Elon Musk's Pay Package and the Threat to the Delaware Corporation

If you look at prospectuses and earnings documents for almost any company, you're going to see a Delaware address. For more than a century, the state has been the place to go to if you're setting up a business. And in fact, Delaware has catered to these corporate clients, setting up an efficient chancery court to settle corporate disputes and producing a huge backlog of case law to act as reliable and efficient precedent. But suddenly, some companies are choosing to leave the state. Most prominent among them is Elon Musk's Tesla, which opted to re-incorporate in Texas after a Delaware judge invalidated his $56 billion pay package. States like Nevada and Texas are now also actively courting companies by enticing them with management-friendly laws. In this episode, we speak with Ann Lipton, University of Colorado law professor and Lawrence W. Demuth Chair, to find out what's at stake in the fight for incorporations and if there's a risk for a race to the bottom in terms of shareholder accountability. Read more:Why Tesla’s Chinese Rival BYD Faces a Raft of TroublesUS Panel Probes Huawei Affiliate’s Presence on Nvidia Campus Only http://Bloomberg.com subscribers can get the Odd Lots newsletter in their inbox each week, plus unlimited access to the site and app. Subscribe at bloomberg.com/subscriptions/oddlotsSee omnystudio.com/listener for privacy information.

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  This is the Bloomberg Tech Minute brought to you by ChatGPT. I'm Carol Muster. Getting hired at SpaceX requires exceptional ability and may include having Elon Musk review a candidate's resume. So writes Bloomberg Business Week's Lauren Grush. She reports that the company culture is defined by Musk and job candidates must understand that a commitment to SpaceX means adhering to this culture and exhibiting loyalty to Elon Musk. To get hired, candidates must demonstrate their achievements from past jobs and hands-on experience matters more to recruiters than advanced degrees, with the company looking for people with raw innate intelligence. A spokesperson for SpaceX didn't respond to a request for comment on its recruiting

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  and hiring practices, but according to recruiters, advisors and those who've interviewed for jobs there, it's the space exploration dream that draws people to the company and Musk invokes that dream regularly to remind workers why they're there. Prospective hires are told that the job will require stamina, including in job ads that candidates quote "must be willing to work extended hours and weekends as needed." One major perk for all that hard work? Employees' access to equity, either the right to buy shares or payment in the form of restricted stock units that vest over time. That's the Bloomberg Tech Minute brought to you by ChatGPT. Get started at chatgpt.com.

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• 2:35Tracy Alloway?

  Hello and welcome to another episode of the Odd Lots Podcast. I'm Tracy Alloway.

• 2:39Joe Weisenthal?

  And I'm Joe Weisenthal.

• 2:40Tracy Alloway?

  Joe, I have a fun fact for you.

• 2:43Joe Weisenthal?

  Go on.

• 2:44Tracy Alloway?

  Are you ready?

• 2:44Joe Weisenthal?

  Yeah.

• 2:45Tracy Alloway?

  Okay, so Delaware has a population of about 1.05 million, a little over a million.

• 2:51Joe Weisenthal?

  Okay.

• 2:51Tracy Alloway?

  It's one of the least populous states.

• 2:53Joe Weisenthal?

  Yeah.

• 2:54Tracy Alloway?

  I think it has fewer people than a lot of big cities in the US.

• 2:58Joe Weisenthal?

  Yeah, for sure.

• 2:58Tracy Alloway?

  However, Delaware has 2.1 million businesses registered in the state. So basically, two businesses for every person.

• 3:07Joe Weisenthal?

  This is a legit fun fact. This is like a legit, I did not know this. I mean, I knew that it was not a very big state population wise. I know that so many corporations or businesses or whatever incorporate in Delaware, but there's sort of two to one ratio. Excellent fun fact, Tracy. Well done.

• 3:23Tracy Alloway?

  Yes, for your next dinner party, you can trot that one out.

• 3:26Joe Weisenthal?

  Yes.

• 3:26Tracy Alloway?

  I mean, obviously, maybe you could argue that Delawareans are just phenomenally entrepreneurial. But as you mentioned, no, as you mentioned.

• 3:33Joe Weisenthal?

  No more than I know. I'm not dismissing them. I just know that that's not really what's going on.

• 3:37Tracy Alloway?

  Right. There's something else going on here, which is that Delaware has become the de facto state for companies incorporating.

• 3:44Joe Weisenthal?

  Yeah, this is like the main thing that we know about Delaware. We don't really, I mean.

• 3:48Tracy Alloway?

  That and chicken farms.

• 3:49Joe Weisenthal?

  And the chickens, right. Not the chickens. But you don't hear much about Delaware, except typically when there is some sort of corporate fight playing out in its courts. And of course, it has a dedicated court system for corporate fights and so forth. And there's some prominent examples over the years where we learn about what the chancery is, and then I forget what the chancery is or where that word comes from. But people seem to like their simplistic streamlined legal system for corporate things, and it seems to have paid off reasonably well.

• 4:19Tracy Alloway?

