The Tiny State Whose Laws Affect Workers Everywhere

WILMINGTON, Del. — Delaware is the center of the business universe. More than half of the publicly traded companies on U.S. stock exchanges are incorporated in Delaware. Two-thirds of Fortune 500 companies—including Coca-Cola, Apple, and American Airlines—are incorporated there. Many list the same building, 1209 North Orange Street, as their address. Their workforces, headquarters, and operations—truly the corporations themselves in anything but a legal sense—are elsewhere.

They’re all here in Delaware for a very simple reason, and it’s not tax avoidance, as is popularly assumed, nor anonymity, another common theory. No, the reason that corporations want to incorporate in Delaware is so that their disputes will be heard by one of the five judges of the state’s Court of Chancery—with no jury—and be decided under Delaware law. And Delaware law is very friendly to business; the state, after all, has a strong incentive to make it so: It gets 40 percent of its revenues from business incorporation, taxes, and franchise fees, according to the state’s Division of Corporations.

The Court of Chancery’s jurisdiction—it handles business cases and some guardianship matters—comes from its medieval roots. In England of the 14th century, a king’s chancellor heard disputes that were likely to require an authority to order someone to change his behavior, rather than just pay money damages.

Most states had Courts of Chancery in colonial times, but then combined them with other courts for cost reasons. Not Delaware. Established in 1792, the Delaware Court of Chancery has gained power over time. Its judges are some of the country’s most renowned experts in business law. The cities in Delaware where billion-dollar cases are decided are not exactly on the beaten path—I visited one branch of the Court of Chancery located in Georgetown, Delaware, a rural county with more chickens than people. “I think it’s a very remarkable thing that Delaware common law is really the national law of corporations for the most part,” one of the five Chancery judges, vice chancellor Sam Glasscock III, told me.

While the expertise of the judges may serve corporations and their directors well, Delaware’s dominance may not be good for the rest of the nation. Delaware law requires, and the Court of Chancery enforces, that a company’s directors must always be trying to maximize profits for shareholders, said Lawrence Hamermesh, a professor at Delaware Law School at Widener University. That means doing what’s best for the company’s share price, no matter how it affects employees or the environment. Many other states, by contrast, have statutes that allow a company to take into account employees or other stakeholders, in the event of a hostile takeover, for instance.

“One thing is absolutely clear: Delaware corporate law cares not at all about employees, communities, customers, or other stakeholders, except insofar as shareholders also gain,” the Boston College law professor Kent Greenfield wrotein Democracy: A Journal of Ideas earlier this year.

Greenfield and a small number of other scholars argue that the practice of allowing corporations to be governed by Delaware law is undemocratic. A state that is hardly affected by a company’s business (except to collect revenues from it) dictates rules governing how a company treats people in other states. “Power without accountability has no democratic legitimacy,” Greenfield writes. For Americans who work for companies incorporated in Delaware, this court may as well be in a whole other country—they essentially have no say over the laws that guide it.

Yet Delaware has no incentive to change its laws. If the state did that, companies would leave. “The law is effectively decided by the very people it is meant to regulate,” Daniel J. H. Greenwood, a professor at Hofstra Law, told me.

Is this the best way to govern corporations, some of the most powerful institutions in American life?

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Corporations, in their current form, are relatively new institutions. In much of the 18th and 19th centuries in America, anyone who wanted to form a corporation had to go to the state legislature, convince them that the corporation was in the public interest, and get a charter, Glasscock, who is also a Vanderbilt professor, told me. There was very little flexibility in what that company could do once it received that charter. If a company was incorporated as a gristmill, for instance, and wanted to also start selling ice from a nearby river, it would have to go to the legislature and get approval to add that purpose.

States such as New York and New Jersey began to liberalize their laws in the early 1800s, allowing people to incorporate companies without the state legislature’s approval. As one of the first states to do so, New Jersey was, for much of the 19th century, where many businesses were incorporated. Delaware copied New Jersey’s corporation law in 1899, permitting companies to incorporate without a specialized legislative mandate.

This proved useful when Woodrow Wilson became governor of New Jersey in 1911, according to Charles Elson, a corporate governance professor at the University of Delaware. Wilson started cracking down on corporations and trusts, and many companies fled New Jersey. They ended up across the river in Delaware.

