Revisiting Corporate Governance Regulation

In my working paper Revisiting Corporate Governance Regulation: Firm Heterogeneity and the Market for Corporate Domicile, which I recently presented at the Law, Economics and Organizations Workshop here at Harvard Law School, I use a discrete choice framework to analyze state design and firm choice of the implications of incorporation: corporate governance laws, corporate taxes and court structure.

In order to exploit the information revealed in the preferences displayed by the different firms, a novel dataset with firm and incorporation characteristics is assembled and then a random coefficient discrete choice model is specified. In the model, incorporation is treated as a “product” that the states design, differentiated along all of the dimensions of the implications of incorporation, including the discrete “price”—the tax implications incorporation imposes on each firm. In every one year period, each heterogeneous firm chooses its preferred “product” by choosing to incorporate, to remain incorporated, or to reincorporate in one of the 51 US jurisdictions. Firms are decomposed into their ownership patterns, director characteristics, industry concentration, financial profiles, the geographical location of their headquarter states, and the residual unobservable dimensions of heterogeneity within them. The choice of incorporation state is seen to be made based on the preferences—resulting from these dimensions of firm heterogeneity—for the laws, court characteristics and taxes that makeup the incorporation implications.

I find that all incorporation implications, the laws, the court characteristics and the incorporation taxes matter. I find that firms are very responsive to incorporation and franchise taxes. In addition, on average, firms like antitakeover statues, but, consistent with an agency story, firms with an institutional shareholder block and venture capital backed firms dislike them. On average, firms dislike mandatory governance statutes restricting managerial power and facilitating the representation of minority shareholders, but these laws are not as restrictive for the choice of firms in concentrated industries. All firms dislike well functioning courts, consistent with a litigation deterrence motive. The recovered firm preferences are then taken to the simulation of recently proposed federal reforms aimed at centralizing the domicile implications and restricting firm choice. They are also related to the documented differential returns earned by firms with better internal governance in the 1990s, as well as to other trading strategies that would have yielded abnormal returns in the 2000s.

The full paper is available for download here.