  People seem to like it, but that might be changing. So you mentioned corporate fights. We had a very prominent example of this relatively recently when. There was the court fight over Elon Musk's compensation at Tesla. And eventually Elon just said, you know, I'm going to pick up my company and move it to Texas and incorporate there. And in fact, we are seeing a few examples of companies choosing to move away from Delaware and to places like Texas or Nevada. And I know this isn't maybe a top of mind news development for many people right now. There's a lot going on.

• 4:55Joe Weisenthal?

  Yeah.

• 4:56Tracy Alloway?

  But I think it's really interesting. It's kind of slow moving and it does have implications for shareholder rights.

• 5:01Joe Weisenthal?

  Totally. I actually think it's a very important, relevant topic. And I'll say this is the reason why, which is that in a sense, a legal system is this network effect and people respect the legal system. And even if maybe there are decisions that go against them, they're like, okay, this is a high quality legal system. It is very hard to rebuild that somewhere else. It also is the sort of thing that if there is some pull elsewhere, then it's interesting to see what does it take to pry entities away from this network where there is years and years and thousands and thousands of decisions upon which to build something resembling a shared law. And so, you know, when I think about the United States, when I think about these bigger questions about how do you move dollars? How do you move entities, industries to other jurisdictions that are maybe younger and

• 5:46Joe Weisenthal?

  don't have the same level of historical jurisprudence? Maybe there is a microcosm, a story to be told about the Delaware history, how it built up, and if there are any threats to it over the medium term.

• 5:58Tracy Alloway?

  Absolutely. Very well put.

• 6:00Joe Weisenthal?

  Thank you.

• 6:01Tracy Alloway?

  So I am happy to say we have the perfect guest. We're going to be speaking with Professor Anne Lipton. She is a law professor at the University of Colorado and Lawrence W. Demuth Chair. So Anne, thank you so much for joining us.

• 6:14Speaker 06

  Thank you so much for the invite.

• 6:15Tracy Alloway?

  I'll start with the obvious question, which is, how did we end up with Delaware as the de facto place for corporate incorporation? Why Delaware?

• 6:25Speaker 06

  Because Delaware actually strategized that it wanted to attract incorporations. And this was back in all the late 1800s, early 1900s. A number of states actually thought that they could make money by having corporations incorporate in their state and pay fees. You could actually open a newspaper at that time and see advertisements for come incorporate in X state. And Delaware made a conscious decision to make its state and its law friendly to corporations that wanted to incorporate there. So, among other things, at the time, one of the main concerns of businesses was that corporate law would be used politically, that the rules would change to effectuate some kind of political policy. So Delaware adopted a constitutional amendment that its judges would have to be politically balanced. So you couldn't

• 7:10Speaker 06

  have more than half, more than a bare majority of one party or the other. So for a seven-member court, no more than four can be a member of one party or another. They also put a constitutional amendment that any changes to the corporate code required a two-thirds vote of the legislature. So trying to insulate their corporate law from political pressures, and then they just made their corporate law very flexible and very manager-friendly. Managers could kind of do what they wanted with it. And it just sort of took off from there.

• 7:37Joe Weisenthal?

  This is really fascinating, this idea of creating the corporate legal system in this sort of glass enclosure through which the political system cannot break. And this is a theme that seems to come up over and over again. We talk about it when we talk about the Federal Reserve and its nominal or de facto independence. This came up when we talked to the Alaska Sovereign Wealth Fund guys and the difficulty that the political system has in accessing the corn seed, so to speak. Talk to us a little bit more about the structures in place and how strong they are to insulate the court system from politics and how durable and thick those glass walls are.

• 8:17Speaker 06

  Yeah, so they can't insulate the court from politics in the sense of the legislature acting and so forth, and that's actually what we've just been seeing. But they are fairly insulated from partisan politics. Partisan politics doesn't play out in the same way that we would understand it in other parts. Of the country or other areas. But so the idea here, well, first of all, I mean, one thing to note, though, is that Delaware's, obviously, it's very blue state voting behavior and judges do things other than decide corporate cases. We do forget that, but they do, in fact, have other things to decide. But still, the judges are politically balanced in order to benefit this corporate system. So what happens with the way laws made in Delaware, corporate laws made, is that it actually doesn't really come from the legislature, which really, most of the legislature isn't, they're not corporate experts.

• 9:02Speaker 06

  They don't know much about corporate law necessarily. They're just legislators. So what happens is there's the Delaware State Bar Association has a corporation law section, and they actually generate the proposed statutes on the theory that they can do it in a sort of nonpartisan, very technocratic way. And then the legislature tends to sort of rubber stamp the stuff that comes out of the corporation law section.

• 9:24Tracy Alloway?

  So, you know, Joe mentioned that sort of network effect earlier, and I think this is really important in law especially, because a lot of legal battles are based on precedent, right? And so we have Delaware as the de facto incorporation state and decades and decades of precedent for judges and lawyers to actually look at. How does that sort of, I guess, precedent or first mover advantage help Delaware?

