(00:50):
for every person.
Speaker 3 (00:51):
This is a legit fun fact. This is like a
legit I did not know this. I mean, I knew
that it was not a very big state population wise.
I know that so many corporations or businesses or whatever
incorporate in Delaware, but there's sort of two to one ratio.
Excellent fun fact tracing.
Speaker 2 (01:06):
Well done, Yes, for your next dinner party. You can
trot that one out. But I mean, obviously, maybe you
could argue that Delawareans are just phenomenally entrepreneurial. But as
you as you mentioned more.
Speaker 3 (01:17):
Than I'm not dismissing them. I just know that that's
not really what's going on, right.
Speaker 2 (01:21):
There's something else going on here, which is the Delaware
has become the de facto state for companies incorporating.
Speaker 3 (01:28):
Yeah, this is like the main thing that we know
about Delaware, and we don't really I mean the chickens, right,
not the chickens. But you don't hear much about Delaware
except typically when there is some sort of corporate fight
playing out in its courts. And of course it has
a dedicated court system for corporate fights and so forth,
and there's some prominent examples over the years where we
(01:50):
learn about what the chancery is and then I forget
what the chancery is or where that word comes from.
But people seem to like their simplistic, streamlined legal system
for things, and it seems to have paid off reasonably well.
Speaker 2 (02:02):
People seem to like it, but that might be changing.
So you mentioned corporate fights. We had a very prominent
example of this relatively recently when there was the court
fight over Elon Musk's compensation at Tesla, and eventually Elon
just said, you know, I'm going to pick up my
company and move it to Texas and incorporate there. And
(02:23):
in fact we are seeing a few examples of companies
choosing to move away from Delaware and two places like
Texas or Nevada. And I know this isn't maybe a
top of mind news development for many people right now.
There's a lot going on. Yeah, but I think it's
really interesting. It's kind of slow moving, and it does
have implications for shareholder rights totally.
Speaker 3 (02:45):
I actually think it's a very important relevant topic. And
I'll say this is the reason why, which is that
in this sense, a legal system is this network effect,
and people respect the legal system, and even if maybe
there are decisions that go against them, like okay, this
is a high qualt a legal system, it is very
hard to rebuild that somewhere else. It also is the
sort of thing that if there is some pole elsewhere,
(03:07):
then it's interesting to see what does it take to
pry entities away from this network where there is years
and years and thousands and thousands of decisions upon which
to build something resembling a shared law. And so, you know,
when I think about the United States, when I think
about these bigger questions about how do you move dollars,
how do you move entities, industries to other jurisdictions that
(03:29):
are maybe younger and don't have the same level of
historical jurisprudence. Maybe there is a microcosm a story to
be told about the Delaware history, how it built up,
and if there are any threats to it over the
medium term.
Speaker 2 (03:42):
Absolutely very well put. Thanks so I am happy to
say we have the perfect guest. We're going to be
speaking with professor Ann Lipton. She is a law professor
at the University of Colorado and Lawrence W. Dmouth Chair,
And thank you so much for joining us.
Speaker 4 (03:57):
Thank you so much for the invite.
Speaker 2 (03:59):
I'll start with the obvious question, which is how did
we end up with Delaware as the de facto place
for corporate incorporation? Why Delaware?
Speaker 4 (04:09):
Because Delaware actually strategized that it wanted to attract incorporations.
And this was back in all the late eighteen hundred's
early nineteen hundreds, a number of states actually thought that
they could make money by having corporations incorporate in their
state and pay fees. You could actually open a newspaper
at that time and see advertisements for come incorporate in
(04:29):
X state. And Delaware made a conscious decision to make
its state and its law friendly to corporations that wanted
to incorporate there So, among other things. At the time,
one of the main concerns of businesses was that corporate
law would be used politically, that the rules would change
to effectuate some kind of political policy. So Delaware adopted
(04:49):
a constitutional amendment that its judges would have to be
politically balanced, so you couldn't have more than half more
than a bare majority of one party or the other.
So for a seven member court, no more than four
can be a member of one party or another. They
also put a constitutional amendment that any change to the
corporate code required a two thirds vote of the legislature,
(05:09):
so trying to insulate their corporate law from political pressures.
