Delawareec

Come Over to Dover A look at why so many companies choose to incorporate in Delaware

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Marissa Cerami Dr. Read AC312 April 3, 2008 Introduction Despite the fact that it is the second smallest state in the nation, more than half of all publicly traded companies in the United States are incorporated in Delaware. Most businesses are attracted to the state because of its flexible corporate laws, ample tax benefits, and access to its practiced Chancery Court, one of the only state courts in America exclusively devoted to hearing business cases. The state also makes it easy for companies to file for incorporation by providing all resources online, and even offering services such as “1-hour,” “2-hour,” and “same day” registration. In some neighboring states, the incorporation process can take more than two weeks. Delaware has perfected the art of attracting businesses to incorporate in the state and as a result has been able to generate more than 25% of its annual revenue from its state corporate franchise tax. Ultimately, Delaware’s approach to providing something for everyonemay be the state’s greatest tool for drawing companies away from other states. Location Freedom Delaware’s corporate laws do not restrict businesses based on physical location. A Delaware corporation need not even maintain an office or an address inside the state. In fact, companies registered in Delaware may have their headquarters in another state or countryand do not even need to conduct any form of business within the state. However, companies registered in another state must register with up to six additional Delaware departments in order to conduct business within the state borders. The Court System Many businesses are attracted to the First State for its court system. The Delaware Court of Chancery has been in existence for over two centuries and has influenced most of the current U.S. corporation case laws. Many businesses feel safer filing in Delaware because the extensive history of its court system and experience dealing solely with business cases makes it “easy to know how shareholders will be treated and how courts will define fiduciary duties for a board and other corporate governing issues” (Enterprise). Since management is able to look at past history of the court and its rulings, the outcome of a corporate case is more predictable. Takeover Defenses Another significant reason that many corporations choose Delaware as their home state, on paper, involves the business laws regarding takeover defenses. A takeover is an attempt by a bidding company to gain controlover a target company. Bidder companies can do so in a number of ways, such as by acquiring enough shares to control the target company’s management. In 1985 two pivotal cases were decided by the Delaware courts involving takeover defense. In Unocal vs. Mesa Petroleum, the Delaware courts upheld a discriminatory stock repurchase by Unocal which was done to avoid a hostile takeover situation by Mesa. In the second case,

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Moran vs. Household International, the court ruled that Moran’s use of the “poison pill” defense was an acceptable business tactic to avoid a hostile takeover (Heron). Following the ruling of Moran in November, 1895, corporations already registered in Delaware quickly amended their corporate bylaws to include “poison pills” and companies who were not incorporated in Delaware flocked tostate to sign up. The Delaware court system’s ruling in Paramount Communications, Inc. v. Time, Inc,upheld the right of directors to refuse a fair offer by a bidder to buy the company. This power of directors to “just say no” is yet another potent takeover defense made available to Delaware corporations during the 1980s. Director Liability Companies registered in Delaware are allowed to include a provision in their original certificate of incorporation which limits or altogether eliminates an executive’s personal liability to a corporation for “breach of his fiduciary duty of care as director in certain circumstances” (Beirut). In other words, the “Business Judgment Rule” protects board members from being responsible for decisions made with respect to advancing shareholder interests and loyalty. The aim of this clause is to attract and retain high quality persons to serve as directors for Delaware corporations by reducing pressure on management’s decisions to stockholders. Many believe this is a dangerous clause because it allows management to be careless in the interest of its shareholders. Managers are shielded from having to deal with petty lawsuits from various shareholders for not acting in the best interest of equity financers, making Delaware a very attractive option to businesses, especially since management makes the decision of where to incorporate the company. Nimble Dividends In some states in the U.S. corporations are required to satisfy prior earnings deficits with current earnings before using them to pay out current dividends. However, in Delaware, a corporation is allowed to pay dividends out of current earnings despite the deficit position of the company. This is known as a nimble dividend and allows companies to make payments to shareholders even in times of an earnings deficit. Nimble Dividends allow management to keep shareholders happy even in times when earnings revenue is at a deficit, reducing some of the pressure on executives to alter the bottom line to impress stockholders. If the shareholders can be satisfied with a dividend in a given year, they may be less concerned about the bottom line of the corporation as long as they have cash coming in. Tax and Fee Advantages Many businesses may also be attracted to the state for the tax benefits it provides to businesses. For starters, Delaware does not impose a sales tax on goods sold to consumers within the state which can make products appear cheaper to customers. The state does impose a small tax on the gross receipts of most businesses which can range from 0.077% to 2.125% depending on the type of company. Because of the vast number of corporations registered in Delaware, the state can afford to keep fees per company relatively low and still manage to bring in more than $300 million per year in business taxes and fees revenue. Delaware also does not charge any state corporate tax on interest of investment income, on business transactions, or when a value-added situation occurs. The First State also does not impose a tax on stock transfers. Conclusion Delaware has been the number one state of incorporation in the nation for more than a century now because of the various benefits it can offer to companies, their management teams,

