112 Yale L.J. 369 (2002)

For decades our common understanding of the organization of economic production has been that individuals order their productive activities in one of two ways: either as employees in firms, following the directions of managers, or as individuals in markets, following price signals. This dichotomy was first identified in the early work of Ronald Coase and was developed most explicitly in the work of institutional economist Oliver Williamson. Recently, public attention has focused on a fifteen-year-old phenomenon called free software or open source software. This phenomenon involves thousands, or even tens of thousands, of computer programmers who collaborate on large- and small-scale projects without traditional firm-based or market-based ownership of the resulting product. This Article explains why free software is only one example of a much broader social-economic phenomenon emerging in the digitally networked environment, a third mode of production that the author calls "commons-based peer production."

The Article begins by demonstrating the widespread use of commons-based peer production on the Internet through a number of detailed examples, such as Wikipedia, Slashdot, the Open Directory Project, and Google. The Article uses these examples to reveal fundamental characteristics of commons-based peer production that distinguish it from the property- and contract-based modes of firms and markets. The central distinguishing characteristic is that groups of individuals successfully collaborate on large-scale projects following a diverse cluster of motivational drives and social signals rather than market prices or managerial commands. The Article then explains why this mode has systematic advantages over markets and managerial hierarchies in the digitally networked environment when the object of production is information or culture. First, peer production has an advantage in what the author calls "information opportunity cost," because it loses less information about who might be the best person for a given job. Second, there are substantial increasing allocation gains to be captured from allowing large clusters of potential contributors to interact with large clusters of information resources in search of new projects and opportunities for collaboration. The Article concludes with an overview of how these models use a variety of technological, social, and formal strategies to overcome the collective action problems usually solved in managerial and market-based systems by property, contract, and managerial commands.

112 Yale L.J. 553 (2002)

Does American corporate law work effectively to enhance shareholder value? The recent corporate governance crisis makes this time as good as any for reexamining the basic structure of this body of law. This Essay provides such a reconsideration of a defining feature of U.S. corporate law--the existence of regulatory competition among states.

In the United States, most corporate law issues are left for state law, and corporations are free to choose where to incorporate and thus which state's corporate law system will govern their affairs. The dominant state in attracting the incorporations of publicly traded companies is, and for a long time has been, the small state of Delaware. Although Delaware is home to less than one-third of a percent of the U.S. population, it is the incorporation jurisdiction of half of the publicly traded companies in the United States and of an even greater fraction of the larger publicly traded companies. Delaware thus plays a central role in setting corporate governance rules for the nation's publicly traded companies.

Why should this small state play such a critical role in the governance of the nation's corporate sector? At first glance, Delaware's existing dominant role might be viewed as inefficient or even illegitimate. The widely accepted justification for the existing state of affairs, however, is that Delaware's dominant role is a product of its winning a competition among states for providing desirable corporate law rules.

Indeed, the dominant view in corporate law scholarship is that allowing Delaware to dominate national corporate law is not a problematic feature, but rather an important virtue, indeed the "genius," of American corporate law. According to the prevailing view among corporate scholars, competition provides powerful incentives for adoption and development of value-enhancing corporate rules. Delaware has won its leading place by offering the best rules, and the competitive pressure it faces can be relied on to ensure that Delaware will continue to provide companies with whatever rules turn out to be best in our dynamic and changing business world.

The view that state competition works well rests on two propositions: (i) that states actively and vigorously compete for incorporations, and (ii) that the ensuing competitive threat provides the dominant state of Delaware, as well as other states, with powerful incentives to provide value-enhancing rules. Those skeptical of state competition have mainly focused on questioning the second proposition. Accepting that states actively compete for incorporations, such critics have argued that the competitive threat might push states in undesirable directions with respect to some important corporate issues.

In contrast, this Essay challenges the standard case for state competition by questioning the claim of the first proposition that states vigorously compete for incorporations. The alleged vigorous race among states vying for incorporations, we argue, simply does not exist. We present evidence that Delaware's dominant position is far stronger, and thus that the competitive threat that it faces is far weaker, than has been previously recognized. We also explain the underlying reasons for the weakness of competition in the market for incorporations. Furthermore, we show that the weakness of competition has major implications for both assessing the performance of state competition and determining the desirable role of federal law in this area.