And then they just made their corporate law very flexible
and very manager friendly. Managers could kind of do what
they wanted with it, and it just sort of took
off from there.
Speaker 3 (05:20):
This is really fascinating, this idea of creating the corporate
legal system in this sort of glass enclosure through which
the political system cannot break. And this is a theme
that seems to come up over and over again. We
talk about it when we talk about the Federal Reserve
and its nominal or de facto independence. This came up
when we talked to the Alaska Sovereign Wealth Fund guys
(05:43):
and the difficulty that the political system has in accessing
the corn seed, so to speak. Talk to us a
little bit more about the structures in place and how
strong they are to insulate the core system from politics,
and how durable and thick those a glass wall.
Speaker 4 (06:00):
Yeah, so they can't insulate the court from politics in
the sense of the legislature acting and so forth, and
that's actually what we've just been seeing, but they are
fairly insulated from partisan politics. Partisan politics doesn't play out
in the same way that we would understand it in
other parts of the country or other areas. But so
the idea here, well, first of all, I mean one
thing to note though, is that Delaware is obviously it's
(06:22):
very blue state voting behavior, and judges do things other
than decide corporate cases. We do forget that, but they
do in fact have other things to decide. But still
the judges are politically balanced in order to benefit this
corporate system. So what happens with the way laws made
in Delaware, corporate laws made, is that it actually doesn't
really come from the legislature, which really most of the
(06:43):
legislature isn't. They're not corporate experts, they don't know much
about corporate law necessarily, they're just legislators. So what happens
is there's the Delaware State Bar Association has a Corporation
Lost section and they actually generate the proposed statutes on
the theory that they can do it in a sort
of non partisan, very technocratic way, and then the legislature
(07:03):
tends to sort of rubber stamp the stuff that comes
out of the Corporation law section.
Speaker 2 (07:08):
So, you know, Joe mentioned that sort of network effect earlier,
and I think this is really important in law, especially
because a lot of legal battles are based on precedent, right,
and so we have Delaware as the de facto incorporation
state and decades and decades of precedent for judges and
(07:28):
lawyers to actually look at, how does that sort of
I guess precedent or first mover advantage help Delaware.
Speaker 4 (07:37):
Well, it's always been assumed that that would help Deltware
because you would have the statute and you have a
decades of precedent, so that companies would kind of know
how questions would be answered. If they came up. So
there are a lot of areas where other states you
just simply do not have information on, like how a
court would treat particular kinds of claims or particular kinds
(07:57):
of disputes. Some of the obvious things are things like
activist takeovers or our proxy contests and takeover defenses, because
we know how that looks in Delaware, because Delaware incorporates
most of the public companies where you have those kinds
of fights. We don't know how that looks in other
states because you don't tend to have as many activist
situations in those other states. So that's always thought to
(08:19):
be sort of an advantage of Delaware that everything plays
out there, and most other states they very often look
to Delaware when they're deciding their own corporate law. Sometimes
they contrast their corporate law with Delaware, but Delaware is
always kind of where they look to deal with these questions,
and that's always considered to be a real advantage of Delaware.
You at least know what's going to happen. But it
(08:40):
also means that because this is case law, it's mostly
not in the store, hasn't been mostly in the statute.
It's judged by judge decisions, and that can also mean
that sometimes it's sort of hard to penetrate because it's
really you've got to read this decision, well, don't forget
this other decision, and don't forget this decision too, and
that can be sort of hard to figure out if
you're just looking at it the first time.
Speaker 3 (09:01):
Yeah, I'm really interested in this tension, right because in theory, okay,
you write down laws on paper and they're all visible
and say, okay, this is consistent. We know what's going
to happen. But also decisions are made by judges and
people dispute them. Otherwise they wouldn't have to have cases
in the first part, if if judges didn't have to
exercise some sort of agency, how do the judges feel
(09:22):
about their own responsibility when deciding these cases to think
about consistency or the underlying deep principles of Delaware corporate
law and the long term implications for the state of
Delaware and for the state when they make their decisions.
Speaker 4 (09:39):
Yeah, so there's a tension there. So you just identified,
like attention, a tension between the state of Delaware versus
general corporate theory and corporate law and I think you
don't become a judge and you don't go into this
area unless you really do appreciate the law and enjoy it.
