Who Does Delaware Tax Favor?

For its corporate law and related services, companies pay Delaware an annual franchise tax that adds up to about 20 percent of the state’s annual revenue. It has long been argued that these payments give Delaware incentives to provide corporate law that maximizes shareholder value.

An article, authored by Michal Barzuza of the University of Virginia School of Law, argues otherwise. The structure of the tax is "not optimally designed to provide Delaware with incentives to maximize shareholder value," Barzuza writes. "Nor does the current tax provide Delaware with incentives to improve corporate governance terms that correlate significantly with firm value, such as staggered boards or liability protection for directors and officers," she argues, even if improving them could result in an increase of several percentage points, or hundreds of billions of dollars, to the value of Delaware’s firms.

Because its tax is not tied to firm performance, even those corporate law amendments that could increase firm value significantly would not increase the amount of tax per firm that Delaware would generate. And since they may antagonize some managers, resulting in some firms reincorporating outside the state, Delaware could even lose revenue from adopting them.

The paper argues that adding a tax component based on changes to corporate value or income on top of the current tax would improve the current system. It would align Delaware’s incentives with those of shareholders and induce it to offer corporate law that maximizes shareholder value.

To read the entire paper, click here.