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Host: Paul Matzko Guest: Peter Van Doren, editor of Regulation magazine, Cato Institute

Paul Matzko: Welcome to Unintended Consequences, a podcast about what can go wrong with government regulation. I’m your host, Paul Matzko, and with me as always is Peter Van Doren, the editor of Regulation Magazine. Peter, we’ve set ourselves a real challenge with this episode, because we need to convince people to care first about Delaware, and then second to care about corporate law. Don’t laugh, don’t laugh — I don’t think the Biden family is in our listening audience. They’d be an easy sell on the first part of this. Probably actually both parts, when I think about it. Either theme by itself is a high bar to clear, but together, the mind boggles. But why don’t we start with the basics. 2.1 million businesses are incorporated in Delaware, and given that the population of the state is just over one million, that means there are two businesses resident, technically, in Delaware for every human being. How the heck did that happen? Why is Delaware so unusual in this regard?

Peter Van Doren: Corporations are creatures of the state, not the federal government. You can incorporate a business, you can create a corporation, in any state in the United States. States compete over incorporation. Historically, New Jersey was the first state to have lots of corporations, and in the first set of competitive-state goings-on, New Jersey’s interest in antitrust with the early oil companies led them to flee New Jersey — this is like the 1910s — and become incorporated in Delaware. We’re going to tell a story now of other forces that seem to threaten Delaware, but basically, over time, Delaware gets a third of its revenue from incorporation fees every year. And the presence in the state is nominal — they’re not there. There’ll be hundreds of thousands sharing the same address; they have a post office box at a law firm. So firms are incorporated in Delaware, but their actual headquarters are wherever they want.

Paul Matzko: But for purposes of adjudication of corporate lawsuits against companies, all that lawsuit stuff is governed by Delaware law. So we’re talking about, like, it could be a shareholder lawsuit that the management of the company is not abiding by the charter — a shareholder lawsuit, or even companies have a contractual agreement and they’ll litigate that where they’re incorporated. So all the fuss is about who’s ripping off whom, whether that is or isn’t occurring, and how that should be adjudicated. Different states have different rule sets, essentially, for how those disputes get arbitrated.

Peter Van Doren: Correct. And Delaware over time has specialized in corporate law because it’s been lucrative for Delaware. So they have a court called the Chancery — which name is odd, right? What’s the Chancery? Well, it’s the Delaware court system that governs corporate civil litigation. And they have a sober legislature. They have a whole reputation of being accommodating to what corporations want, and yet not doing crazy things, basically following what contracts and corporate charters say and adjudging those cases in a way that has come to maximize shareholder value. So there’s a literature — a law school literature, Roberta Romano at Yale who’s written for Regulation over the years — and these law-and-economics scholars have argued that competitive state incorporation has been good for American companies and has served market interests very well. Delaware is the entity everyone looks to, to carry out that role historically, until the stuff we’re going to talk about.

Paul Matzko: So it is interesting. On the one hand, if you were not at all familiar with corporate law — I knew about Delaware’s importance, kind of, but still — I think you’d be surprised that this is a matter of competition between 50 states. You would think of incorporation as being a federal thing. Maybe in some countries they do — the national government incorporates companies — but then you don’t end up with a Delaware, right? Or a New Jersey before it, or maybe a Nevada or Texas after it. Stay tuned for more on that point. So that’s very interesting. But it also makes — I think there’s an interesting, very market-friendly point here — which is that this competition didn’t lead to, I don’t know, complete lawlessness. Didn’t lead us to Somalia. Actually led to—

Peter Van Doren: Well, it’s not — again, the term of art, we talk about races to the bottom and races to the top, right? Cynical people often talk about races to the bottom, that a policy area exhibits a so-called race to the bottom, especially if you deregulate — you’ll necessarily end up with a race to the bottom. Democrats and liberals often talk about markets as races to the bottom, and that we need less laissez-faire and more intervention to prevent one. The competition among states for corporate charters has been viewed very favorably by the literature — this has not been a race to the bottom. And in some sense, until recently, it hasn’t even been a race — i.e., Delaware is it. And this reputation, and the money for Delaware, has been thought to be so valuable that Delaware would never do anything to mess this up, right? In equilibrium, you don’t chop anything, cut anything, or change anything that affects a third of your state revenue. Delaware doesn’t have an income tax. They don’t have all the services other states have that are funded by whatever. Delaware doesn’t have a sales tax.