• 9:53Speaker 06

  Well, it's always been assumed that that would help Delaware because you would have the statute and you have decades of precedent so that companies would kind of know how questions would be answered if they came up. So there are a lot of areas where other states, you just simply do not have information on like how a court would treat particular kinds of claims or particular kinds of disputes. Some of the obvious things are things like activist takeovers or proxy contests and takeover defenses because We know how that looks in Delaware because Delaware incorporates most of the public companies where you have those kinds of fights. We don't know how that looks in other states because you don't tend to have as many activist situations in those other states. So that's always thought to be sort of an advantage of Delaware, that everything

• 10:38Speaker 06

  plays out there. And most other states, they very often look to Delaware when they're deciding their own corporate law. Sometimes they contrast their corporate law with Delaware, but Delaware is always kind of where they look to deal with these questions. And that's always considered to be a real advantage of Delaware. You at least know what's going to happen. But it also means that because this is case law, it's mostly not in this or hasn't been mostly in the statute, it's judge by judge decisions. And that can also mean that sometimes it's sort of hard to penetrate because it's really you've got to read this decision. Well, don't forget this other decision and don't forget this decision too. And that can be sort of hard to figure out if you're just looking at it for the first time.

• 11:17Joe Weisenthal?

  Yeah, I'm really interested in this tension, right? Because in theory, okay, you write down laws on paper and they're all visible and say, okay, this is consistent. We know what's going to happen. But also, decisions are made by judges and people dispute them. Otherwise, they wouldn't have to have cases in the first part if judges didn't have to exercise some sort of agency. How do the judges feel about their own responsibility when deciding these cases to think about consistency or the underlying deep principles of Delaware corporate law and the long-term implications for the state of Delaware and for the state of when they make their decisions?

• 11:56Speaker 06

  Yeah, so there's a tension there. So you just identified like a tension, a tension between the state of Delaware versus general corporate theory and corporate law. And I think you don't become a judge and you don't go into this area unless you really do appreciate the law and enjoy it. And I mean, the Delaware judges are extremely thoughtful about corporate law and what the right answer is and how corporations should work. They don't always have exactly the same theories, but they definitely have a point of view. And they care very much about how corporate law operates. But, and you know, this is where some of the tension is today, if corporate boards are unhappy with their decisions over and over and over again, then Delaware may lose incorporations to other states. And how that plays out between sort of fidelity to a vision of what corporate law should be, coupled

• 12:41Speaker 06

  with the straight up reality that if managers are unhappy and incorporate elsewhere, Delaware doesn't have Doesn't get to do much anymore. That's a tension that's been playing out for just as long as Delaware's been incorporating companies. I mean, that's always, I don't think judges are usually consciously making that decisions based on that, or they're certainly trying not to, but that tension is always present and has been present in the past.

• 13:04Tracy Alloway?

  Before we get to why companies, some companies seem unhappy with Delaware at the moment, I'm going to go ahead and ask Joe's classic question whenever this comes up, which is, what is a Chancery Court?

• 13:17Speaker 06

  Well, it's just the name for the Delaware courts that hear corporate cases. So, I mean, the fun, this is a very technical legal point, but historically, there were two types of courts in the world. There were the Courts of Law and the Courts of Equity. The Courts of Law followed sort of these stringent rules, and the Courts of Equity were literally sort of about fairness and dealing with what's the right answer and doing justice as opposed to according to technical rules that were laid down. And so there was two separate courts, and that was from England, and that was true in the United States. And then the United States, in the 30s or so, melded the two courts at the federal level, and most states did the same. So there would just be one court that heard all the cases, law cases and equity cases. But Delaware never did that.

• 14:02Speaker 06

  So it still has the separate Court of Law and the Court of Equity, which is the Chancery Court. So its historical origins are essentially rooted in this idea of fairness and commanding people to take the proper actions. And it doesn't sit with a jury. The cases are heard just by the judges. The judges find facts, would otherwise juries would do that, but the judges find facts in the Delaware Court of Chancery. They're very expert. They are, you know, they're all drawn from corporate practice before they get on the bench. And that's what they do. I mean, they hear other things besides corporate cases. Other things fall into this category of equity. But the main thing, obviously, is the corporate cases.

• 14:56Speaker 00

  What's next for virtual assets? I'm Jacob Rees, host of Economy Scale, a series exploring growth in key global sectors. And in this episode, we're diving into the digital forces shaping finance. Sean McHugh from Dubai-based Virtual Assets Regulatory Authority has this to say.

• 15:12Speaker 07

  We're seeing a lot of institutional players come in, digital asset dedicated hedge funds, high-frequency traders and that sort of thing, and folks who service institutional clients.

• 15:21Speaker 00

  As more capital enters the market, adaptive regulation is likely to become increasingly key. Reese Merrick of Ripple says.

• 15:29Speaker 08

  A lot of regulators globally would like to keep the industry at arm's length. That's the opposite here. I think also what you'll find is that regulation and frameworks can come out, but some of them are maybe a slight iteration on some 80-year-old policy and not actually in line with what the technology can do and offer. And again, that's very different in Dubai.

