Charles M. Elson is the Edgar S. Woolard, Jr., Chair in Corporate Governance and the Director of the John L. Weinberg Center for Corporate Governance at the University of Delaware. A nationally-recognized expert in corporate governance, Elson recently sat down to talk with Alexandra Duszak about threats to Delaware’s unique position as a corporate home, his love of crab cakes and more.
TSD: Let’s get right to it: As much as a third of Delaware’s revenue and a significant chunk of our economy is tied to the state’s unique status as a corporate haven. Given recent federal legislation (and other threats), do you think this is a sustainable position? How do you see the state’s prospects 10 or 15 years down the road?
CE: The state’s prospects are not good, because ultimately the federal government has taken over a good part of what we do in our regulation of corporations. Regulation of corporate boards, which was traditionally state-oriented, is now, because of Dodd-Frank and Sarbanes-Oxley, in several respects federally-oriented, and the federal regulation of it doesn’t mean necessarily that people will flee the state, but it means when you incorporate, the state of Delaware is no longer as relevant as it once was to an incorporation. Historically, you incorporated here because you wanted to take advantage of our laws and our courts, but if a good part of what we regulate is now federally regulated, there’s no real point to incorporating here. You incorporate where you happen to do business, and that’s the challenge. I don’t think it’s a federal corporation statute that we fear, I think it’s that we have less relevance to incorporations—that’s the danger. I think ten, 15 years from now, we’ll probably feel the effects of it. It’s not going to happen overnight.
TSD: Could we—or why haven’t we—been doing a better job protecting and promoting that status?
CE: I think we could pressure the federal regulatory structure as best we can to stay away from board processes, but at this point, no, other than a rollback of certain federal legislation that was passed, I think were going to have a really tough time, and the only thing we can do is continue to be known as a place where our courts are respected by investors and by corporations worldwide, and they feel that we are a neutral, fair forum to resolve their disputes. But other than that, I don’t think there’s much we can do. I think the time to have done something was two years ago, when Dodd-Frank appeared.
TSD: What are the implications for this state’s finances if that special status starts to fracture?
CE: Twenty-seven percent of our revenue comes from the franchise tax, which are taxes that are paid for the privilege of incorporating here. Another couple of percent comes from the escheat tax–basically, an unclaimed property statute that applies to corporate dividends. Then you have to add personal income taxes, corporate income taxes on the various businesses that service the corporate industry—law firms and related businesses—and you’re probably talking well over half the state’s tax revenues coming from corporate sources. So the less corporate action, the less the corporate tax stream will lead to us. That’s going to be tough, not to mention the jobs that are tied up in this area as well, so you’ve got jobs and revenues. It’s a pretty big deal for the state.
It’s like water breaking against a beach front; it’s a steady erosion and what’s happened is the surf, because of the federal legislation, has gotten much more intense, which means the wearing away of our franchise only intensifies. How long it will take? I don’t know. It could be a couple years, it could be many years, but I think ultimately, we will not be in the same position in 20 years that we are in now unless the federal regime is stopped in its tracks and perhaps even rolled back a little bit. That being said, I think for investors, the federal structure is problematic. I don’t think the federal structure protects investors, I think we protected investors in a much more intelligent and dramatic way than the federal government did, or will do for a variety of reasons.
TSD: Many people are still steaming about the financial fiasco of 2008—and as we read about huge pay packages at big banks they are wondering if anything has really changed in terms of accountability and oversight. Are you comfortable with corporate governance and risk management in our financial industry?
CE: I don’t think corporate governance was the reason the big banks had the problems they had. It was a problem of evaluating the value of certain assets. I don’t think that was governance-related. I think the governance changes that have been developing in the last couple of years are helpful. The notion of independent directors, the notion of equity-holding directors, the notion of freer and fairer elections for directors, I think, create accountability structures that make the boards much more effective at overseeing management. Whether it’s the financial industry or any industry, I think that’s true. I think Dodd-Frank ultimately will not have the positive impact that its creators intended. I think it’s ultimately going to make capital much harder to come by in this country, and as I think we’ve seen in the last year, it will not fuel the economic recovery that’s necessary, I think, to restore this country and its economy to the vital role in the world economic community that it once played.
TSD: You have taken on some projects to help local institutions create better governance structures. What is the one piece of advice you would offer to any organization when it comes to oversight and accountability?
CE: I think the issue is that the board is there to monitor management for the benefit, in the case of for-profits, the shareholders, and in the case of the not-for-profits, the public. The key to being a good monitor is you have to be independent of management. You’ve got to have a stake in the organization itself; in the case of a for-profit owner, stock ownership. In the case of a not-for-profit, you’ve got to be an active donor. Finally, you have to be subject to a vibrant election process so that if you don’t act effectively, you can be replaced. In the case of a for-profit, all sorts of things such as proxy reimbursement and other kinds of tools have been developed, like majority voting, to ensure effective turnover of boards when necessary. In the case of a not-for-profit, a pretty searching board evaluation process on an annual basis ensures that those who remain on the boards are active in overseeing the boards. It’s pretty straightforward and pretty simple advice. I think if you carry that forward, I think you’ve done the right thing.
TSD: You are widely acknowledged as one of the nation’s leading experts in your field and you could be teaching anywhere. Why Delaware?
CE: If you teach corporate law, this is the epicenter for corporate regulation. Even though we’ve taken a big hit the last two or three years, I think this is still, of all the states, if you do corporate governance, corporate regulation, the best place to do it. I think it’s a vibrant community; there are many interesting things going on here culturally and I think it’s a nice place to live. I think professionally speaking, there’s a lot to be said for the corporate community. Our legal community is really second to none, both in terms of our private legal community and our judges. And from someone who’s interested in this area, there really couldn’t be a better place to be. It’s also a really nice place to live, which is why I’m so concerned about what happens to the corporate franchise here. If we lose it, it’s not only, I think, a loss for investors, but from a personal standpoint as a citizen, I think it would be a real disaster for the state. Investors will be harmed, and the state will be harmed and I don’t want to see that happen. I’m kind of concerned that we’re really moving very quickly down that road, and I haven’t seen our public officials, in their responses, being as effective as I hoped they might have been in the process.
TSD: What are some of your favorite local haunts?
CE: We’ve become big crab aficionados. We’re always on the search for the best crab cake. We used to look for good barbecue when we were in Florida, now it’s the crab cake. So I think a good crab cake, I would search out any day. I think, culturally in this town, there’s just a lot of things to do here. If you’re interested in business history, the Hagley Museum is phenomenal. The Delaware Museum of Natural History is a real gem. The Delaware Art Museum, the Brandywine River Museum and Winterthur are huge attractions, and it’s amazing for a community this small have those kinds of treasures available to us. I think this is a pleasant place to live, and as far as local hangouts, we travel everywhere from Helen’s Sausage Shop down in Smyrna—it’s a favorite—to Walter’s Steakhouse downtown–that’s always kind of fun–to every crab cake place we can find. It’s a nice town, we’ve enjoyed it alot. No complaints at all.