Paul Matzko: Wow. So someone in Maryland, when we go to the shore in the summer — you cross that Delaware line and, you know, the booze is cheap. Everything’s cheaper in Delaware. And there’s a housing boom — people are moving there because Maryland is a higher-tax state. Anyway, so Delaware, they had a good gig.

Peter Van Doren: Yeah, yeah. Well, and it’s interesting — the features — until I read this article, I didn’t realize what that flexible, as-minimal-as-feasible corporate chartering system actually incubated in Delaware. They developed this fairly robust set of habits, or virtues. If you’re a business and you want to invest, you want certainty, you want stability, you want the predictability and soberness of the Delaware political system — and any changes it made to corporate law, that predictability was its defining feature. It was adults in the room, full stop, always adults in the room. This is real money, lots of money, lots at stake — you don’t mess around with this stuff. And that reputation was honed over 70, 80 years, ever since the exodus from New Jersey incorporation that gave Delaware its kickstart after World War I or so. As a result of a century of that, they now have a century of deep precedent on basically every matter involving corporate law, which means you can predict what will happen if you do this or don’t do that, and how the words in incorporation charters will be interpreted. Everyone agrees this word and this clause will lead to this outcome, and there won’t be anyone saying, “Oh, no, it doesn’t, you just don’t understand.” Which creates an efficiency: you don’t have as many frivolous lawsuits, because you don’t sue when you know you’re going to lose, given this deep body of precedent.

Paul Matzko: I was also struck by the way there’s a flexibility there — it’s not one-size-fits-all. Different companies can charter in different ways. There’s a section here I’ll paraphrase, which I think really sums it up — they use a jargony term for it, “heterogeneous demand for corporate law.” Different strokes for different folks, I suppose, doesn’t work as well in the academic journals. But the way they put it is something like this: an early-stage, founder-led technology company may care intensely about insulating management from litigation noise and short-term shareholder pressure. A controlled company may want legal rules that allow a powerful insider to pursue an idiosyncratic long-term strategy without constant judicial second-guessing. A company with repeated needs for outside capital may need especially credible governance commitments to reassure investors. Different firms can rationally want different combinations of managerial freedom, investor protection, contractual flexibility, and adjudicative scrutiny. Different companies are different — this shouldn’t be rocket science. And Delaware wasn’t; it was predictable but flexible. Those two traits were extraordinarily important for the third of its revenue that incorporation brought in. But that’s now under threat.

Peter Van Doren: May we lay a little groundwork here with a name people are going to know. There is one man in particular who is not happy with the Delaware system. What is the first letter of his name, Paul? What’s the second letter of his name?

Paul Matzko: E — for Elon Musk.

Peter Van Doren: Hey, we’ll get there. So — Elon Musk was not happy with the predictability. He would argue Tesla, his company, should have even more flexibility than Delaware allowed for. This came to a head a few years ago — our listeners may have heard about the board voting a big payout for Musk, something like $50 billion. This was litigated, and the Chancery said, no, you can’t rearrange things quite like that. Elon said — I can’t say the word on a podcast — Elon said, essentially, no one should incorporate in Delaware ever, and he was going to incorporate in Texas for his companies, because the payouts they wanted to give him were his business and nobody else’s. But all this is rooted in the fact that when Tesla was incorporated under the Delaware system, there are certain obligations to shareholders, and you’re not supposed to change that midstream. Basically, they were changing things to give him a bigger pay package, and the judge said, in effect, you can’t do that — this was stipulated, and now you can’t change the terms just because things are going well. And there’s also debate over — I forget the exact term they used — “controller-dominated firms,” I think is the technical term, i.e., Elon owns most of the company.