And I mean the Delaware judges are extremely thoughtful about
corporate law and what the right answer is and how
corporations should work. They don't always have exactly the same theories,
(10:02):
but they definitely have a point of view and they
care very much about how corporate law operates. But and
this is where some of the tension is today. If
corporate boards are unhappy with their decisions over and over
and over again, then Delaware may lose incorporations to other states.
And how that plays out between sort of fidelity to
(10:22):
a vision of what corporate law should be couple with
the straight up reality that if managers are unhappy and
incorporate elsewhere, Delaware doesn't have doesn't get to do much anymore.
That's a tension that's been playing out for just as
long as Delaware has been incorporating companies.
Speaker 5 (10:37):
I mean, that's.
Speaker 4 (10:37):
Always I don't think judges are usually consciously making that
decisions based on that, or they're certainly trying not to,
but that tension is always present and has been present
in the past.
Speaker 2 (10:48):
Before we get to why companies some companies seem unhappy
with Delaware at the moment, I'm going to go ahead
and ask Joe's classic question whenever this comes up, which
is what is a chancery.
Speaker 4 (11:02):
Well, it's just the name for the Delaware courts that
here corporate cases, So I mean the fun This is
a very technical legal point, but historically there were two
types of courts in the world. There were the courts
of law and the courts of equity. The courts of
law followed sort of these stringent rules, and the courts
of equity were literally sort of about fairness and dealing
(11:22):
with what's the right answer and doing justice as opposed
to according to technical rules that were laid down. And
so there was two separate courts, and that was from England,
and that was true in the United States, and then
the United States in the thirties or so melded the
two courts at the federal level, and most states did
the same, so there would just be one court that
heard all the cases law cases and equity cases. But
(11:44):
Delaware never did that, so it still has this separate
court of law and the Court of equity, which is
the chancery court. So its historical origins are essentially rooted
in this idea of fairness and commanding people to take
the proper actions. And it doesn't sit with a jury.
The cases are heard just by the judges. The judges
(12:05):
find facts. Would otherwise juries would do that, but the
judges find facts in the Delaware Court of Chancery, they're
very expert. They are, you know, they're all drawn from
corporate practice before they get on the bench, and that's
what they do. I mean, they hear other things besides
corporate cases. Other things fall into this category of equity.
But the main thing, obviously is the corporate cases.
Speaker 3 (12:40):
So I want to eventually get into the Elon paid
case and maybe get you read on it, et cetera.
But before we do that, you mentioned that this is
nothing new. Some of these there are these long standing
questions about the Delaware and its persistence. Can you give
us a little history or what are you know? What
were the Elon cases pre the Elon cases that sort
(13:00):
of maybe had people questioning the sort of durability of
the Delaware system the.
Speaker 2 (13:06):
Long, long, long ago before Elon Elon l.
Speaker 4 (13:10):
Lepe It's in the eighties. It was that long ago.
It was the eighties. There were two big incidents. So
one case of like these are the basic law cases
that you learn if you're in any kind of basic
corporate law class. So one case was called Ben Gorkum. Basically,
a company was selling itself and they settled on a price,
and shareholders sued, claiming that the board didn't take proper
(13:31):
care and setting this price. Nobody suggested they were acting
in bad faith, but they just didn't take the time
to make sure that they got the best price. And
the Delaware Supreme Court agreed, and it held that the
directors could be held personally liable for damages for essentially
not getting the right price for the company. And that
terrified boards because these boards could be acting in good
faith and still could be I mean, not selling the
(13:54):
company for enough. That's serious money damages. So Delaware amended
its corporated so that companies can now add a provision
to their charter that says directors will not be held
liable for monetary damages for negligence, and that really also
boosted companies incorporating in Delaware after that, and by now
(14:15):
every state has adopted a similar thing. But at the
time that was done essentially because they knew that they
had just scared the Jesus out of boards. And another
issue that came up, this is also in the eighties,
was during the hostile takeover era. This was like you know,
the deal decade. There were lots and lots of hostile
takeover attempts, and when there's a hostile takeover attempt, boards
put up barriers, usually shareholder rights plants poison pills to
(14:36):
prevent hostile takeovers. And there was a real question as
to how far boards could go to fend off a
hostile acquirer, even if the shareholders wanted this deal. And
at first the Delaware courts were pretty strict about it.
