Corporate Inversions and the Unbundling of Regulatory Competition

Several US public companies have recently executed “tax inversions” – acquisitions that move a corporation’s residency abroad while maintaining its listing in domestic securities markets. When appropriately structured, inversions replace American with foreign tax treatment of extraterritorial earnings, often at far lower effective rates. Regulators and politicians have decried the “inversionitis” pandemic, with many championing radical tax reforms. This paper questions the prudence of such extreme responses, both on practical and on conceptual grounds. Practically, I argue that inversions are simply not a viable strategy for many firms, and thus the ongoing wave may abate naturally (or with comparatively modest tax reforms). Conceptually, I assess the inversion trend through the lens of regulatory competition theory, in which jurisdictions compete not only in tax policy, but also along other dimensions, such as the quality of their company law. I argue that just as US companies have a strong aversion to high tax rates, they have an affinity for robust corporate governance rules, a traditional strength of American corporate law. This affinity has historically given the US sufficient market power to impose tax premiums with little fear of chasing off incorporations, because US law has traditionally bundled tax residency and state corporate law into a conjoined regulatory package. To the extent this market power remains durable, I show that radical tax overhauls would be unhelpful (and even counterproductive). An analogously blameworthy culprit for inversionitis, I argue, can be found in an inconspicuous source: Securities Law. Over the last fifteen years, federal law has progressively suffused national securities regulations with mandates relating to internal corporate governance matters – a traditional domain of state law. Those federal mandates, in turn, have displaced and/or preempted state law as a primary source of governance regulation for US-traded issuers. And, because US securities law applies to all listed issuers (regardless of tax residence), this displacement has gradually “unbundled” domestic tax law from corporate governance, eroding the US’s market power in regulatory competition. An effective elixir for this erosion, then, may also lie in securities regulation. I propose two alternative reform paths: either (a) domestic exchanges should charge listed foreign issuers for their consumption of federal corporate governance policies; or (b) federal law should cede corporate governance back to the states by rolling back many of the governance mandates promulgated over the last fifteen years. Rosalinde & Arthur Gilbert Foundation Professor of Law, Business and the Economy, UC Berkeley. Email: etalley@law.berkeley.edu. Many thanks to Scott Altman, John Armour, Alan Auerbach, Joe Bankman, Bobby Bartlett, Victor Fleischer, Andrew Hayashi, Ed Kleinbard, Julia Mahoney, Ruth Mason, Alex Raskolnikov, Roberta Romano, Steven Davidoff Solomon, Leo Strine, and seminar participants at USC, Universidad de Chile, University of Virginia, and the Chinese University of Hong Kong for helpful comments and discussions. Samantha Strimling provided excellent research assistance. All errors are mine. Corporate Inversions and the Unbundling of Regulatory Competition (E. Talley)