Delaware had not abolished its Court of Chancery by the time corporations started moving across the river from New Jersey. And as corporations moved to Delaware and the Court of Chancery heard more and more disputes, the court became renowned for its expertise in business law. Delaware had found an industry, and companies had found a place where they could try their disputes. Dickens fans might remember that the novel Bleak House revolves around lengthy legal proceedings in a Court of Chancery, and the court does not come off well; the legal profession and the court are both satirized as long-winded money-wasters. But most corporate lawyers prefer to argue their cases in Delaware.

“Managers like it because they feel that the judges understand how business operates,” Elson told me. “They know if there is a dispute it will be fairly done.” Investors and managers say Delaware gives them some particular advantages today. Delaware operates under the “business judgment rule,” which allows directors to manage corporations with a certain leeway, as long as they are acting in the best interest of the corporation. Give a failed executive a big exit package? Fine, as long as you can argue it’s in the best interest of the company. Acquire a risky start-up for billions? Fine, as long as you can argue it’s in the best interests of the company.

But how does the court assess what’s in the best interest of a company? When I asked Glasscock what Chancery judges look at when they’re weighing disputes, he said it was simple: At the end of the day, they want to make sure managers and directors are applying their business judgement to maximize shareholder value. “It’s the good of the company, which is synonymous with the good of stockholders of the company,” he told me.

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What benefits a company’s stockholders might not benefit its employees or its customers or even their managers. When eBay bought Craigslist and wanted to make the company more profitable, Craigslist’s managers (who were also its founders) objected, saying doing so would ruin the company’s unique corporate culture. In the lawsuit that followed, the Court of Chancery judge sided with eBay, saying Craigslist had to follow the principle of maximizing shareholder value, Hamermesh told me, no matter the desires of the company’s founders.

Delaware has little desire to change its laws to make them more employee-friendly. “If other states outcompete us, or provides better value, and you can move a corporation as easily as filing documents, they can be headquartered anywhere,” Glasscock told me.

In fact, Delaware is constantly trying to become more business-friendly, which some outsiders say is harmful to those who don’t own corporations. In 2009, for instance, concerned that it was losing “pre-eminence” in corporate litigation, Delaware passed a law allowing litigants with more than $1 million at stake to try cases in the Court of Chancery in closed arbitration proceedings, meaning that the public would never know what had happened. A group called the Coalition for Open Government sued, calling the practice unconstitutional, and won in lower courts. The Court of Chancery took a public stance on the matter, arguing that there was no reason the public should have access to all hearings. The Court of Chancery asked the Supreme Court to hear the case, but the high court declined, leaving the lower court’s ruling in place.

“The Delaware legislation is a dramatic example of rich litigants using their resources to close court systems,” the Yale professor Judith Resnick wrote in an op-ed in The New York Times.

Are there ways that Delaware’s law could be made to take stakeholders from other states into account? In Germany, for example, large companies are required to have elected employee representatives sit on their boards. There, employees are involved in making decisions for the company. Yet in the United States, it’s directors and managers who make decisions for the company, and courts in Delaware that decide disputes between them. Nowhere do employees’ or customers’ interests come in. To change that would require revisions in Delaware law, which is an unlikely occurrence.

“What doesn’t happen is a political debate in which people say, ‘Maybe we need to change the notion of profit maximization above all,’” Greenwood told me. “We don’t have a debate about what governance rights employees should have at large corporations.”

Even if states did try to change their laws to allow customers or employees to have more of a role in corporate governance, their laws would not apply to corporations incorporated in Delaware. States aren’t trying, though, Greenwood says, because lawmakers know that corporations can easily reincorporate in business-friendly Delaware without changing anything else about their business.   

Yet there are some fixes, according to Greenwood and Greenfield, the Boston College professor. In his Democracy essay, Greenfield suggests states make laws that say they are allowed to govern corporations whose “principal place of business” is within their borders. A company’s headquarters, then, could determine which state’s laws it falls under. This is how Europe determines which law governs corporations, he says.

The second fix, often talked about in the field of corporate law, is to use national law, not state law, to govern corporations. Other countries govern corporations at the national level, after all. There’s no reason the United States, home to some of the biggest corporations in the world, couldn’t do that too.“Corporations of a sufficient size to affect national interests should be chartered at the national level,” Greenfield writes.

When shareholders gain, employees and customers often lose. But the idea that companies must maximize shareholder value has been a tenacious one in American business, and one that has benefited the state of Delaware. This began a century ago when Delaware made life easier for corporations, and the state still profits from this race to the bottom today. The rest of the country, however, isn’t making out quite as well.