They after a certain point they were saying, look, you
got to let shareholders decide. The board can't just block
beneficial proposals to buy the company if the shareholders want it.
(14:59):
And once again there were threats to that companies would leave,
they would leave Delaware so that they could protect against
hostile takeover attempts, and at that point the Delaware Supreme
Court backed off. It adopted new standards that allow much
more deference to boards when they are fighting off hostile
takeover attempts.
Speaker 2 (15:17):
So fast forward to today. I just want to make
sure we have our priors correct.
Speaker 6 (15:22):
We love, we love establishing our priors on this podcast,
but you know those examples aside, does it feel like
nowadays there is perhaps more discussion of alternatives to Delaware
or more companies that seem to be moving away.
Speaker 4 (15:36):
Yeah, so I don't know if statistically the numbers really
move the needle. We've seen definitely some high profile announcements
of companies planning to move, but we just don't have
enough data right now to see whether this is a
serious like actual exodus. But there's definitely a lot more discussion,
and there's definitely a lot more boards thinking, our lawyers
(15:56):
thinking they have to counsel boards whether you want to
incorporate in Delaware, when before that one wouldn't even have
been a question. So that's definitely something that's happening.
Speaker 3 (16:03):
Well, why so, what is it if a lawyer is
counseling boards? Don't just because you know, I've known people
who have launched startups at times and the idea of
incorporation in Delaware that was just obviously what you did
right You just did it right away. So what is
it that a lawyer might say, well, maybe take a
few beats and think about this. What has actually changed
(16:24):
that's caused that.
Speaker 4 (16:25):
Well, Delaware understands fought back, and it's changed its law
very recently to sort of fight this off. But essentially
the issue, most of the issue is shareholder liability or
liability to shareholders and vulnerability to a shareholder lawsuit. And
most of that vulnerability is vulnerability to a shareholder lawsuit
over conflicted transactions. That's the main headline thing. There are
(16:46):
a few other issues that have come up, but the
main headline thing is boards feeling as though Delaware has
made it too easy for shareholders to sue over conflicted transaction.
Speaker 3 (16:57):
What's a conflicted transaction? Just so we know these terms.
What is an example of one, either figurative or actual.
Speaker 4 (17:03):
Actual Tesla buying Solar City. Elon Musk was on both
sides of that transaction. He's on the board of Tesla
and he's on the board of and running Solar City,
and so Tesla is using its resources to buy out
Elon Musk company. So that's a classic conflict transaction.
Speaker 2 (17:18):
That actually reminds me just speaking of Elon, but how
big a deal was Tesla moving from Delaware to Texas
because we talk about this network effect. Is it the
case that one high profile company moves and suddenly all
these other companies are like, we're going to do that too.
Speaker 5 (17:34):
Yeah.
Speaker 4 (17:34):
I think it's a big deal. I mean, first of all,
you know, we all know that it was inspired by
the that move was inspired by the pay package case.
But I think some of the grumblings about Delaware are broader.
But I think that was a big deal. If for
no other reason, then Elon Musk is very admired by
a lot of CEOs, a lot of venture capitalists, a
lot of Silicon Valley. They look to him as a
real role model. And so when he publicly announces that
(17:57):
he's had it with Delaware and shows that it's possible
to take a pub company and gets shareholder support for
moving out of Delaware, even if he is as special
and he has a particular relationship with the shareholders that
may not be shared by other companies, I think that's
the kind of thing that has boards thinking putting it
on the table.
Speaker 3 (18:12):
Let's talk about the pay package deal. I don't know, Like, look,
I really don't know much about the law or anything
about this stuff at all. But I say when I say, hey,
this was the compensation package she agreed to. Who is
this judge to say that he can't get paid? Intuitively,
to me, it's he was outrageous. Why is this judge
(18:32):
canceling his pay package? But this is my dumb guy
just reading ahead. I didn't even read the article probably,
so what I'm being honest here? So why don't you
tell me, as someone who actually understands this stuff, how
we should read what that case was all about?
Speaker 4 (18:46):
Okay, So remember the issue here is conflicted transactions. Yeah,
Musk's pay was a standard conflicted transaction in the sense
that the board was deciding what it was going to
pay at CEO, which is very much well with the
the board discretion. But the board included Elon Musk and
his brother, So therefore this was your classic conflict transaction.