Part II of this paper discusses the conventional premise that states compete actively for incorporations. We highlight the key role that this premise plays in the views of supporters of state competition. We also discuss how, at least for the purpose of the debate, critics of state competition have often accepted this premise.

Part III then discusses evidence indicating the absence of active competition among states for corporate charters. We pay close attention in this Part to the patterns of incorporations among states that have been documented in a recent empirical study by Alma Cohen and one of us. Although half of the publicly traded companies are incorporated outside Delaware, Delaware does not face any significant competitors in the business of attracting and serving out-of-state incorporations. The vast majority of non-Delaware corporations do not incorporate in a state that competes with Delaware over the hearts (or pockets) of firms incorporating out-of-state; rather, these firms simply remain incorporated in the state where they are headquartered.

In assessing the competitive threat facing Delaware, it is important to consider Delaware's position in the market for out-of-state incorporations. Among firms that do "shop" for out-of-state incorporations, Delaware captures approximately 85% of all incorporations. Delaware is thus a virtual monopoly in the out-of-state incorporations market, and no other state holds a significant position in this market. For example, whereas Delaware captures 216 out-of-state incorporations of Fortune 500 companies, no other state captures even 10 such incorporations, and the five states that follow Delaware's lead capture a total of 27 such out-of-state incorporations. Similarly, whereas Delaware captures about 3744 out-of-state incorporations of publicly traded companies, each other state attracts fewer than 180 such incorporations. Furthermore, Delaware's longstanding dominance of the out-of-state incorporation market, and the larger incorporation market, has been growing. Indeed, examination of recent trends indicates that Delaware's dominance can be expected to keep growing even further in the near future.

Its dominant position enables Delaware to make substantial supracompetitive profits. While Delaware's expenses on providing corporate law rules to the nation's firms are exceedingly small, it captures large franchise tax revenues--which on a per capita basis amount to $3000 for each household of four--that constitute a large fraction of the state's budget. Still, notwithstanding these supracompetitive returns, other states have not been making any visible efforts to mount a serious challenge to Delaware's dominance. No state, as it were, has been giving Delaware a run for its money.

What explains Delaware's powerful and unchallenged dominance? Some states, especially large states for which such profits would not be significant, might well be simply indifferent to the prospect of making profits from the incorporation business. There are, however, enough small states in the United States for which profits such as those Delaware has been making would be quite attractive; such states would have had strong motivation to mount a challenge to Delaware's dominance if such a challenge could have been expected to succeed in enabling them to capture a significant fraction of these profits. That this has not been happening, notwithstanding Delaware's persistent supracompetitive returns, indicates in our view that mounting a challenge to Delaware has not been viewed as likely to be profitable.

Part IV analyzes the reasons for the absence of active competition. Drawing on the theory of industrial organization, we identify a number of structural features of the incorporation market that can explain why a challenge to Delaware's dominance by some other small state is unlikely to be profitable. The "product" currently offered by Delaware should be viewed as including not only its rules but also its institutional infrastructure, including Delaware's specialized chancery court, and the network benefits currently enjoyed by Delaware corporations. As a result, a state that would offer the same rules, but charge lower incorporation taxes and fees, would not be able to attract many out-of-state incorporations. Although its current incorporation taxes are in the aggregate meaningful for Delaware, such taxes never exceed $150,000 for any given firm, and reductions in such expenditures are unlikely to lead firms incorporating out-of-state to forgo the benefits from the institutional infrastructure and network externalities provided by Delaware. Similarly, a state that merely offers the same rules as Delaware with some marginal improvements cannot hope that such marginal improvements would by themselves attract many out-of-state incorporations.