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• 15:58Speaker 01

  This is the Bloomberg Tech Minute, brought to you by ChatGPT. I'm Carol Muster. Getting hired at SpaceX requires exceptional ability and may include having Elon Musk review a candidate's resume. So writes Bloomberg Businessweek's Lauren Grush. She reports that the company culture is defined by Musk and job candidates must understand that a commitment to SpaceX means adhering to this culture and exhibiting loyalty to Elon Musk. To get hired, candidates must demonstrate their achievements from past jobs and hands-on experience matters more to recruiters than advanced degrees, with the company looking for people with raw innate intelligence. A spokesperson for SpaceX didn't respond to a request for comment on its recruiting

• 16:40Speaker 01

  and hiring practices, but according to recruiters, advisors and those who've interviewed for jobs there, it's the space exploration dream that draws people to the company. And Musk invokes that dream regularly to remind workers why they're there. Prospective hires are told that the job will require stamina, including in job ads that candidates, quote, "must be willing to work extended hours and weekends as needed." One major perk for all that hard work? Employees' access to equity, either the right to buy shares or payment in the form of restricted stock units that vest over time. That's the Bloomberg Tech Minute, brought to you by ChatGPT. Get started at chatgpt.com.

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• 18:21Joe Weisenthal?

  So I want to eventually get into the Elon Pay case and maybe get your read on it, et cetera. But before we do that, you mentioned that this is nothing new. Some of these, there are these longstanding questions about the Delaware and its persistence. Can you give us a little history? Or what are, you know, what were the Elon cases, pre the Elon cases? That sort of maybe had people questioning the sort of durability of the Delaware system?

• 18:47Tracy Alloway?

  The long, long, long ago, before Elon.

• 18:50Joe Weisenthal?

  Elon Avant Lelet.

• 18:51Speaker 06

  It's in the 80s. It was that long ago. It was the 80s. There were two big incidents. So one case of like, these are the basic law cases that you learn if you're in any kind of basic corporate law class. So one case was called Ben Gorkum. Basically, a company was selling itself and they settled on a price and shareholders sued claiming that the board didn't take proper care in setting this price. Nobody suggested they were acting in bad faith, but they just didn't take the time to make sure that they got the best price. And the Delaware Supreme Court agreed and had held that the directors could be held personally liable for damages for essentially not getting the right price for the company. And that terrified boards because these boards could be acting in good

• 19:32Speaker 06

  faith and still could be, I mean, not selling the company for enough. That's serious money damages. So Delaware amended its corporate code so that companies can now add a provision to their charter that says directors will not be held liable for monetary damages for negligence. And that really also boosted companies incorporating in Delaware after that. And by now, every state has adopted a similar thing. But at the time, that was done essentially because they knew that they had just scared the bejesus out of boards. And another issue that came up, this was also in the 80s, was during the hostile takeover era. This was like, you know, the deal decade. There were lots and lots of hostile takeover attempts. And when there's a hostile takeover attempt, boards put up barriers, usually shareholder

• 20:16Speaker 06

  rights plans, poison pills to prevent hostile takeovers. And there was a real question as to how far boards could go to fend off a hostile acquirer, even if the shareholders wanted this deal. And at first, the Delaware courts were pretty strict about it. They, after a certain point, they were saying, look, you got to let shareholders decide. The board can't just block beneficial proposals to buy the company if the shareholders want it. And once again, there were threats to that companies would leave. They would leave Delaware so that they could protect against hostile takeover attempts. And at that point, the Delaware Supreme Court backed off. It adopted new standards that allowed much more deference to boards when they are fighting off hostile takeover attempts.

• 20:58Tracy Alloway?

  So fast forward to today, I just want to make sure we have our priors correct. We love testing our priors.

• 21:05Joe Weisenthal?

  We love establishing our priors on this podcast.

• 21:07Tracy Alloway?

  But you know, those examples aside, does it feel like nowadays there is perhaps more discussion of alternatives to Delaware or more companies that seem to be moving away?

• 21:17Speaker 06

  Yeah, so I don't know if statistically the numbers really move the needle. We've seen definitely some high profile announcements of companies planning to move, but we just don't have enough data right now to see whether this is a serious, like, actual exodus. But there's definitely a lot more discussion and there's definitely a lot more boards thinking or lawyers thinking they have to counsel boards, whether you want to incorporate in Delaware, when before that wouldn't even have been a question. So that's definitely something that's happening.

• 21:44Joe Weisenthal?

  Well, why? So what is it if a lawyer is counseling boards, don't just, because I, you know, I've known people who have launched startups at times and the idea of incorporation in Delaware, that was just obviously what you did, right? You just did it right away.

• 21:58Speaker 06

  Absolutely.

• 21:59Joe Weisenthal?

  So what is it that a lawyer might say, well, maybe take a few beats and think about this? What has actually changed that's caused that?