Speaker 3 (19:08):
It was a board, but a lot of CEOs are
on their board.
Speaker 4 (19:11):
Yes, okay, So under Delaware law, the general rule is
a conflicted transaction will get close scrutiny by a court
unless it's cleansed. And how do you cleanse it? You
put an independent decision maker in the mix, and then
the court will say, well, I'll just defer to the
independent decision maker. And you have two options for an
independent decision maker, the unconflicted board members or the shareholders.
(19:34):
And usually, I mean, this doesn't happen. You have to
understand how unusual a case was. Usually that's more than sufficient.
You have the unconflicted board members decide the pay, or
you have the disinterested shareholders vote on the pay. And
at that point Delaware says, I'm out, you guys, god bless.
The problem here was that the unconflicted board members were
(19:55):
not unconflicted. So they were all like he stocks Tesla's
board with people who were basically his bestest buds. And
they created a committee that was supposed to be the
independent members of the committee, and the committee still had
close ties to Musk. And then the committee formed a
working group that would really do the compensation package, and
they picked the people with the closest ties to Musk
to put in the working group. And there were all
(20:17):
these facts about how he interfered with the committee's deliberations
and they just deferred to him. So given that the
court felt that like they didn't put actual independent decision
makers at the board level, so then they took it
to the shareholders and the mayde a shareholder vote, but
there was not full disclosure in the proxy statement. The
shareholders were not fully informed, and for obvious reasons, shareholders
can't cleanse anything unless they have full information. So left
(20:40):
with the situation where the board was not independent of
Musk and the shareholders were not fully informed. That's why
the court felt, well, I have to evaluate the pay
package because no independent decision maker was put in the mix,
and then from there she decided it was too much.
Speaker 2 (20:58):
So this might be a tough question ask. But since
we're talking, you know, this discussion or debate centers on
shareholder liability. As you've laid out, do we have any
research that actually tells us what happens to share prices
and stocks when a company's signals that it's going to
move away from Delaware or when it actually does it.
Speaker 4 (21:20):
We have incredibly mixed evidence. The fact is that scholars
have been fighting about this forever whether it makes a difference,
and some have found that maybe it's beneficial depending on
the type of company, Like, I mean, Delaware is expensive.
I mean the whole point of Delaware having this chartering
business is that's how the state funds itself. It gets
twenty five percent of revenues from incorporation fees. No other
(21:40):
state does anything like that. So for smaller companies with
less resources, it can be beneficial to move away from Delaware.
But mostly this is something where different scholars will come
up with different things. We just don't know for sure,
and that's probably because Delaware has been dominating for so long,
at least for public companies, that it's hard to tell
if there's a serious movement away.
Speaker 5 (21:59):
Now now it's.
Speaker 3 (22:00):
Interesting, so let's talk about the allure of, say, reincorporating
in Texas. You know, I could see just sort of
for vibes in vague ideological things. Elon wants to go
to Texas. I'm not surprised, and they're probably the politicians
or yeah, Elon, come on down. The shareholders are like,
we're going to get away from those blue states that
(22:22):
impost communism on you by not letting you get your
billion dollar pay package or whatever. All that being said,
the goal, it seems to me, or why people like
Delaware is right, this idea of balance, because while there
may be an Elon must cult that loves to hand
him money, and not every shareholder wants to have that
relationship with their CEO where they're just working over a
(22:45):
lot of money. And so it seems to me that Okay,
maybe Texas is a good fit for Elon and his shareholders,
but that's still in many cases, some sort of court
system that imposes maintains a balance of power between the CEO,
the board and the outside share holders is still what's
going to be desirable for most companies.
Speaker 4 (23:02):
Yeah, so this is a complicated question. That is exactly
how Delaware has sold itself. Essentially that it maintained a balance,
that it mostly gave boards incredible amounts of flexibility and
incredible amounts of deference, but ultimately there was some basic
floor of protections for shareholders. The issue, well, there are
twofold issues. The first is that ultimately corporate managers are
(23:24):
the ones who make decisions about where to incorporate when
they do a startup. I mean, once you're actually publicly traded,
if you want to move, you need a shareholder vote,
But before then, you can pick any company you want
to And even if you need a shareholder vote once
you're publicly traded, as we saw with Tesla, if you're
a meta or where you have a controlling shareholder, the
shareholder vot'ess really easy. It's just what the controlling shareholder wants.
