Getting Stuck Between Bottom and Top: State Competition for Corporate Charters in the Presence of Network Effects

For decades, American legal scholars have debated over the implications of allowing corporations to choose in which state they will incorporate, irrespective of where they do business. Until recently the debate has centered almost exclusively on whether the managers who choose where to incorporate have incentive to choose a state whose laws favor managers to the disadvantage of shareholders (the race to the bottom thesis) or whether their incentives are to choose states whose laws treat shareholders properly (the race to the top thesis). Recently, some scholars have questioned whether the state charter competition process will necessarily lead to an optimal choice from the point of view of corporate decisionmakers, whatever the incentives of those decisionmakers might be. The presence of a variety of network effects may cause corporations to incorporate in a state which already has taken the lead in the charter race, even if some other states might offer better substantive law. For instance, corporations may prefer a state which has a well-developed, and hence more predictable, body of corporatelaw, or they may prefer to appear before judges who from much experience are familiar with corporate law matters. These effects may cause the whole system to get stuck with sub-optimal laws dominating