Race to the Bottom Recalculated: Scoring Corporate Law Over Time

Brian Cheffins is Professor of Corporate Law at the University of Cambridge. The following post is based on an article co-authored by Professor Cheffins, Steven A. Bank, Paul Hastings Professor of Business Law at UCLA School of Law, and Harwell Wells, Associate Professor of Law at Temple University Beasley School of Law.

In The Race to the Bottom Recalculated: Scoring Corporate Law Over Time we undertake a pioneering historically-oriented leximetric analysis of U.S. corporate law to provide insights concerning the evolution of shareholder rights. There have previously been studies seeking to measure the pace of change with U.S. corporate law. Our study, which covers from 1900 to the present, is the first to quantify systematically the level of protection afforded to shareholders.

Our study draws on quantitative techniques developed by academics researching comparative corporate governance. In particular, we rely on three indices constructed to measure aspects of corporate law on a cross-border basis. These are a six element “anti-director rights index” (ADRI), an “anti-self-dealing index” (ASDI) and a 10 variable shareholder protection index constructed by an academic team associated with Cambridge University’s Centre for Business Research (CBR SPI).

We use each of the three indices to measure corporate law in three different regimes: Delaware, Illinois and the Model Business Corporations Act (MBCA), the model set of laws promulgated by the Committee on Corporate Laws of the Section of Business Law of the American Bar Association. With each of the three indices we deploy we start by ascertaining the present-day score for each of these three corporate law regimes. We then work backwards to identify changes to the law that would have caused scores to move up or down over time.

We use our methodology to test four hypotheses:

  • 1) Given a general consensus that competition among states for incorporation business served to erode shareholder rights, corporate law index scores, to the extent they reflect state law, should decline over time.
  • 2) Given that various observers have suggested reform at the federal level bolstered shareholder protection, corporate law index scores, to the extent they reflect federal law, should increase over time.
  • 3) If changes to federal law heavily influenced the scoring of individual components of a corporate law index, aggregate scores for that index should have increased over time.
  • 4) Changes to the ADRI, which does not take federal law into account, will be negatively correlated with changes to the ASDI and the CBR SPI, which do.

Our findings on balance confirm H1, but the trend was hardly robust. H2 and H3, in contrast, are strongly confirmed. H4 was confirmed with respect to the CBR SPI but not with the ASDI, primarily because the ASDI was less influenced by federal law reforms than the CBR SPI.

Our findings cast new light on the interrelationship between jurisdictional competition and the development of corporate law in the US. Our leximetric analysis indicates, for instance, that if state law was affected by a meaningful “race” between states competing for incorporation business, this “race” likely did not occur during the 20th century. We also demonstrate quantitatively that federally-oriented reform bolstered considerably shareholder protection over time and indeed more than off-set whatever diminution occurred due to state law changes. Our ability to make these points empirically illustrates how leximetric analysis can facilitate our understanding of jurisdictional competition and the historical development of corporate law more generally.

The full study is available for download here.

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