So moving is not hard, and so the only reason
(23:47):
essentially that you wouldn't do it is if you really
thought you were going to pay a price with shareholders.
It's not clear how much of a price shareholders are
going to inflict for being in a state with fewer protections.
So the theory is always been the cost of capital
will be higher if you're in a state with fewer protections,
but it's not clear how much that plays in. As
(24:07):
you just asked, like, is there really a shareholder of
value price for moving to a different state. It's not
clear shareholders really have the power to push back, and
Delaware also seeing this move, weakened a lot of the
shareholder protections that led to verdicts like the Musk pay
package case. So now we really don't know if there's
a difference.
Speaker 2 (24:41):
Why would a minority shareholder actually approve to move to
a jurisdiction where ostensibly they have fewer rights.
Speaker 4 (24:49):
Because remember ninety percent of this is about shareholder litigation.
There may be are and conflict transactions and suing over
conflict transactions. That is most of what this.
Speaker 5 (24:58):
Fight is about.
Speaker 4 (24:59):
It's not the only thing that's most of it. There
is a huge debate about whether shareholder litigation is in
fact the best way to handle this problem. I mean,
there are all kinds of concerns about strike suits. There
are concerns that this is just lawyer driven litigation. In
the Tornetti case that Elon must pay package. Remember the
shareholder there held nine shares, literally nine shares of Tesla stock.
(25:22):
So there's a real question about whether shareholder litigation is
in fact a game that's worth the candle. Unquestionably, there
are real problematic transactions, and shareholder litigation can win very
huge payouts for shareholders, but usually those payouts come from
the insurance that the company itself paid for in these settlements.
(25:44):
And whether or not that ultimately is the best way
to handle a conflict transaction situation is a very debated question.
So shareholders may very well think they can move to
a jurisdiction with fewer protections on the theory that ultimately
less litigation is better for the company.
Speaker 3 (26:00):
It is a very strange situation because essentially, again you
have this situation in which the shareholders were upset at
the state for not allowing more shareholder money to go
into the pocket of one person. That's a very strange situation,
et cetera. Shareholder lawsuits always strike me as a little
bit interesting field in general. I remember back twenty five
(26:21):
years ago and I sometimes used to buy and trade
individual stocks and a stock would miss earnings and then
suddenly you get an email it's like, this company is
filing suit. It's like, why do I want to take
a part in a lawsuit against this company that I
am a co owner of? Does this actually benefit me
or does this benefit anyone other than the lawyer. I've
never been totally clear on that either, just in general,
(26:43):
even setting aside sort of these conflict questions.
Speaker 4 (26:46):
Yeah, I mean that's it's a very debated question. But
for most of these suits, I mean, there is a
difference between a suit for fraud under the federal securities
laws and a state law suit for breach of fiduciary duty,
which is what Delaware handles. And there, I mean, when
there's a lawsuit like that, any payment is supposed to
come from the directors to the shareholders or to the company.
(27:07):
So that's that's the theoretical monitor benefit. But directors usually
don't pay out a pocket that got insurance, so if
they pay, it's the insurance. And guess who pays for
the insurance corporation does.
Speaker 2 (27:17):
Now you're going to think about shareholder lawsuits differently, Joe, or.
Speaker 3 (27:20):
Just yeah, I still don't Okay, keep going.
Speaker 2 (27:24):
All right, So you touched on this earlier, but Delaware
isn't exactly standing still while it sees companies move elsewhere.
Is this just going to result in a sort of
race to the bottom in terms of shareholder rights where
states are just like, well, if you drop your standards
or if you alter the balance here, I'm going to
do the same thing, and everyone just kind of races
(27:47):
to the bottom.
Speaker 4 (27:48):
I think that's what we're absolutely seeing. I mean, Nevada
and Texas are essentially selling their law as creating barriers
to shareholder lawsuits. And that's what Delaware did. It changed
its law to put up more barriers. Now it did
some more subtlely, which is exactly why I think they're
still like this race. Because Delaware didn't want to like
openly say now that's it, we're just barring shareholder lawsuits.
