The North Dakota Experiment

Last week the North Dakota Legislature adopted the North Dakota Publicly Traded Corporations Act.  To quote the Act’s sponsor, the North Dakota Corporate Governance Council, the Act “provides a governance structure for publicly traded corporations that gives shareholders greater rights than they currently have under other state laws.  It has been designed to reflect the best thinking of institutional investors and governance experts and addresses each of the current hot topics in corporate governance.”  A director of the Council, and the law’s drafter, is William H. Clark, Jr., from Delaware’s neighbor, Pennsylvania.

In brief, the law permits firms incorporated under North Dakota law after July 1, 2007 to elect to include a provision in their articles that they elect to be subject to the new statute.  Shareholders then get a set of provisions that looks like a shareholder rights advocate’s wish list, including majority voting for directors, advisory shareholder votes on executive compensation committee reports, a right for certain shareholders to propose board nominees on the company’s proxy statement; reimbursement of proxy expenses to shareholders to the extent they are successful in getting nominees elected; a requirement of a non-executive board chair; and restrictions on poison pills and other takeover devices.  The Economist recently applauded the Flickertail State‘s plan “to poach company incorporations from Delaware” as “injecting some much-needed competition into the field of corporate law and governance.” 

As a longtime champion of state corporate competition, I suppose I should be happy to see this development.  Isn’t it an example of what Roberta Romano has called The Genius of American Corporate Law? Isn’t it, after all, an answer to those who say that we need to federalize corporate law to get reform?  Doesn’t it provide a natural experiment to see whether corporations really want the reforms that have been proposed?  Well, sort of.

Certainly it shows how any little state can enter what I and Erin O’Hara refer to as a “law market” in our paper Corporations and the Market For Law.  Moreover, the ND project demonstrates how practicing lawyers can be the mechanism driving this market, as I argued in Lawyers as Lawmakers: A Theory of Lawyer Licensing.  Though here it wasn’t really ND lawyers, but a Philly import, Bill Clark.  Clark has already applied his drafting skills to a large number of projects, including all of the Pennsylvania business entity laws and several “model” and “uniform” law proposals by the National Conference of Commissioners on Uniform State Laws.

As an aside, these “uniform law” projects indicate that Clark doesn’t really seem committed to the idea of state “experimentation.”  Indeed, Clark has fiercely opposed the idea of entity “proliferation,” and has been a leading light in the “entity rationalization” move towards combining all business entities into a single statute–a move I sharply criticized in Making Sense of Entity Rationalization.  But this just shows that lawyers have a variety of motives for participating in lawmaking.

The big question is whether ND can compete with Delaware just by differing and offering provisions some corporations may want.  ND qualifies as a legitimate competitor in one way: it will make the kind of money from the incorporation business ($60 per 10,000 shares of capital stock, and up to $80,000 per year from each firm, according to Section 10-35-28) that should give it a Delaware-type incentive to “bond” it to maintaining and developing its law.  (For an extended discussion of that point, see Roberta Romano’s seminal article Law as Product: Some Pieces of the Incorporation Puzzle.)

But ND needs more.  After all, Delaware has a deep and highly reputed “infrastructure” of judges and lawyers to run its corporate law system.  Although the costs of the infrastructure may be well worth the franchise fee (see, for example, Marcel Kahan and Ehud Kamar, The Myth of State Competition in Corporate Law) (suggesting that Delaware’s infrastructure costs $2 million a year), this money won’t buy the highly skilled corporate lawyers and judges ND needs to truly compete.  Shareholders of North Dakota’s publicly traded corporations are banking on sensible and coherent interpretation over a long period by an unknown set of judges, and advice from an unknown set of lawyers. 

Indeed, it would seem that firms that really did want the ND provisions might be well-advised to provide for arbitration rather than court hearings.  Of course, this assumes they can enter into enforceable agreements to arbitrate shareholder disputes, something that might ultimately be up to the SEC (as I noted here), an idea that has been proposed for Europe (in Regulatory Competition in EU Corporate Law After Inspire Art: Unbundling Delaware’s Product for Europe, by Christian Kirchner, Richard W. Painter, and Wulf A. Kaal.)

Even if ND did somehow get its act sufficiently together, and even if it did attract enough business to be a viable competitor, Delaware would be waiting in the wings to snatch the business away, a notion Lucian Bebchuk and Assaf Hamdani pointed out in Vigorous Race or Leisurely Walk: Reconsidering the Competition Over Corporate Charters.  As The Economist noted, if ND is successful, “Delaware is highly likely to respond with reforms of its own.  Experience suggests that Delaware understands very well the cost of losing its edge in this lucrative business.”

And ND has the additional problem of luring established firms given that they’re subject to existing weak shareholder rules in Delaware and elsewhere.  Thus, The Economist noted, “managers are likely to make it as hard as possible for shareholders to force through a relocation.  In practice, boards can resist such shareholder pressure for years.”  To be sure, ND may be able to lure some startups, anxious to make some sort of a point to investors, as Google did with its auction (though note that Google also featured dual-class stock).

Then there’s the serious question, logistics aside, whether corporations actually want these reforms.  It’s far from clear that even a company that wanted to be “shareholder friendly” would want all of the included reforms.  Nevertheless, the ND statute compels acceptance of the terms as a package.  Thus, the ND project is a test not only of shareholder governance, but of the one-size-fits-all assumption of the corporate governance industry.  For example, does the same corporation that has majority shareholder voting for directors also need shareholder proxy access and reimbursement of proxy expenses?  Too bad if it doesn’t, because ND is telling companies that they need belts and suspenders.

Finally, if corporations really want these provisions, they don’t need to go to North Dakota.  We can get a true market test just from corporations adopting these or similar provisions on their own.  Just as we didn’t need North Dakota to invent the poison pill–we had Marty Lipton–we don’t need ND to eliminate it.  ND does add the ability to reliably signal to investors that the firm has adopted all of the shareholder-friendly provisions.  But this sort of signal can be standardized without the statute.  If it turns out that a lot of firms want these provisions, they can just stay in Delaware and count on getting them from the ever-responsive Delaware legislature.

In short, the ND experiment is less interesting than it may seem.  But any firms that want it know where to go.  The ND website features a helpful map that tells you just where in the U.S. North Dakota is.