• 22:06Speaker 06

  Well, Delaware, understandably, has fought back and it's changed its law very recently to sort of fight this off. But essentially, the issue, most of the issue is shareholder liability or liability to shareholders and vulnerability to a shareholder lawsuit. And most of that vulnerability is vulnerability to a shareholder lawsuit over conflicted transactions. That's the main headline thing. There are a few other issues that have come up, but the main headline thing is boards feeling as though Delaware has made it too easy for shareholders to sue over conflicted transactions.

• 22:38Joe Weisenthal?

  What's a conflicted transaction? Just so we know these terms. What is an example of one, either figurative or actual?

• 22:44Speaker 06

  Actual Tesla buying SolarCity. Elon Musk was on both sides of that transaction. He's on the board of Tesla and he's on the board of and running SolarCity. And so Tesla is using its resources to buy out Elon Musk's company. So that's a classic conflict transaction.

• 22:59Tracy Alloway?

  That actually reminds me, just speaking of Elon, but how big a deal was Tesla moving from Delaware to Texas? Because we talk about this network effect. Is it the case that one high profile company moves and suddenly all these other companies are like, we're going to do that, too?

• 23:15Speaker 06

  Yeah, I think it's a big deal. I mean, first of all, you know, we all know that it was inspired by the that move was inspired by the pay package case, but I think some of the grumblings about Delaware are broader. But I think that was a big deal. If for no other reason than Elon Musk is very admired by a lot of CEOs, a lot of venture capitalists, a lot of Silicon Valley. They look to him as a real role model. And so when he publicly announces that he's had it with Delaware and shows that it's possible to take a public company and get shareholder support for moving out of Delaware, even if he is his special and he has a particular relationship with the shareholders that may not be shared by other companies, I think that's the kind of thing that has boards thinking, putting it on the table.

• 23:53Joe Weisenthal?

  Let's talk about the pay package deal. I don't know, like, look, I really don't know much about the law or anything about this stuff at all. But I say, when I say, hey, this was the compensation package she agreed to? Who was this judge to say that he can't get paid intuitively to me? It seems outrageous. Why is this judge cancelling his pay package? But this is my dumb guy just reading ahead. I didn't even read the article, probably. So why don't you, I'm being honest here. So why don't you tell me as someone who actually understands this stuff, how we should read what that case was all about?

• 24:27Speaker 06

  Okay, so remember, the issue here is conflicted transactions.

• 24:31Joe Weisenthal?

  Yeah.

• 24:31Speaker 06

  Musk's pay was a standard conflicted transaction in the sense that the board was deciding what it was going to pay its CEO, which is very much well within the board discretion. But the board included Elon Musk and his brother. So therefore, this was your classic conflict transaction. It was a board.

• 24:50Joe Weisenthal?

  But a lot of CEOs are on their board.

• 24:52Speaker 06

  Yes.

• 24:52Joe Weisenthal?

  Okay.

• 24:52Speaker 06

  So, under Delaware law, the general rule is a conflicted transaction will get close scrutiny by a court unless it's cleansed. And how do you cleanse it? You put an independent decision maker in the mix and then the court will say, well, I'll just defer to the independent decision maker. And you have two options for an independent decision maker, the unconflicted board members or the shareholders. And usually, I mean, this doesn't happen. You have to understand how unusual a case was. Usually, that's more than sufficient. You have the unconflicted board members decide the pay, or you have the disinterested shareholders vote on the pay. And at that point, Delaware says, I'm out. You guys, God bless. The problem here was that the unconflicted board members were not unconflicted.

• 25:37Speaker 06

  So they were all like, he stocks Tesla's board with people who are basically his bestest buds. And they created a committee that was supposed to be the independent members of the committee. And the committee still had close ties to Musk. And then the committee formed a working group that would really do the compensation package. And they picked the people with the closest ties to Musk to put in the working group. And there were all these facts about how he interfered with committee's deliberations, and they just deferred to him. So given that, the court felt that like they didn't put actual independent decision makers at the board level. So then they took it to the shareholders and they had a shareholder vote. But there was not full disclosure in the proxy statement. The shareholders were not fully informed. And for obvious reasons, shareholders can't cleanse anything unless they have full information.

• 26:20Speaker 06

  So left with a situation where the board was not independent of Musk and the shareholders were not fully informed, that's why the court felt, well, I have to evaluate the pay package because no independent decision maker was put in the mix. And then from there, she decided it was too much.

• 26:39Tracy Alloway?

  So this might be a tough question to ask, but since we're talking, you know, this discussion or debate centers on shareholder liability as you've laid out. Do we have any research that actually tells us what happens to share prices and stocks when a company signals that it's going to move away from Delaware? Or when it actually does it?

• 27:00Speaker 06

  We have incredibly mixed evidence. The fact is that scholars have been fighting about this forever, whether it makes a difference. And some have found that maybe it's beneficial depending on the type of company. Like, I mean, Delaware is expensive. I mean, the whole point of Delaware having this chartering business is that's how the state funds itself. It gets 25% of its revenues from incorporation fees. No other state does anything like that. So for smaller companies with less resources, it can be beneficial to move away from Delaware. But mostly, this is something where different scholars will come up with different things. We just don't know for sure. And that's probably because Delaware has been dominating for so long, at least for public companies, that it's hard to tell if there's a serious movement away. Now we'll know.

