Can Musk Dethrone Delaware as the Reigning Business-Friendly State?
If the 2024 election has taught us anything about the balance of power in the worlds of business and politics, it is that one man has risen to a new height of influence in both: Elon Musk. At times, it seems as if Musk’s influence knows no bounds. Everything from government efficiency to international relations seems to fall under his purview. It begs the question, how weighty is the voice of Elon Musk? Following the Delaware Chancery Court’s rejection of his monumental pay package in January 2024, will Elon Musk’s reactionary decision to move Tesla’s incorporation from Delaware to Texas impact the latter’s status as a corporate haven? Chances are, Delaware’s position is less contentious than Musk and some of his peers may think.
Two things need to be clarified in order to make any headway in answering these questions: 1. Why is Delaware the belle of the ball, and 2. What prompted the move?
Why is Delaware the Belle of the Ball?
Delaware is the United States’ de facto incorporation state. Every day, over 600 companies register in Delaware, and, in fact, Tesla was formerly one of approximately 330 Fortune 500 companies incorporated in the state. This tendency is not a mere coincidence — it’s a strategic decision on the part of both the state and corporations to create an environment conducive to the business interests of large companies and high net worth entities. Delaware’s legal and regulatory institutions have manufactured conditions that are favorable for corporations. Corporations, in turn, have reinforced these conditions by continuing to anchor themselves to the state. In return for its loyalty to big business, Delaware receives franchise taxes, incorporation fees and a robust legal and financial services industry drawing in corporate lawyers and financial institutions that serve the many companies incorporated in the state.
Delaware’s pro-business position is constructed of three key entities that provide multi-layered incentives to the individual and corporate entities who do business in the state. The first and perhaps most prominent facet is the Delaware Chancery Court, accompanied by the Delaware corporate code and the Division of Corporations.
The Chancery Court
The Court of Chancery stands as perhaps Delaware’s most compelling selling point for corporations. As a specialized court dealing exclusively with business disputes, it offers corporations something unique in the American judicial landscape. The court’s judges are widely regarded as experts in corporate law, and their written opinions have built up a rich body of predictable case law that businesses purport to reliably follow. The court also has a notable absence of jury trials. For corporations, bench trials eliminate the uncertainty associated with lay jurors understanding and coming to verdicts regarding complex business matters. Perhaps most significantly, the court’s adherence to the “business judgment rule” is a significant liability shield for corporate leaders. Under this principle, as long as corporate leaders act in good faith, with due care and without conflicts of interest, the court will refrain from challenging their decisions, even if those decisions result in poor outcomes.
The Delaware Corporate Code
The Delaware Corporate Code, formally known as the General Corporation Law (DGCL), represents another crucial advantage. What sets Delaware’s corporate code apart is not just its content, but how it is created and maintained. For over half a century, a council of 27 specialized lawyers have been the keepers of this code, crafting regulations that are then rubber-stamped by the state legislature. While the lack of oversight might raise eyebrows, it provides something businesses value enormously: stability and predictability. Unlike other states where corporate laws can fall victim to partisan politics or hasty rulemaking, Delaware’s approach ensures that changes to corporate law are measured, deliberate and focused on maintaining the state’s business-friendly environment.
The Division of Corporations
The Division of Corporations completes Delaware’s triumvirate of business-friendly institutions by providing administrative efficiency in addition to the predictability and stability offered by the courts and code. Operating fifteen hours daily until the clock hits 12:00 a.m., the Division offers an optimized approach to filing that can establish a new corporation in as little as thirty minutes if new corporations are willing to shell out expediting fees. The Division of Corporations is famous for catering to every beck and call of the corporations it does business with—going so far as to gain internationally recognized certifications for their customer-focused approach, managerial prowess and streamlined process.
The synergy between these three institutions creates a self-reinforcing cycle. The Chancery Court provides legal certainty and protection for management, the Corporate Code offers stability and flexibility and the Division of Corporations ensures smooth administrative operations. Together, they create an environment where businesses can operate with minimal friction and maximal predictability.