The existing rules governing reincorporations further constrain the ability of a challenger to attract quickly a significant number of out-of-state incorporations. Reincorporations must be initiated by the board before being brought to a shareholder vote. Therefore, even if a rival state could identify a set of rules that could make shareholders substantially better off, this state would be unable to attract quickly many out-of-state incorporations unless the rules are also preferable for managers. This significantly narrows, of course, the scope of improvements in substantive rules on which a potential challenge could be based.

Finally, even if a rival were to identify some substantial set of changes that could significantly benefit both shareholders and management, and even if the rival were willing to invest up-front in institutional infrastructure, the profitability of a challenge could be undermined by the inability of the rival to launch a swift hit-and-run challenge. The substantial amount of time that would be required for the challenger to adopt changes and for firms to respond to them would provide Delaware with ample opportunity to react. Delaware could "match" by adopting the challenger's improved rules; Delaware's out-of-state incorporators might then stick with Delaware due to its initial network benefits, and the challenger would merely serve as a stalking horse pulling Delaware to improve its rules. Furthermore, even if the challenger were somehow able to capture a significant fraction of the out-of-state incorporation market, price competition between the challenger and Delaware would likely bring down prices; in this case, the challenger would bring down Delaware's current profits without being able to capture a substantial fraction of them.

Part V turns to exploring the implications of the weak-competition account we develop for assessing the performance of state competition in corporate law. Our analysis indicates that the incentives of Delaware and of other states are likely to be quite different. Delaware is in the business of attracting and profiting from out-of-state incorporation. Its interests would be best served by policies that maintain its monopoly and undermine possible threats to it, and that increase the profits it makes from its position. In contrast, other states cannot, and do not expect to, obtain such a position in the out-of-state incorporation market, and maximizing revenues from such incorporations is thus irrelevant for such states. Accordingly, we examine separately the implications of our analysis for both Delaware law and the corporate law of other states.

Among other things, we show that our account of state competition undermines the view that rules produced by state competition should be regarded as presumptively efficient. Neither Delaware nor other states face the type of competitive situation in which a limited slack could gravely hurt a player's interests. We also explain how our account leads to the conclusion that states would tend to provide rules that, with respect to some issues, such as takeover protections, are more favorable to managers than would be optimal for shareholders.

Our weak-competition account suggests that the greatest threat confronting Delaware is not competition from other states but the possibility that the federal government will intervene in a way that would undermine Delaware's position. We discuss in Part V how, in light of this threat, Delaware's interests might be best served by providing a body of law that is largely judge-made and relies on open-ended and flexible standards. Furthermore, to the extent that Delaware is moved to act in shareholders' interests by the fear of triggering a federal intervention, this fear can provide a check only against rather large deviations from shareholder interests, and whatever benefits come from it should be attributed to the disciplinary role not of state competition but of federal fiat.

Finally, Part VI discusses the implications of the weak-competition account we put forward for the desirable role of federal law in this realm. The absence of strong competition undermines the basis for the view that Delaware's dominance is the product of its winning a vigorous competition. Thus, the analysis implies that the case for preferring state competition to mandatory federal rules is much weaker than supporters of state competition have assumed.

Furthermore, we argue that, given the weakness of existing competition, state competition, as currently structured, could in all likelihood be improved by using "choice-enhancing" federal intervention. This type of intervention, which has been put forward by Allen Ferrell and one of us in earlier work, could invigorate state competition. In particular, it would be desirable for federal law to provide a federal incorporation option, as Canada's federal law does, as well as to enable shareholders to initiate and approve via a vote reincorporation to another state. Such federal intervention could introduce substantial and healthy competition in this market to the benefit of investors.

Although much of the work on state competition has taken as given the presence of active competition, there has been some prior work, upon which we build, discussing why Delaware has a dominant position. Among other things, earlier work has highlighted the significance of network externalities and legal infrastructure, which are important elements of our analysis.

In a contemporaneous work, Marcel Kahan and Ehud Kamar also challenge the vigorous competition account of state competition, offering an analysis that complements ours. Kahan and Kamar persuasively document that states other than Delaware have not made a determined effort to attract and profit from out-of-state incorporations; this evidence complements the evidence on which we focus concerning the patterns of incorporation among states. In explaining the absence of vigorous competition, Kahan and Kamar take a different approach from ours, arguing that states other than Delaware do not compete because state decisionmakers pursue political goals rather than profits. In contrast, we suggest that such a "political" story cannot adequately explain why other small states would not eagerly seek to capture Delaware's profits if they could do so; instead, we focus on "economic" explanations as to why they cannot do so, i.e., why attempts to capture these profits can be expected to fail.