(28:09):
So they wrote a lot of words and their complex words,
but ultimately they may all come out to the same thing.
All three stays have made it much much harder, if
not virtually impossible, for anything, but in the most fraudulent
circumstances shareholders to bring claims. So I think we're at
that race. We're watching it right now.
Speaker 3 (28:25):
I could understand why a public company board or a
public company would say, Okay, we want to be in
a jurisdiction where it's much harder for shareholders to bring lawsuits,
et cetera. Is the calculus different depending on the maturity
of the company, And could you say, like an early
stage startup, like I said, I've known people in the
startup space, first, one of the first things they do
(28:46):
is incorporate in Delaware. In those situations, maybe from the
legal perspective, did the vcs own the company in a
more deep way than public company shareholders do, even though
nominally they're all just shareholders and there's a separate board.
Speaker 4 (29:02):
Yes, and a shareholder litigation. This kind of shareholder litigation
is extremely rare in VC back or smaller companies, and
that's because who the shareholders are. I mean, the shareholders
are largely insiders or friends of VC they don't want
to anger them. They may have signed arbitration agreements that
would prevent any kind of lawsuit anyway. So this issue
of litigation is much more of a public company problem.
(29:28):
That said, there were some issues that were really bugging
the startup community that Delaware fixed as well. For example,
a lot of startups like to have shareholder agreements where
one shareholder is given essentially governance rights, not because they're
a shareholder and they can vote their shares, but because
they have a contractual right to say, board, you're not
allowed to merge unless I approve. Board you're not allowed
(29:49):
to take on debt unless I approve. And Delaware a
couple of years ago a court decision, i think very
correctly under Delaware law at the time, said well, you
can't do that in a corporation. The board has to
run the company. You can't just hand over governance rights
to a shareholder by saying, well, here's your contract, you
get to approve all board decisions. That really scared the
VC community, and Delaware reacted immediately by authorizing those kinds
(30:11):
of shareholder agreements.
Speaker 3 (30:12):
Tracy, I think there's gonna be some very interesting questions
of corporate governance that come up. You know some of
these episodes that we've discussed where AI startups the company
gets ACQUI hired, and not all the value gets accrued
to shareholders or different class of shareholders depending on what
employee are. I bet there will be some very interesting
corporate governance law that comes out of this, for sure.
Speaker 2 (30:32):
And you know there's going to be some state that
tries to pitch itself as like the place to incorporate
AI start Yeah, okay, So speaking of startups, if Joe
and I were going to incorporate and become odd Lots,
I guess we'd be in LLC.
Speaker 5 (30:46):
Maybe not LAN, it probably would be yeah, okay.
Speaker 2 (30:48):
Odd Lots LLC. And you were our lawyer, our hypothetical
lawyer giving us legal advice, hypothetical what would you advise
us to do here? Where should we incorporate?
Speaker 4 (31:00):
Well, so, first of all, in LLC is not a corporation,
So I just want to you would not be incorporated,
you would be organizing in LLC. But actually I would
tell you not to go to Delaware, Nevada, Oro, or
Texas because Delaware dominates in public companies and these seedback
companies like professionalized startups, but it doesn't dominate in small
(31:20):
like you know, your average family business, your average local business.
It does not dominate there at all. And it's it's
not designed for that. So if you, I mean, you
guys are professionals, but you know, in a small relationship
back company, Delaware laws in some ways too ruthless. The
other states have a lot more protections for essentially non lawyer,
(31:41):
family ish friendish businesses. That might be more appropriate.
Speaker 1 (31:45):
Well, I don't know.
Speaker 3 (31:46):
We might, it might be we could be big, it
might be a professional operation. I guess have one more question.
How rare is the US for having this patchwork of
corporate systems, Like if we went to another country, is
there jurisdiction shopping the same way?
Speaker 4 (32:02):
No? Well, see, I understand we're like fifty different countries
in Europe. It's like, you know, so Europe, you used
to be that you couldn't do what we do in
the United States, where you incorporate in Delaware, but all
your business operations are somewhere else. It used to be
in Europe that essentially it was, but as country by country,
if you had your headquarters in a country, you were
(32:24):
supposed to organize in that country. And you couldn't mix
and match. Europe changed the law, but it's still so
that you could theoretically jurisdiction shop among European countries, you know,
or going to have your headquarters and all your operations
in one place and organized in another place, another country.