Interestingly, Delaware maintains this business-friendly environment while having one of the highest corporate income tax rates in the nation at 8.7%. This high rate actually serves a dual purpose: it discourages companies from physically locating in the state while also helping Delaware counter accusations of being a tax haven for the wealthy. The state’s real revenue comes from incorporation fees and franchise taxes in large volumes. Incorporation fees are the one-time cost of registering a business while franchise taxes are paid annually by companies to continue doing business in Delaware. In 2023, the franchise tax alone accounted for $2.39 billion in tax revenue — over ⅓ of Delaware’s total tax revenue for the year. This fosters a mutually beneficial arrangement where companies get legal and administrative benefits while Delaware receives steady income without the burden of physically hosting these corporations.
Delaware’s complex interplay of institutions demonstrates why its position as America’s corporate capital is unlikely to be challenged successfully by other states. While individual elements of Delaware’s system might be replicable, the combined effect of its three key institutions, backed by decades of expertise and precedent, creates a unique value proposition that continues to attract businesses from around the world.
What Prompted Musk to Leave Delaware?
This brings us directly to the second question. If Delaware is so fantastic for corporations, what would be a compelling enough reason to move? Elon Musk’s infamous battle with Delaware might have finally come to a head in February of 2024, but the impetus for the entire conflict actually began in 2018. In 2018, Tesla’s board of directors approved a blockbuster compensation plan absolutely incomparable in size to any other in the public markets to date. As noted in the post-trial decision in the case of Tornetta v. Musk, this pay package was “250 times larger than the contemporaneous median peer compensation plan and over 33 times larger than the plan’s closest comparison, which was Musk’s prior compensation plan.” The board structured the plan so that Musk would receive 12 tranches, or segments, of stock over the subsequent decade. Each tranche was worth 1% of Tesla’s total outstanding shares, making the total worth of the proposed pay package approximately $2.6 billion at the time it was issued. But Musk’s stock-to-be came with one key caveat: each tranche would only vest if Tesla met specific market cap and revenue targets under Musk’s leadership. If all conditions were met, the 12 tranches of stock could reach a maximum future value of $55.8 billion. At first glance this seems like a relatively straightforward form of compensation. Think of it like the goliath of performance-based bonuses. Grow the company, enrich shareholders, and the board will reward you in turn. One shareholder didn’t seem to agree.
Richard Tornetta took issue with the board’s proposed package, subsequently filing a lawsuit alleging that the compensation plan was both excessive and a breach of fiduciary duty by Tesla’s board of directors. The lawsuit alleged that the plan unfairly benefited Musk, a controlling shareholder, at the expense of Tesla and its minority shareholders. The meat of the trial revolved around the standard of review the court applies when evaluating Musk’s compensation plan. Essentially, how much scrutiny does the plan necessitate, and who bears the burden of proof to demonstrate the fairness of the plan?
Tornetta’s lawyers argued in favor of the entire fairness standard. Simply, this standard applies in cases where a controlling shareholder is involved in a transaction and therefore arguably has an opportunity to unfairly influence the transaction in their favor. This particular standard dictates that the defendant—in this case, Musk—has the burden of proof to demonstrate that the transaction was entirely fair to both the corporation and its minority shareholders. Musk and his lawyers had a two pronged burden of proof. The first prong, fair dealing, requires the defendant to prove the fairness of the process of putting together the pay package—structuring, negotiation, etc. The second prong, fair price, requires the defendant to demonstrate that the proposed compensation reflects a fair valuation.
On January 30, 2024 the Delaware Court of Chancery ruled against Musk. Elon Musk posted on X: “Never incorporate your company in the state of Delaware.” Crucially, the court ruled that he was in fact a controlling shareholder and, as a result, the entire fairness standard, including the two prongs of fair dealing and fair price, did apply. In regard to first prong, the court noted that Musk had extensive influence over the negotiation process, the board did not adequately consider alternative options and the plan was not benchmarked against comparable compensation plans. Meanwhile, in regard to the second prong, the court also found an absence of any market-based evidence to justify the proposed compensation, and that the defendants failed to prove that the plan was necessary to retain Musk or to achieve Tesla’s goals.