Paul Matzko: The second gentleman we need to talk about is Zuckerberg, right? So Meta gets tied up into this as well, eventually.

Peter Van Doren: So — situations where you have one person, often the founder, who controls a very large number of shares. Are they doing their due diligence to anyone who isn’t themselves, or are they just voting themselves changing the incorporation rules because it’s now convenient for them? In Delaware, a judge said, you can’t do this. Elon said, I want to do this, so I’m going to go to a place that will let me do this — i.e., Texas. That’s the short version.

Paul Matzko: Correct. So this led to much fear and trembling in certain circles of corporate law — that Delaware — that there would be — the Elon exit — this would precipitate a “DEXIT,” Delaware exit. DEXIT.

Peter Van Doren: I kind of hate that. I know it’s a play on Brexit, but gosh.

Peter Van Doren: But anyway, so that DEXIT — more companies would follow, and eventually what happened to New Jersey, when companies fled to Delaware, would happen to Delaware. They’d go to Nevada or Texas, I think, were the two leading candidates. And then Delaware might have to have a sales tax or an income tax like other states.

Paul Matzko: Well, you can imagine — if they lost a third of their annual budget, there’d have to be some belt-tightening.

Peter Van Doren: Or lots of potholes. One or the other, or probably both. Let’s be realistic.

Paul Matzko: So Delaware reacted — I don’t know if I fully understood all the particulars of the law, but they tried to make some changes to soothe things.

Peter Van Doren: Basically, the lawyers for Musk and Meta rewrote a statute in Delaware to suit their needs, and the legislature rolled over and passed it. And the Delaware regime, which was flexible — in other words, the whole suit against Tesla wasn’t really about flexibility. If you’d said upfront you wanted Musk to run everything forever and get whatever he wanted, and written that into the corporate charter, that’s fine. But they didn’t do that.

Paul Matzko: Well, the judge claimed.

Peter Van Doren: The legislature reacted by doing — instead of adding flexibility — a one-size-fits-all approach, which Delaware never had, that was more founder-oriented, because two founders were causing a fuss and threatening to leave, and there were trillions at stake. That’s the short version of Delaware in 2025. The corporate law in Delaware became, in some sense, less sober and more political — subject to what Ted Lowi called “interest group liberalism.” It’s like: some big dudes whined, and we responded, just like in any other state or political system, even though we’ve never done that before. The scholars who wrote this article for Regulation said this is pretty shocking for a corporate lawyer — what do you tell your CEO now about what will happen if you get sued in Delaware? You can’t say anymore.

Paul Matzko: It would be ironic if the measure meant to prevent DEXIT actually causes DEXIT, so to speak, because you’ve just undermined the legitimacy and flexibility of your system.

Peter Van Doren: But we won’t know, I suppose. I’m sure folks will be watching — it’ll take time to work its way out and see. It’s possible the Delaware-based Chancery system is so robust that even this set of triggers won’t be enough to fully undermine it. But it bears watching.

Paul Matzko: I like stories like this, because there are these vastly significant but submerged systems. This is a big deal that nobody’s ever heard of, except nerds.

Peter Van Doren: Yeah, but even you and I, who are well-read and are weird nerds — I’d heard about this, but I didn’t understand it until I read this article, which is really well-written and helped me get to the basis of what this fight was about. The Times had covered it, but not in a way that illuminated it for me the way this article does — which I hope it does for our listeners too.

Paul Matzko: Well, and it’s the systems that have — I mean, the implications not just for the companies involved but for the whole country of how this shakes out.

Peter Van Doren: Yeah, we’re talking about trillions of dollars of corporate capital flowing from here to there. And there are probably implications for corporate structures too — if we’re limiting flexibility in one way, there’ll be knock-on effects that may or may not be in shareholders’ — i.e., middle American 401(k) holders’ — interests. As Americans increasingly own stock through 401(k)s, this isn’t just rich guys playing with each other.