• 27:41Joe Weisenthal?

  It's interesting. So let's talk about the allure of, say, reincorporating in Texas. You know, I could see just sort of for vibes and vague ideological things.

• 27:52Speaker 06

  Taxes.

• 27:52Joe Weisenthal?

  Elon wants to go to Texas. I'm not surprised. And they're probably the politicians or yeah, Elon, come on down. The shareholders are like, oh, we're gonna get away from those blue states that impose communism on you by not letting you get your billion dollar pay package or whatever. All that being said, the goal, it seems to me, or why people like Delaware is right, this idea of balance. Because while there may be an Elon Musk cult that loves to hand him money and not every shareholder wants to have that relationship with their CEO where they're just forking over a lot of money. And so it seems to me that, okay, maybe Texas is a good fit for Elon and his shareholders. But that's still

• 28:32Joe Weisenthal?

  in many cases, some sort of court system that imposes, maintains a balance of power between the CEO, the board, and the outside shareholders is still what's going to be desirable for most companies.

• 28:43Speaker 06

  Yeah. So this is a complicated question. That is exactly how Delaware has sold itself. That essentially that it maintained a balance, that it mostly gave boards incredible amounts of flexibility and incredible amounts of deference. But ultimately, there was some basic floor protections for shareholders. The issue, well, there are twofold issues. The first is that ultimately, corporate managers are the ones who make decisions about where to incorporate when they do a startup. I mean, once you're actually publicly traded, if you want to move, you need a shareholder vote. But before then, you can pick any company you want to. And even if you need a shareholder vote, once you're publicly traded, as we saw with Tesla, if you're a meta or where you have a controlling shareholder, the shareholder vote's really easy. It's just what the controlling shareholder wants. So moving is not hard.

• 29:27Speaker 06

  And so the only reason essentially that you wouldn't do it is if you really thought you were going to pay a price with shareholders. It's not clear how much of a price shareholders are going to inflict for being in a state with fewer protections. So the theory has always been the cost of capital will be higher if you're in a state with fewer protections. But it's not clear how much that plays in, as you just asked, like, is there really a shareholder of value price for moving to a different state? It's not clear shareholders really have the power to push back. And Delaware also seeing this move weakened a lot of the shareholder protections that led to verdicts like the Musk pay package case. So now we really don't know if there's a difference.

• 30:23Speaker 01

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• 31:07Speaker 01

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• 31:51Tracy Alloway?

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• 32:10Tracy Alloway?

  Why would a minority shareholder actually approve to move to a jurisdiction where ostensibly they have fewer rights?

• 32:25Speaker 06

  Because, remember, 90% of this is about shareholder litigation. There may be, or, and conflict transactions and suing over conflict transactions. That is most of what this fight is about. It's not the only thing, it's most of it. There is a huge debate about whether shareholder litigation is, in fact, the best way to handle this problem. I mean, there are all kinds of concerns about strike suits. There are concerns that, you know, that this is just lawyer-driven litigation in the Torneta case, the Elon Musk pay package. Remember, the shareholder there held nine shares, literally nine shares of Tesla stock. So there's a real question about whether shareholder litigation is, in fact, a game that's worth the candle.

• 33:05Speaker 06

  Unquestionably, there are real problematic transactions and shareholder litigation can win very huge payouts for shareholders, but usually those payouts come from the insurance that the company itself paid for in these huge settlements. And whether or not that ultimately is the best way to handle a conflict transaction situation is, is a very debated question. So shareholders may very well think they can move to a jurisdiction with fewer protections on the theory that ultimately, less litigation is better for the company.

• 33:35Joe Weisenthal?

  It is a very strange situation because essentially, again, you have this situation in which the shareholders were upset at the state for not allowing more shareholder money to go into the pocket of one individual person. That's a very strange situation, et cetera. Shareholder lawsuits always strike me as a little bit interesting field in general. I remember back 25 years ago when I sometimes used to buy and trade individual stocks and a stock would miss earnings and then suddenly you get an email, it's like, this company is filing suit. It's like, why do I want to take a part in a lawsuit against this company that I am a co-owner of? Does this actually benefit me or does this benefit anyone other than the lawyer? I've never been totally clear on that either, just in general, even setting aside sort of these conflict questions.

• 34:21Speaker 06

  Yeah, I mean, that's it's a very debated question. But for most of these suits, I mean, there is a difference between a suit for fraud under the federal securities laws and a state law suit for breach of fiduciary duty, which is what Delaware handles. And there, I mean, when there's a lawsuit like that, any payment is supposed to come from the directors to the shareholders or to the company. So that's the that's the theoretical monetary benefit. But directors usually don't pay out of pocket. They've got insurance. So if they pay, it's the insurance. And guess who pays for the insurance? Corporation does.

• 34:52Tracy Alloway?

