Developing Two‐tiered Regulatory Competition in EU Corporate Law: Assessing the Impact of the Societas Privata Europaea
| Date | 01 March 2014 |
| Author | Martina Eckardt,Wolfgang Kerber |
| Published date | 01 March 2014 |
| DOI | http://doi.org/10.1111/j.1467-6478.2014.00660.x |
JOURNAL OF LAW AND SOCIETY
VOLUME 41, NUMBER 1, MARCH 2014
ISSN: 0263-323X, pp. 152±71
Developing Two-tiered Regulatory Competition in
EU Corporate Law: Assessing the Impact of the
Societas Privata Europaea
Martina Eckardt* and Wolfgang Kerber**
Since the Centros ruling in 1999, Europe has evolved a two-tiered
system of corporate laws. This opens up the possibility of some
horizontal regulatory competition between the corporate laws of the
member states. Following a draft regulation on the European Private
Company (SPE), an additional legal form tailored to the needs of small
and medium-sized enterprises (SMEs) is being proposed. We analyse
whether such a supranational European legal form can be recom-
mended from the perspective of the economic theory of legal
federalism. We present a general theoretical framework for studying
centralization/harmonization versus the decentralization of legal rules
and regulations in regard to corporate law in the EU. Our analysis of
the empirical evidence on horizontal regulatory competition and the
advantages or disadvantages of such an additional legal form for
SMEs shows clearly that it might render many benefits, compared with
the existing situation of only (partial) horizontal competition.
INTRODUCTION
Some 20.7 million small- and medium-sized enterprises (SMEs) in the EU
account for 99.8 per cent of all the companies established in the EU. These
SMEs employ 67 per cent of the workforce and provide nearly 60 per cent of
152
*Andra
Âssy University Budapest, Pollack Miha
Âly te
Âr 3., H-1088 Budapest,
Hungary
martina.eckardt@andrassyuni.hu
** University of Marburg, Am Plan 2, 35032 Marburg, Germany
kerber@wiwi.uni-marburg.de
The authors thank the editors of the Journal of Law and Society for valuable comments
and suggestions. An earlier version of this article is part of the Festschrift for the
seventieth birthday of Christian Kirchner, Humboldt University, Berlin: W. Kaal, M.
Schmidt, and A. Schwartze (eds.), Festschrift zu Ehren von Christian Kirchner Recht im
o
Èkonomischen Kontext (2014).
ß2014 The Author. Journal of Law and Society ß2014 Cardiff University Law School
the gross value added.
1
Unsurprisingly, given their importance to the single
market, SMEs are on the political agenda at EU level. The Small Business
Act, implemented in 2008, identified a number of obstacles for SMEs and
introduced an Action Plan, which was revised in 2012.
2
One of the key
proposed initiatives was the introduction of the European Private Company
(Societas Privata Europaea, `SPE'). The intention of the SPE was that it
should complement already existing supranational legal forms like the Euro-
pean Economic Interest Grouping (`EEIG') introduced in 1985, the European
Company (Societas Europaea, `SE') introduced in 2001, and the European
Cooperative Society (Societas Cooperativa Europaea, `SCE') introduced in
2003 as a private cooperative company with a legal personality.
The SPE's particular advantage is that it is tailored to the needs of SMEs
doing business internationally throughout the EU single market. Some 40 per
cent of SMEs are involved in import, export or foreign direct investment.
3
Additionally, on average, about 2 per cent of all SMEs in the EU invest
abroad, which amounts to around 500,000 enterprises.
4
However due to their
size, SMEs have additional challenges when doing business abroad. It was
these challenges that the SPE was designed to address. However, the process
of introducing the SPE has come to a standstill. No agreement could be
reached on a draft regulation of the SPE during the Hungarian Council
Presidency in 2011, although most of the points of disagreement between the
different actors involved had been successfully removed by that point.
5
The
EU Commission no longer sees completing the SPE legislation as a priority
in its revised Action Plan, but instead intends to explore other possibilities
for facilitating the cross-border activities of SMEs.