But they don't. They don't really have that norm. It's
just viewed as sort of weird. So for them, where
(32:45):
your operations are are largely going to be with the law,
the corporate law that governs your entity.
Speaker 2 (32:51):
Is there transnational jurisdiction shopping? Could you get you know,
like a foreign company that wants to incorporate in the US.
Speaker 4 (32:58):
Well, yes, but it's much more lucky that a US
company wants to incorporate outside the country in Ireland. Yes,
for other kinds of you know, tat that used to
be a big deal for tax reasons and so forth.
Speaker 2 (33:10):
All right, and Lifton, thank you so much for coming on.
Odd lots really appreciate it. That was great.
Speaker 5 (33:15):
Thank you for having me, Joe.
Speaker 2 (33:30):
That was so interesting. I really think I think business
journalism in general or financial journalism doesn't cover legal stuff enough.
Speaker 3 (33:38):
Well, Matt Levine has proved it, because there's a huge
demand for his newsletter precisely because he's one of the
few destinations that actually talks about the chancery and all
this stuff. But to your point, right, this proves the point.
Speaker 2 (33:48):
He's the exception that proves the point the entire point,
and accounting as well, and insurance insurance. Okay, wait, I'm
not going to just criticize our colleagues in financial journalism. No,
that was fascinating. I do find the whole race to
the bottom idea a little bit concerning for obvious reasons.
And I guess like it's sort of that network effect
(34:11):
that you were discussing earlier, But once the ball gets
rolling in that direction, it just seems really hard to stop.
Speaker 3 (34:19):
It's just I agree, and I think this is something
very The sheer influence that Elon has and all the
people who look to him and see him as the
model is very interesting. On the other hand, you know,
there are not many CEOs out there for whom the
cult is so strong that people thirst to give him money.
(34:40):
And so the question of whether shareholders of other companies
want to be incorporated in states, whether they would actually,
unlike the current research, inflict some sort of cost of
capital penalty for non Delaware Incorporated States is going to
be an interesting question. But the ball is rolling, that's
going to be so interesting.
Speaker 2 (34:58):
Once the sample size it's a little bigger and you
can see like the actual impact on stock prices. So
I take your point, But there are shareholders who potentially
would say, well, if a company doesn't have to deal
with a lawsuit from like a shareholder who has nine shares,
maybe that's a good thing, and that's like a trade
off worth making.
Speaker 3 (35:19):
Yeah, I don't know. I mean nine shares and he
had this pay package. She was like, he signed a deal.
Could you imagine? Could you imagine how annoyed you would
be if your pay package got canceled because of some
shareholder with nine shares.
Speaker 2 (35:36):
I can't pay package of millions. I would be annoyed.
Speaker 3 (35:39):
It doesn't matter how rich I am. I would cannot
imagine my fury. I would be the richest person of
the world. I would be so annoyed by that.
Speaker 2 (35:45):
Okay, So now that we've annoyed Joe, shall we leave
it there?
Speaker 3 (35:48):
Let's leave it there.
Speaker 5 (35:49):
Okay.
Speaker 2 (35:49):
This has been another episode of the All Thoughts podcast.
I'm Tracy Alloway. You can follow me at Tracy Alloway.
Speaker 3 (35:55):
And I'm Joe Wisenthal. You can follow me at the Stalwart,
follow our producers Kerman rode Is at Carman armand dash
Ol Bennett at dashbot at, Kilee Brooks at Kilbrooks. From
our Odd Lots content, go to Bloomberg dot com slash
odd Loads were a daily newsletter, and all of our episodes,
and you can chat about all of these topics twenty
four to seven in our discord Discord dot gg slash odd.
Speaker 2 (36:16):
Lots And if you enjoy odd Lots, if you like
it when we dig into legalities in the US legal system,
then please leave us a positive review on your favorite
podcast platform. And remember, if you are a Bloomberg subscriber,
you can listen to all of our episodes absolutely ad free.
All you need to do is find the Bloomberg channel
on Apple Podcasts and follow the instructions there. Thanks for listening.
Speaker 4 (37:04):
E
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Joe Weisenthal
Tracy Alloway
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