DP5133 Race to the Top or Bottom? Corporate Governance, Freedom of Reincorporation and Competition in Law
This paper investigates the governance structure choices of firms when there is competition between legal systems. We study the impact of the allocation of control over choice of governance and reincorporation on firms? technologies and technological specialization of countries in the context of a model of the firm in which there are agency conflicts between shareholders and managers. We show that the allocation of control over firms? reincorporation decisions determines the corporate governance choice ex ante and the outcome of the competition between legal regimes ex post. When managers have control over firms? reincorporation then competitive deregulation and ?runs to the bottom? ensue. When shareholders have partial or full control then there is diversity in governance structures. Runs to the bottom are not necessarily socially undesirable but they have a feedback effect on firms? choices of technologies that may make the party in control worse off ex ante. We show that it is impossible for any country to achieve social welfare maximization of its existing and new enterprises. With competition between legal regimes, start-up and mature companies incorporate in different jurisdictions even when reincorporation is correctly anticipated.