6
The question we focus on in this article is whether the introduction of an
additional European legal form for limited liability companies is legitimate
153
1
P. Wymenga, V. Spanikova, A. Barker, J. Konings, and E. Canton, EU SMEs in 2012: at
the Crossroads. Annual Report on Small and Medium-sized Enterprises in the EU, 2011/
12 (2012) 15, at ies/sme/facts-figures-analysis/
performance-review/files/supporting-documents/2012/annual-report_en.pdf>.
2 European Commission, ```Think Small First'' ± A ``Small Business Act'' for Europe'
(COM(2008) 394 final); European Commission, `Action Plan: European Company
Law and Corporate Governance ± a Modern Legal Framework for More Engaged
Shareholders and Sustainable Companies' (COM(2012) 740 final), at
lex.europa.eu/LexUriServ/LexUriServ.do?uri=COM:2012:0740:FIN:EN:PDF>.
3 European Commission, Internationalisation of European SMEs ± Final Report
(2010) 4 6, at tp://e c.euro pa.eu/ enterp rise/ polici es/sme /marke t-acce ss/fil es/
internationalisation_of_ european_smes_final_en.pdf>.
4 id., p. 10.
5 For details, see the papers in The European Private Company ± Societas Privata
Europaea (SPE), eds. H. Hirte and C. Teichmann (2013), especially P. Hommelhoff
and C. Teichmann, `Societas Privata Europaea (SPE) ± General Report' 1. See, also,
R. Lewis and A. Buzdrev, `The European Private Company: Entrepreneurial Flexi-
bility and the Practicalities of National Law' (2012) 3 International J. of Business and
Social Science 63.
6 European Commission, op. cit., n. 2, pp. 12 ff.
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from the perspective of the economic theory of legal federalism. To this end,
we analyse the current situation which, after Centros in 1999
7
and the cases
that followed it, already facilitates some degree of horizontal regulatory
competition between national legal forms. Based upon these results, we ask
what the advantages and disadvantages of an additional legal form at the EU
level will be. Our emphasis thus is less on a discussion of the specific pros
and cons of the draft statute of the European Private Company. It is focused
on the more fundamental question of whether introducing an additional
European form of a limited liability company makes sense at all, given that
there is already a certain free choice of legal forms from different countries
through the effect of decisions of the European Court of Justice (ECJ) based
on freedom of establishment treaty provisions.
This article is structured as follows: in the second section we present a
general theoretical framework for analysing the problem of centralization/
harmonization versus decentralization of legal rules and regulations in regard
to corporate laws within the European Union. This includes the possibilities
of horizontal and vertical regulatory competition in a two-tiered legal
system. As such, it provides a clear framework for assessing the potential
impact of this proposal. The third section analyses the results of empirical
studies about the extent of horizontal regulatory competition which we
already experience in regard to legal forms of limited liability companies
within the EU. Based upon these results, the fourth section analyses the
possible benefits but also problems of the introduction of such an additional
European legal form. The last section concludes that based on our analysis
the introduction of an additional legal form for SMEs might render many
benefits without considerable disadvantages when compared with the
existing situation of only (partial) horizontal competition between the legal
forms of the member states.
A TWO-TIERED SYSTEM OF CORPORATE LAWS
Companies are characterized by one or more persons pooling their assets
with the ultimate objective of gaining a profit from joint production. This
implies a common-pool problem. Decision-making rights and control mech-
anisms are necessary to coordinate the joint use of the pooled assets and the
resulting profits (or losses). Asymmetric information and principal-agent
problems between the company owners and its other stakeholders (like
creditors, employees, management, and so on) lead to moral hazard and
adverse selection problems. Due to contingencies and general uncertainty,
the writing of complete contracts is prohibitively costly. Accordingly, cor-
porate laws offer different legal forms with special property rights, decision-
154
7Centros Ltd v. Erhvervs- og Selskabsstyrelsen (Case C-212/97) 9 March 1999.
ß2014 The Author. Journal of Law and Society ß2014 Cardiff University Law School
making rules, and information and disclosure rights to mitigate the resulting
governance problems. Thus, it contributes to reducing the agency and
transaction costs of team production.