  Now you're going to think about shareholder lawsuits differently, Joe.

• 34:55Joe Weisenthal?

  Or just, yeah, I still don't. Okay, keep going.

• 34:59Tracy Alloway?

  All right. So you touched on this earlier, but Delaware isn't exactly standing still while it sees companies move elsewhere. Is this just going to result in a sort of race to the bottom in terms of shareholder rights, where states are just like, well, if you drop your standards or if you alter the balance here, I'm going to do the same thing. And everyone just kind of races to the bottom.

• 35:23Speaker 06

  I think that's what we're absolutely seeing. I mean, Nevada and Texas are essentially selling their law as creating barriers to shareholder lawsuits. And that's what Delaware did. It changed its law to put up more barriers. Now, it did so more subtly, which is exactly why I think there's still like this race, because Delaware didn't want to like openly say, no, that's it. We're just barring shareholder lawsuits. So they wrote a lot of words, and they're complex words, but ultimately they all come out to the same thing. All three states have made it much, much harder, if not virtually impossible, for anything but in the most fraudulent circumstances shareholders to bring claims. So I think we're at that race. We're watching it right now.

• 36:00Joe Weisenthal?

  I could understand why a public company board or a public company would say, okay, we want to be in a jurisdiction where it's much harder for shareholders to bring lawsuits, et cetera. Is the calculus different depending on the maturity of the company? And could you say like an early stage startup? Like I said, I've known people in the startup space. First, one of the first things they do is incorporate in Delaware. In those situations, maybe from the legal perspective, did the VCs own the company in a more deep way than public company shareholders do, even though nominally they're all just shareholders and there's a separate board?

• 36:37Speaker 06

  Yes, and shareholder litigation, this kind of shareholder litigation is extremely rare in VC-backed or smaller companies. And that's because who the shareholders are. I mean, the shareholders are largely insiders or friends of VC. They don't want to anger them. They may have signed arbitration agreements that would prevent any kind of lawsuit anyway. So this issue of litigation is much more of a public company problem. That said, there were some issues that were really bugging the startup community that Delaware fixed as well. For example, a lot of startups like to have shareholder agreements where one shareholder is given essentially governance rights, not because they're a shareholder and they can vote their shares, but because they have a contractual right to say, "Board, you're

• 37:21Speaker 06

  not allowed to merge unless I approve. Board, you're not allowed to take on debt unless I approve." And Delaware, a couple of years ago, a court decision, I think very correctly under Delaware law at the time, said, "Well, you can't do that in a corporation. The board has to run the company. You can't just hand over governance rights to a shareholder by saying, 'Well, here's your contract. You get to approve all board decisions.'" That really scared the VC community, and Delaware reacted immediately by authorizing those kinds of shareholder agreements.

• 37:47Joe Weisenthal?

  Tracy, I think there's going to be some very interesting questions of corporate governance that come up. You know, some of these episodes that we've discussed where AI startups, the company gets aquahired and not all the value gets accrued to shareholders, or different class of shareholders depending on what employee you are. I bet there will be some very interesting corporate governance law that comes out of this.

• 38:06Tracy Alloway?

  For sure. And you know there's going to be some state that tries to pitch itself as like the place to incorporate AI startups.

• 38:12Joe Weisenthal?

  An AI startup, yeah.

• 38:13Tracy Alloway?

  Okay, so speaking of startups, if Joe and I were going to incorporate and become Odd Lots, I guess we'd be an LLC, maybe? Not LLC.

• 38:22Speaker 06

  Yeah, it probably would be.

• 38:23Tracy Alloway?

  Yeah, okay. Odd Lots LLC. And you were our lawyer, our hypothetical lawyer, giving us legal advice.

• 38:30Joe Weisenthal?

  Hypothetical.

• 38:31Tracy Alloway?

  What would you advise us to do here? Where should we incorporate?

• 38:35Speaker 06

  Well, so first of all, LLC is not a corporation.

• 38:38Tracy Alloway?

  Oh, okay.

• 38:38Speaker 06

  You would not be incorporated. You would be organizing an LLC. But actually, I would tell you not to go to Delaware, Nevada, or Texas. Because Delaware dominates in public companies. And VC-backed companies, like professionalized startups. But it doesn't dominate in, like, you know, your average family business, your average local business. It does not dominate there at all, and it's not designed for that. So if you, I mean, you guys are professionals, but you know, in a small relationship-backed company, Delaware law is in some ways too ruthless. The other states have a lot more protections for essentially non-lawyer, family-ish, friendish businesses that might be more appropriate.

• 39:20Joe Weisenthal?

  Well, I don't know. We might, it might be.

• 39:23Tracy Alloway?

  We could be big.

• 39:23Joe Weisenthal?

  It might be a professional operation. I just have one more question. How rare is the US for having this patchwork of corporate systems? They're like, if we went to another country, is there jurisdiction shopping the same way?

