Berkeley Program in Law and Economics

Academics studying public firms' choice of governance arrangements have largely assumed that stock prices accurately reflect the effect of these arrangements on firm value. As a result, firms going public generally have an incentive to seek arrangements that maximize shareholder value, and states seeking incorporations have an incentive to offer such arrangements. Oddly, this literature has ignored the considerable evidence that stock prices are frequently "noisy" -- deviating significantly from fundamental value. This Article systematically analyzes the effect of noisy stock prices on firms' choice of governance arrangements. It demonstrates that stock price noisiness leads firms to seek - and states to offer -- arrangements with a current-owner bias - that is, arrangements favoring both insiders and current public shareholders at the expense of future public shareholders and long-term corporate value. Current-owner bias can explain many features of (and gaps in) state corporate law as well as the governance arrangements chosen by public firms. The problem of current-owner bias also has important normative implications for the desirability of the market for corporate charters, the proper relationship between mandatory federal securities regulation and state corporate law, and the wisdom of recent proposals to "empower" firms to choose their own securities regime.