8
By choosing a legal form, firms can choose between different sets of rules
for their governance. Different legal forms (as, for example, public limited
liability companies, private limited liability companies, and so on) offer
appropriate solutions for different kinds of companies and their needs.
Corporate laws can be described as a combination of a set of mandatory rules
and facilitative law. Mandatory rules are necessary to deal with market
failure problems and the need to achieve further objectives. This is the
regulatory dimension of corporate law rules. However, company law at its
core is primarily a facilitative law. In that respect, it usually provides a broad
legal scope for designing the constitutions of firms, but also offer a set of
default rules for standard solutions. Within the EU, all member states offer
sets of different legal forms with a combination of mandatory rules and
facilitative law. Due to different legal traditions, there has been a wide
variety of these national legal forms. This holds especially true for the
specific private limited liability companies legal forms for SMEs, that we are
dealing with in this article.
Although there is some consensus from an economic perspective about the
most efficient legal solutions in regard to a number of firm-related issues,
other key questions have not found a satisfactory answer yet.
9
This is because
in many or indeed most jurisdictions there are additional objectives pursued
by corporate law other than economic efficiency. The experience of serious
failures in corporate governance over time indicates that so far, we have not
yet developed optimal legal rules for companies. In our view, regulatory
competition might be an important mechanism that could contribute to the
development of better legal solutions for the governance of firms.
10
To analyse the advantages and disadvantages of an additional supra-
national European legal form for SMEs, we use the theoretical framework of
legal federalism. It allows for legal rules on different levels of a multi-tiered
system of jurisdictions. It analyses the optimal vertical allocation of
regulatory and facilitative law within such a multi-tiered system of law from
an economic perspective. In the following, we apply the framework of a two-
tiered system of corporate laws for SMEs, that is, that both the member
155
8 A.A. Alchian and H. Demsetz, `Production, Information Costs, and Economic
Organization' (1972) 62 Am. Economic Rev. 777; J. Armour, H. Hansmann, and R.
Kraakman, `What is Corporate Law?' in The Anatomy of Corporate Law. A
Comparative and Functional Approach, eds. R. Kraakman et al. (2009, 2nd edn.) 1;
M. Eckardt, `Der Einfluss der Unternehmensrechtsform auf die Internationalisierung
von kleinen und mittleren Unternehmen' in Der Donauraum in Europa,Andrassy
Studien zur Europaforschung, Vol. 1, eds. E. Bos et al. (2012) 125.
9 Kraakman et al., id.
10 K. Heine and W. Kerber, `European Corporate Laws, Regulatory Competition and
Path Dependence' (2002) 13 European J. of Law and Economics 43.
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states and the EU can provide legal forms for SMEs. In doing so,
competence rules are very important for such a two-tiered system of legal
rules. They determine to what extent firms can choose between the corporate
laws and the legal forms they provide within this two-tiered system (choice
of law by firms). Additionally they determine how problems are solved in
the case of conflicts between different corporate laws (conflict of laws rules;
jurisdictional issues). These rules are essential for the working of the entire
two-tiered system, because they decide on the possibility and extent of
horizontal and vertical regulatory competition between different legal forms
for SMEs.
The economic theory of legal federalism offers a number of criteria for
assessing what the optimal degree of centralization or decentralization of
legal rules should be.
11
These criteria run as follows:
(i) One group refers to different types of costs, like static economies of
scale, information and transaction costs, externalities, costs through
inconsistencies of the legal order and through distortions of competition
(barriers to trade), which usually tend to favour a centralized provision
of legal rules.
(ii) Heterogeneity between member states in regard to the problems that are
solved by corporate laws as well as to different objectives (preferences)
supports arguments for more decentralization.
(iii) Decentralized knowledge as well as the need for innovation and
adaptability of corporate law solutions are important arguments for a
decentralized provision and for experimentation with company laws.
(iv) Political economy problems (rent-seeking behaviour as well as high
political transaction costs) provide arguments both for centralized and
decentralized solutions.
(v) Strong legal traditions with long-established corporate law solutions in
the member states lead to powerful path-dependence arguments and
point to the necessity to take into account the historical status quo
favouring the established decentralized legal forms.