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and their shareholders. Because the state makes money off incorporation fees, filing fees, processing fees, and taxes, Delaware has found a way to offer something for everyone in order to attract more businesses to the state. Limited director liability reduces pressure on management teams, nimble dividends allow shareholders to claim dividends in years where earnings are at a deficit, and customers of corporations who do business in the state do not have to pay sales tax on items they purchase. Delaware is in the business of attracting business and seems to be running the number one firm in the nation.

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Works Cited Brooks, Nelson B and Stephen Jackson. “Keeping Up with a New Act.” CAMagazine Apr. 2003. 2 Apr. 2008 . “Corporations Still Flocking to Delaware.” New York Times27 Dec. 1997: D14. Lexis Nexis. Bentley College Library, Waltham, MA. 30 Mar. 2008 <www.lexisnexis.com>. Crystal, Gary. “What is a Delaware Corporation.” WiseGeek. 2003. 2 Apr. 2008 . “Delaware Corporations Choice for More than Fifty Percent of US Corporations.” Beirut Times 20 Jan. 2000. LexisNexis. Bentley College Library, Waltham, MA. 30 Mar. 2008 <www.lexisnexis.com>. “Delaware Incorporation Benefits Local Firm.” Enterprise Vol. 27, Issue 43, 20 Apr. 1998. Regional Business News. EBSCOHost. Bentley College Library, Waltham, MA. 30 Mar. 2008. <www.ebscohost.com>. File Certificates of Business Formation. 24 Mar. 2008. State of New Jersey Department of the Treasury Division of Revenue. 30 Mar. 2008. . Heron, Randall A. and Wilbur G. Lewellen. “An Empirical Analysis of the Reincorporation Decision.” Journal of Financial and Quantitative Analysis. Vol. 33No. 4 Dec. 1998. JSTOR. Bentley College Library, Waltham, MA. 30 Mar. 2008 . Johnson, Carrie. “Incorporation Rules Enable Fraud, Officials Warn Panel.” Washington Post 15 Nov. 2006: D02. 30 Mar. 2008 <www.wahsingtonpost.com>. Kihlstrom. Richard E. and Michjael L. Wachter. “Corporation Policy and the Coherence of Delaware Takeover Law.” University of Pennsylvania Law Review EBSCOHost. Bentley College Library, Waltham, MA. 30 Mar. 2008. <www.ebscohost.com>. McCormick, Eleanor. "Nimble Dividends: Some States Do Permit Dividends Despite Deficit in Accumulated Earnings. " Journal of Accountancy (pre-1986) 88.000003 (1949): 196. ABI/INFORM Global. ProQuest. Bentley College Library, Waltham, MA. 30 Mar. 2008 . Paredes, Troy A. “The Firm and the Nature of Control: Toward a Theory of Takeover Law” Journal of Corporation Law Vol. 29, p 103. 30 Mar. 2008 .

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Shaw, Bill. “Statutory Limits on Director Liability - Protection for Corporate Officers.” Business Horozons July-August, 1989. BNET. 1 Apr. 2008 . State of Delaware: The Official Website of the First State. 16 Jul. 2007. 30 Mar. 2008 . “Triumph of the Pygmy State.” The Economist 25 Oct. 2003. US Ed. Lexis Nexis. Bentley College Library, Waltham, MA. 30 Mar. 2008 <www.lexisnexis.com>.