• 39:37Speaker 06

  No, well, see, understand, we're like 50 different countries in Europe. It's like, you know, so, so Europe, you used to be that you couldn't do what we do in the United States, where you incorporate in Delaware, but all your business operations are somewhere else. It used to be in Europe that essentially it was, but it's country by country. If you had your headquarters in a country, you were supposed to organize in that country, and you couldn't mix and match. Europe changed the law, but it's still so that you could theoretically jurisdiction shop among European countries. You know, or have your headquarters and all your operations in one place and organize in another place, another country. But they don't, they don't really have that norm. It's just viewed as sort of weird.

• 40:19Speaker 06

  So for them, where your operations are, are largely going to be the law, the corporate law that governs your entity.

• 40:27Tracy Alloway?

  Is there transnational jurisdiction shopping? Could you get, you know, like a foreign company that wants to incorporate in the US?

• 40:33Speaker 06

  Well, yes, but it's much more likely that a US company wants to incorporate outside the country.

• 40:38Tracy Alloway?

  In Ireland or something.

• 40:39Speaker 06

  Yeah, so for other kinds of, you know, that used to be a big deal for tax reasons and so forth.

• 40:45Tracy Alloway?

  All right. Anne Lipton, thank you so much for coming on Odd Lots. Really appreciate it. That was great.

• 40:50Speaker 06

  Thank you for having me.

• 41:04Tracy Alloway?

  Joe, that was so interesting.

• 41:06Joe Weisenthal?

  It's super interesting.

• 41:07Tracy Alloway?

  I think business journalism in general, or financial journalism, doesn't cover legal stuff enough.

• 41:14Joe Weisenthal?

  Well, Matt Levine has proved it because there's a huge demand for his newsletter precisely because he's one of the few destinations that actually talks about the Chancery and all this stuff. But to your point, this proves the point.

• 41:23Tracy Alloway?

  He's the exception that proves the entire point. And accounting as well.

• 41:28Joe Weisenthal?

  Yes, that too.

• 41:29Tracy Alloway?

  And insurance.

• 41:29Joe Weisenthal?

  And insurance.

• 41:30Tracy Alloway?

  Okay, wait, I'm not going to just criticize our colleagues in financial journalism. No, that was fascinating. I do find the whole race to the bottom idea a little bit concerning for obvious reasons. And I guess like, it's sort of that network effect that you were discussing earlier. But once the ball gets rolling in that direction, it just seems really hard to stop.

• 41:54Joe Weisenthal?

  It's just, I agree. And I think this is something very, the sheer influence that Elon has and all the people who look to him and see him as the model is very interesting. On the other hand, you know, there are not many CEOs out there for whom the cult is so strong that people thirst to give him money. And so the question of whether shareholders of other companies want to be incorporated in states, whether they would actually, unlike the current research, inflict some sort of cost of capital penalty for non Delaware incorporated states is going to be an interesting question. But the ball is rolling.

• 42:32Tracy Alloway?

  That's going to be so interesting once the sample size gets bigger.

• 42:36Joe Weisenthal?

  Yeah, gets a little larger, yeah.

• 42:36Tracy Alloway?

  And you can see like, the actual impact on stock prices. So I take your point, but there are shareholders who potentially would say, well, if a company doesn't have to deal with a lawsuit from like, a shareholder who has nine shares.

• 42:50Joe Weisenthal?

  Nine shares, yeah.

• 42:51Tracy Alloway?

  Maybe that's a good thing and that's like, a trade off worth making.

• 42:54Joe Weisenthal?

  Yeah, I don't know. I mean, nine shares and he had this pay package. Seems like, he signed a deal. I'd be so annoyed. Could you imagine? Could you imagine how annoyed you would be if your pay package got canceled because of some shareholder with nine shares?

• 43:11Tracy Alloway?

  My pay package of millions, I would be annoyed.

• 43:14Joe Weisenthal?

  It doesn't matter how rich I am, I would cannot imagine my fury. I would be the richest person in the world, I would be so annoyed by that.

• 43:21Tracy Alloway?

  Okay, so now that we've annoyed Joe, shall we leave it there?

• 43:23Joe Weisenthal?

  Let's leave it there.

• 43:24Tracy Alloway?

  Okay, this has been another episode of the Odd Lots Podcast. I'm Tracy Alloway. You can follow me at Tracy Alloway.

• 43:30Joe Weisenthal?

  And I'm Joe Weisenthal. You can follow me at TheStalwart. Follow our producers, Carmen Rodriguez at CarmenArmin, Dashell Bennett at Dashbot, and Cale Brooks at CaleBrooks. For more Odd Lots content, go to Bloomberg.com/oddlots. We have a daily newsletter and all of our episodes. And you can chat about all of these topics 24/7 in our Discord, discord.gg/oddlots.

• 43:51Tracy Alloway?

  And if you enjoy Odd Lots, if you like it when we dig into legalities in the US legal system, then please leave us a positive review on your favorite podcast platform. And remember, if you are a Bloomberg subscriber, you can listen to all of our episodes absolutely ad-free. All you need to do is find the Bloomberg channel on Apple Podcasts and follow the instructions there. Thanks for listening.

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