(vi) Assessing the advantages and disadvantages of possible regulatory
competition processes, which might be triggered within a decentralized
system, also provides essential informati on for deciding between
centralized and decentralized solutions.
In the United States, state-level corporate law has provided one of the
most important examples of regulatory competition, which also triggered the
first controversy regarding whether such competition entails beneficial or
156
11 R. Van den Bergh, `Towards an Institutional Legal Framework for Regulatory
Competition in Europe' (2000) 53 Kyklos 435; W. Kerber, `European System of
Private Laws: An Economic Perspective' in The Making of European Private Law,
eds. F. Cafaggi and H. Muir Watt (2008) 64.
ß2014 The Author. Journal of Law and Society ß2014 Cardiff University Law School
harmful results.
12
In the ensuing general discussion, it turned out that, on the
one hand, regulatory competition can lead to better regulations through
enhancing efficiency, faster adaptation, and more innovations of legal rules
as well as less negative welfare effects through rent seeking. However, these
potential advantages can be counterbalanced by a number of negative
effects. The most important ones are higher information and transaction
costs as well as race-to-the-bottom problems, which might lead to a too low
level of regulations, especially in regard to the mandatory dimension of legal
rules. Another problem is that a dynamic process of regulatory competition
might not emerge at all, for instance, because of a lack of sufficient
incentives for politicians or jurisdictions to engage in it. The overall result of
both the theoretical and empirical research on regulatory competition is that
it depends on the particular field of law and a number of specific circum-
stances whether, on balance, regulatory competition will have positive
effects or not.
13
An important additional insight is that the institutional
framework under which regulatory competition takes place has a crucial
influence on what kind of regulatory competition emerges and what its
overall outcome is. Choice-of-law and conflict-of-law rules as well as rules
governing the mobility of firms are of utmost importance in this respect.
14
Three main types of allocation of regulatory powers can be derived from
the empirical experience with two-tiered regula tory systems like the
European Union, as well as from theoretical analysis. To some extent these
pure types can be combined and mixed, leading to hybrid forms. In the
following, we present these types in regard to company law and discuss their
main characteristics.
Full harmonization or perfect centralization (type 1) of corporate laws is
the simplest form. It implies that only one uniform set of legal forms for firms
exists for all member states in the EU. SMEs would not be able to choose
between the different legal forms for private limited liability companies from
different member states. However, they would be able to use the same legal
form throughout the whole EU. In addition to that, the same mandatory rules
would apply to all SMEs within the EU. In this way, any regulatory
competition would be eliminated. An analysis based on the theory of legal
federalism would show a number of advantages, but also large problems in
comparison to more decentralized solutions. Harmonization has been the
dominant form in a number of other legal fields in the EU, for example, in
157
12 L Bebchuk, `Federalism and the Corporation: The Desirable Limits on State
Competition in Corporate Law' (1992) 105 Columbia Law Rev. 1435; R. Romano,
The Genius of American Corporate Law (1993).
13 J.-M. Sun and J Pelkmans, `Regulatory Competition in the Single Market' (1995) 33
J. of Common Market Studies 67; K. Heine, Regulierungswettbewerb im Gesell-
schaftsrecht. Zur Funktionsfa
Èhigkeit eines Wettbewerbs der Rechtsordnungen im
europa
Èischen Gesellschaftsrecht (2003); Kerber, op. cit., n. 11.
14 H. Muir Watt `Choice of Law in Integrated and Interconnected Markets: A Matter of
Political Economy', (2003) 9 Columbia J. of European Law 383; Kerber, id.
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large parts of consumer law. In respect of corporate laws, however, a full
harmonization or centralization approach seems unrealistic in the foreseeable
future due to the significant variety present in existing corporate laws.