Notably, up until January 30, the story of this case revolved around salary and board independence. Musk himself wrote, “I recommend incorporating in Nevada or Texas if you prefer shareholders to decide matters.” But in saying this, Musk implicitly signaled an argument that has grown in popularity since: Delaware is not shareholder friendly and not business friendly. On January 31, that sentiment became all the more obvious. Musk posted a poll on his social media platform, X: “Should Tesla change its state of incorporation to Texas, home of its physical headquarters?” 1,102,554 votes later he had an answer, with 87% saying yes. On June 14, 2024, after a shareholder vote, Musk officially shifted Tesla’s incorporation from Delaware to Texas. The same day, 72% of Tesla shareholders also voted to reapprove Musk’s compensation package, sending the case back to the Delaware Chancery Court to be adjudicated. Delaware retained jurisdiction over the dispute because the lawsuit was filed in the state of Tesla’s original incorporation.
Chancellor McCormick rejected the reapproved package once again on December 2, 2024. Musk and his lawyers, in an attempt to prompt a revision of the original ruling, brought an identical pay package back to Tesla stockholders for review. Their argument relied on a common law ratification defense—the premise of which is that if stockholders vote to ratify the pay package, their action would remedy the original conflict of interest. Chancellor McCormick cited “four fatal flaws” in this approach. First, Musk and his lawyers used the re-review and ratification of the original pay package as evidence, but evidence created after an unfavorable post-trial decision to reverse the outcome is inadmissible. Second, the common-law ratification defense was made after the original post-trial decision had been rendered and thus was deemed untimely and inapplicable. Third, while the stockholders voted to approve the alleged unfair transaction, their vote does not immediately make that transaction legally valid. Finally, even if the stockholder vote could legally validate this transaction, stockholders were provided with misleading or incorrect information prior to this specific vote. Musk characterized the decision as “[l]awfare,” stating that “[s]hareholders should control company votes, not judges” in a post on X.
The decision sparked outrage from other key figures in Silicon Valley as well. Startup accelerator company Y-Combinator co-founder Paul Graham mused on X: “It used to be automatic for startups to incorporate in Delaware. That will stop being that case if activist judges start overruling shareholders.” Graham also suggested that startups should consider reincorporating in Nevada. The Valley seems to see this as a dramatic overreach of judicial power and a devaluation of shareholder decisions, but the mass-exodus Musk and his contemporaries are alluding to has yet to happen.
The Big Picture
Unequivocally there has been a decrease in business entity formations in the last two years. In 2022, 313,650 business entities were formed in Delaware. In 2023 that number decreased by about 5%. But it is highly likely that this trend is likely related to other key economic factors, such as the tightening of venture capital funding and the subsequent slowdown in the startup world. High interest rates in 2023 and 2024, even amidst the gradual rate cuts in 2024, may have also fostered a hostile environment for nascent companies seeking debt financing. It may be true that other states—such as Nevada and Texas—are building business-friendly environments in the interest of competing with Delaware, but the new era of corporate governance that Musk seems to be gunning for seems far away.
While Musk’s dramatic departure from Delaware may have sparked conversations about alternative incorporation destinations, the reality remains far more nuanced than a simple suggestion of future migration. Delaware’s supremacy in corporate law isn’t merely a function of narrow and specific actions taken by its current institutions. Rather, it is the product of centuries of careful cultivation. The gestalt of Delaware’s regulatory ecosystem is greater than the sum of its parts. States like Texas and Nevada may emulate individual aspects of Delaware’s framework, but they lack the deep institutional memory, the vast body of precedential corporate case law and the intricate interplay between courts, legislation and administration that makes Delaware unique. One case alone cannot undo the Chancery Court’s 232 plus years of corporate jurisprudence. Such depth cannot be replicated overnight, much less in a matter of months, years or decades. While Musk’s influence in both business and politics is undeniable, it is unlikely he will be the straw to break the proverbial camel’s back. The upheaval that Musk seeks requires a much greater and long-term push against the structural advantages Delaware has built over generations. Any significant shift in America’s corporate landscape would necessitate more than a call to action from a single disgruntled influential figure, no matter their prominence nor their company’s market cap.
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