Paul Matzko: So for middle- and upper-middle-class people who have investments through their company’s 401(k) plans — yeah, I’m affected by this, and I’m almost near retirement, and I don’t want anybody to mess this up. Well, in that sense, it reminds me of what we did an episode about — the International Building Code. Again, a system that no normal person spends any time learning about. It’s really important, but it’s huge, and to the extent that it works or doesn’t, it affects how literally every home we live in, every retail store we visit, is structured. This is the most important thing not being discussed in the 2024 election, right?

Peter Van Doren: Yeah, right. And this is another one of those systems that’s hugely important but underappreciated. So I was struck by that story in this regard.

Paul Matzko: I suppose on this front, we talk about 401(k)s and big systems — if you have a 401(k), you probably have an index fund at least available to you, and if you’re smart, you take advantage of it, like Peter and I. But the debate over Elon Musk and SpaceX, and whether there’s shenanigans going on with listing on various indexes — which would automatically put a huge amount of passive capital into the stock, keeping the share price higher than it would be otherwise — my brother emailed me and said, “I don’t want SpaceX in my retirement fund, what am I going to do, how do I get out of this?” I did a little reading, and the S&P 500 — it takes a year to get in, even if the value is high enough. But the NASDAQ index has changed its rules to allow SpaceX in immediately. So for any Vanguard or Fidelity fund with a NASDAQ index component, my brother’s correct — you’re now instantly involved in Musk-land, even if you don’t want to be. I feel like this is an underappreciated point.

Peter Van Doren: I think there’s the surface-level stuff that gets well covered in the press, and our public attention gets paid to that. For Musk, that would be what DOGE was doing last year — lots of print dedicated to that story. But the fact that he’s making significant interventions into the foundations of our financial system, the index system — this is submerged, somewhat overlooked. The Times did have a story, so it wasn’t totally submerged, but only for New York Times readers. And even more underappreciated is what’s going on with corporate law and incorporation in Delaware. Those are probably the most significant things he’s done in the last year, in terms of potential ramifications for the US and global economy.

Paul Matzko: Though — that’s why you should listen to Unintended Consequences, dear listener. The Times is focusing on Musk’s little company town where the launches occur, and how it’s a company town — the old coal-town, West Virginia, or—

Peter Van Doren: Or textile-town, South Carolina, right? It’s a bad company town, and everyone inside is a believer, and the normal people are shunned. That’s the Times narrative about his little launch site.

Paul Matzko: By the end of the day, that’s small potatoes compared to the structural—

Peter Van Doren: Focusing on something that’s important for 17 people, and not for 170 million 401(k)—

Paul Matzko: Correct. Owners.

Peter Van Doren: So do we have a takeaway from Delaware at large, beyond the Musk stuff?

Paul Matzko: Well, we need to make sure we don’t end without mentioning that the article ends with an escape hatch to all of this — one that wasn’t part of the 2025 statute, but was part of a 2024 statute. These law professors discovered it and argue that Delaware has oddly created an escape clause from its own new uniform 2025 statute, one the Delaware legislature doesn’t appear to know it created.

Peter Van Doren: And is that the system of private tribunals they propose? Explain that a little.

Paul Matzko: Well, the authors — Eric Talley from Columbia, and we’ve had articles in Regulation over the years asking why corporate law is even public. Why not just contracts, where everyone pays a subscription to a private adjudication service, the judges judge, and there you go? Think of how consumer groups don’t like the clauses we all sign, without knowing it, that say you can’t sue a company and any dispute has to go through private arbitration. Delaware enacted, in effect, the same thing for all corporate legal disputes there — but Delaware itself doesn’t seem to know it did that. That’s the ironic point of the article. The authors say: all the doom and gloom about Musk and Meta, don’t worry about it. If everyone reads this article and the judicial decisions that back it up, in effect we’re now looking at the possibility of private corporate law, where dispute resolution is paid for by a subscription fee to a Delaware arbitration panel. So instead of states competing with different rule sets, you’d have private associations providing these arbitration services.

Peter Van Doren: Well, in effect, in Delaware it would be one option, but an alternative to the Chancery — so within Delaware, you’d have competing systems.