Apure decentralization approach without direct regulatory competition
(type 2) is one of the opposite types. SMEs would only be able to choose from
corporate laws at the member state level; at the same time, however, they
would have to be established according to the corporate law of the member
state in which they were doing business. If a firm wants to be recognized as a
legal entity in another member state, it has to establish there in one of the
member states' legal forms. This means (i) that a firm cannot migrate with its
legal form to another member state, and (ii) that there is no direct freedom of
choice of corporate laws between member states. Therefore, there is no direct
regulatory competition between these laws. However, that is not the full
picture: investors are free to choose in which member state they want to
establish their firm (mobility of capital) and do business and, as such, there is
still some indirect regulatory competition between different corporate laws
through locational (that is, inter-jurisdictional) competition. In this case
investors can only choose between a whole package of public goods,
regulations, and taxes by choosing between different locations. Accordingly,
the competitive pressure in regard to the specific corporate law, for example,
for SMEs, is very weak. In other fields of regulation, this solution is well
known within the EU as the principle of the country of destination. Historic-
ally in corporate law, the conflict-of-laws rules have been the traditional `real
seat' or `incorporation' doctrines, which were prevalent in the EU until the
Centros d ecisio n in 1999 and s ubseque nt ruling s underm ined thei r
applicability and effect.
15
By doing so, the ECJ has taken a step, in the
context of corporate mobility, in the direction it took in the Cassis de Dijon
jurisprudence regarding the `country of destination' and `country of origin'
principles in respect of natural persons' mobility in the EU.
16
A pure decentralization approach combined with free choice of law and
direct regulatory competition (type 3) is the other, opposite type, compared
with a full harmonization approach. Here, too, only the member states offer
legal forms with limited liability for SMEs. But the firms can choose freely
between these national corporate laws. This implies (i) the freedom to
choose between all national corporate laws when starting a business, and
also (ii) the possibility of doing business with the legal form of one member
158
15 See, for example, Cartesio Oktato
Âe
Âs Szolga
Âltato
Âbt (Case C-210/06, 16 December
2008).
16 A. WisÂniewski and A. Opalski, `Companies' Freedom of Establishment after the ECJ
Cartesio Judgment' (2009) 10 European Business Organization Law Rev. 595. For a
more nuanced account of the complex legal situation in the EU in regard to corporate
law, see M. Schaper, Selektion und Kombination von Gesellschaftsformen im
institutionelle n Wettbewerb. Type nvermischung und h ybride Rechtsform en im
europa
Èischen und US-amerikanischen Wettbewerb der Gesellschaftsrechte (2012).
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state throughout the whole EU as well as to migrate with an already
established legal form to other member states. In its pure theoretical form,
this implies that all legal forms with limited liability for SMEs compete
directly with each other in the EU. The partial replacement of traditional
conflict of law rules in the EU through the jurisprudence of the ECJ can be
interpreted as a transition in the direction of this third main approach of pure
decentralization with free choice of law and direct regulatory competition.
This form is ± to a large extent ± practised in the United States, where only
the individual states offer corporate laws, while firms can choose between
these laws without being restricted as to where they do business within the
country. In the United States, empirical research in regard to competition
between corporate laws tends to support the advantages of regulatory
competition. Significantly, the evidence found does not support race-to-the-
bottom concerns.
17
Nevertheless, Europe is not the United States, and this
type of allocation of regulatory powers has raised concerns in the EU as to
whether the ensuing process of regulatory competition between corporate
laws from the member states might lead to a race-to-the-bottom problem.
In addition to these pure types of allocation of regulatory powers in a two-
tiered system of legal rules, there exist also hybrid forms. They are
combinations of the three pure types discussed so far.
Minimum harmonization constitutes an important group of such a hybrid
form. At the central level, minimum rules are established, which all legal
rules and regulations on member state level have to fulfil. Beyond these
minimum rules, member states are allowed to enact rules with higher
regulatory standards. In regard to corporate laws, this would imply that the
EU would enact certain minimum standards. If the standards of the minimum
rules are very high, then this solution is very close to full harmonization,
whereas very low minimum standards render such a solution very similar to
a pure decentralization approach. Such a minimum harmonization with the
possibility of stricter national standards can come in two variants. In the first,
the regulated entities have to comply with the stricter domestic regulations,
that is, this is a combination of harmonization (type 1) with decentralization
according to the host country principle (type 2). This would imply that the
member state can enforce its higher national standards within its territory,
because in regard to these rules no direct competition takes place. However,
there is also a second variant, which we can observe in other regulatory
fields in the EU (like, for example, product regulation). In this case member
states can enact higher regulatory standards in their national laws than the
EU minimum rules. However, due to the application of the home-country
rule, only domestic firms have to comply with these higher regulatory
standards, whereas firms from other member states need only comply with
their home-country rules. This leads to direct regulatory competition and
159
17 R. Romano, `Competition for State Corporation Law' in The New Palgrave
Dictionary of Economics and the Law, Vol. 1, ed. P. Newman (1998) 364.