Our work differs from earlier and contemporaneous work by others in several important respects. First, we show that the patterns of incorporations indicate that Delaware's dominant position in the incorporations market is far stronger and more secure than has been previously recognized. Second, we provide a comprehensive analysis of the structural features of the market for corporate law--the "industrial organization" of this market--that make it unprofitable for other small states to challenge Delaware's position. Third, other works that have discussed imperfect competition in the incorporation market, including the contemporaneous work by Kahan and Kamar, have largely remained agnostic or even doubtful about the merits of federal intervention. In contrast, we show that the lack of meaningful competition in the incorporation market undermines the case for the existing system and provides an important basis for supporting a federal role.

Some of the points discussed in this Essay are more fully or rigorously developed in two companion pieces. An empirical study by Alma Cohen and one of us provides a comprehensive study of the patterns of incorporations, and we draw on it in Part III. A theoretical work by Oren Bar-Gill, Michal Barzuza, and one of us develops the first formal model of state competition over incorporations; this model pays close attention to the industrial organization features of the incorporation market, and we build on its insights in Part IV.

112 Yale L.J. 665 (2002)

The National Labor Relations Board (NLRB or the Board) has, for many years, wrestled with the problem of whether various classes of professional employees who regularly exercise discretion and judgment in their jobs should be classified as "supervisors" and therefore denied the collective bargaining rights the National Labor Relations Act (NLRA) extends to other employees. The Act clearly recognizes that professional employees exercise some level of judgment and discretion. The Act, however, also makes "independent judgment" in the exercise of certain acts (e.g., hiring, firing, and promotion) the touchstone of supervisory status. So the distinction between supervisors and mere professional employees turns on the level of independent judgment exercised in certain capacities; this distinction becomes crucial to determining which employees receive bargaining protection. Reading as de minimis the amount of independent judgment needed to clear the supervisor threshold would remove professionals from the coverage of the Act completely--a result clearly at odds with congressional intent, given the express inclusion of professional employees in the Act. This inherent tension between the inclusion of professional employees and the exclusion of employees who exercise independent judgment has been at the root of much of this conflict.
 
This Comment examines a recent Supreme Court decision, NLRB v. Kentucky River Community Care, Inc., that exemplifies the struggle over the classification of professional employees, specifically registered nurses, as "supervisors." The Board has consistently tried to classify nurses as nonsupervisory professional employees, while the Court has repeatedly cabined nurses within the class of supervisors. The Board's efforts have been focused on achieving protection for all nurses who exercise any kind of discretion, crafting statutory arguments that would narrowly interpret the supervisory-status requirements. Striking down these interpretive strategies, the Court has rejected broad protection for registered nurses.
 
This Comment suggests a new interpretive strategy that the NLRB could adopt in order to afford at least some bargaining protection to certain classes of nurses and other professional employees, albeit not the broadest level of protection that the NLRB has previously sought. This strategy counsels focusing on one of the statutory criteria that defines a supervisor, the "responsibly to direct" term, which the NLRB has largely ignored in litigation. The plain text of the Act, standard interpretive tools, and policy considerations of the statute all militate toward differentiating mere professional employees from supervisors, not on the grounds of mere "independent judgment," but via the capacity in which that judgment is exercised. When a professional exercises independent judgment to carry out functions with respect to other employees and is accountable for the results and performance of the other employees, clearly he is responsibly directing these employees. This narrow reading of the "responsibly to direct" term splits the difference between inclusion of professional employees and exclusion of supervisors who exercise "independent judgment," resolving the inherent tension between these two terms. Responsible direction should therefore be the touchstone of supervisory status when the professional employee is not carrying out one of the specific functions that automatically qualify as supervisory.