Paul Matzko: That’s why I read this article with enthusiasm — it explained the whole Musk fuss, which I didn’t understand, and then said: don’t worry about the Musk fuss, we’re going to have “Cato-land” even though no one knows it, i.e. private corporate law. And these are professors at Columbia — this isn’t Liberty University, they’re not movement people, if I can use that phrase. These are sober law professors saying it’s okay to have managerial companies and shareholders, it’s okay to have all these different ways of doing things, and disputes don’t even have to be resolved within a public legal system. And they may be right. One of the things I tell folks — when I started, back in the day, working at Cato and moved into think-tank and nonprofit land — one of the things I learned being in the DC-area world was the extent to which even small changes that create new structural incentives can have really significant, long-term, unforeseen effects. And they’re often underrated — we all argue about the visible things and forget the rest. Like we’ve been talking about 401(k)s: the 401(k) is an accident. There was a very small section — the 401(k) section of the tax code — that was never intended to create a permanent retirement vehicle. And yet that little tweak created an incentive structure that someone eventually noticed, someone writing an article. Maybe these authors have seized on the same kind of thing here, with corporate law. We’ll see if they’re right.

Peter Van Doren: But this — these are moments like these that we may look back on and say, oh, we were there, we saw it — not quite as early as the authors, but they helped us see it.

Paul Matzko: One last thing I’ll mention. The historian in me was reminded, as I was reading about this — when I heard the word “chancery,” I thought, where have I heard “chancery” before? That’s an odd term, right — there’s no franchise named the Chancery, maybe we can start one. But I thought, where have I heard that? I’ve heard it in Dickens. It’s been a long time since I read Bleak House by Charles Dickens, but the setup for that novel is — the other term for this is an equity court. Chancery is the court in charge of an equity law system. Equity comes about when you have an issue with common law. Common law — think of the British system, where you have emergent order from the bottom, a bunch of different judges making rulings, and a consensus emerges from the ground up, a norm that emerges from that. But the problem with common law is it can tend to be inflexible — it becomes the consensus opinion, but then you get these odd, arbitrary carve-outs or loopholes; it can be surprisingly inflexible over time. So in England, some centuries ago, they created a system to address the problems with common law, called the equity court system, run through a chancery. “Chancery” comes from “chancellor” — the judge is a chancellor, an authority above the regular executive authorities, like the Pope, except England got rid of that — or like how a university has a chancellor, notionally above the president, who runs the day-to-day and the fundraising. The chancellor…

Peter Van Doren: Presides.

Paul Matzko: Presides.

Peter Van Doren: I did not know that. Professor Matzko is on the case.

Paul Matzko: So — a few hundred years before, they create this equity chancery court to address the failures of the common law system, but over time it itself became unwieldy, corrupted, and problematic. That’s what Bleak House — that’s what Dickens is criticizing. There’s a famous case in there, Jarndyce v. Jarndyce — the things that go on and on, cases that span multiple generations. So it’s a critique of the critique — of the solution to a previous problem. And it’s interesting that part of the problem was that England did not have competitive federalism when it came to law, the way we do. They had one emergent common-law system, that’s it — and then they had to engineer a singular solution to try to correct it, and even that became corroded, versus the US system, where we have 50 states competing in a federalist sense — incorporate your business in Alaska if you want to. So I think it speaks to the health of competitive federalism, in this case in the corporate-law venue.

Peter Van Doren: So — yeah — the difference between Dickensian Britain and the American system. I bow my head to Professor Matzko.

Paul Matzko: That’s our show. But I have a special request for you, if you’re still listening: we’d like to run a mailbag episode to tackle your questions about regulations. Have you ever wondered why your state, local, or federal government has some rule — and what its, well, let’s be frank, often negative effects on your community might be? Please send us an email at ucpodcast@​cato.​org. Again, that’s ucpodcast@​cato.​org. Thank you for listening, and please leave a review on your podcast platform of choice — that helps more people find us. Thank you to Sedona Lamar for producing, and until next time, be well.