ß2014 The Author. Journal of Law and Society ß2014 Cardiff University Law School
does not allow the particular member state to enforce its higher standards
within its own territory. This second variant of minimum harmonization is
therefore a combination of harmonization (type 1) with decentralization, free
choice of law and direct regulatory competition (type 3).
Partial harmonization is another hybrid form of harmonization and
decentralization, in which one part of the relevant legal rules for corporate
governance are harmonized, while other parts are left to the national
legislators. This might be an appropriate solution, if there are serious
concerns about race-to-the-bottom problems in regard to specific aspects of
corporate law without eliminating direct regulatory competition in regard to
all other rules of the respective legal form. Hybrid forms resulting from a
mixture of the two types of pure decentralization with and without free
choice of law (type 2 and type 3) are also possible: for example, in general,
firms might be free to choose between different legal forms with limited
liability from different member states and use them within the entire EU.
However, in respect of certain issues, for example, co-determination, they
have to comply with the domestic rules of the host country. As a result, in
regard to most aspects of corporate law, direct competition among the legal
forms from different member states is possible, with the exception of certain
explicitly defined issues. Other complex hybrid forms might be mixtures of
all three main types: one part of corporate law rules might be harmonized
(type 1), another part might be under direct competition through free choice
of law (type 3), whereas some governance issues require compliance with
the specific domestic rules of the host country (type 2).
So far, however, we have not taken into account the additional possibility
of choosing between corporate laws at the EU level and at the member state
level, leading to the possibility of vertical regulatory competition. In fact the
proposal of the SPE aims at such a solution. In addition to the 27 private
limited liability company statutes of the member states, firms would be able
to choose the SPE as an additional European option and use it within the
entire EU. In its pure form, without rules about minimum and partial
harmonization, the provision of such a European legal form is primarily only
the provision of a twenty-eighth legal form that competes with all the other
national legal forms. However, other examples of additional European
options for legal rules (such as optional European contract law rules) have
shown that a European provision of optional legal rules might lead to special
advantages, but also to specific problems, which can differ considerably
from those of a pure horizontal regulatory competition. Especially important
here are path-dependency problems and dangers of a monopolization of the
European solution in the long run.
18
160
18 Regarding vertical regulatory competition in corporate law, see K. RoÈ pke and K.
Heine, `Vertikaler Regulierungswettbewerb und europaÈischer Binnenmarkt ± die
EuropaÈische Aktiengesellschaft als supranationales Rechtsangebot' (2005) 56 Ordo
Yearbook of Economic and Social Order 157.
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Based upon such a theoretical framework with a two-tiered system of
corporate laws in the EU, the above mentioned economic assessment criteria
from the theory of legal federalism could be used for analysing which of
these different types and hybrid forms are optimal from an economic per-
spective, both with regard to the extent of centralization or decentralization
and to the extent and form of regulatory competition. The experience with
other fields of law shows that sophisticated combinations of centralized and
decentralized rules, with a perhaps limited degree of direct regulatory com-
petition, might be a particularly promising solution for dealing with the
manifold trade-offs between the advantages and problems of (de)centraliza-
tion and regulatory competition.
19
This article does not attempt such a
complex analysis in regard to limited liability corporate law, although this
could lead to valuable insights. In the following, we only analyse the
advantages and disadvantages of the introduction of a twenty-eighth legal
form for limited liability companies for SMEs, compared with the current
legal situation in which SMEs can already choose between the different legal
forms of the member states.
HORIZONTAL REGULATORY COMPETITION BETWEEN LIMITED
LIABILITY CORPORATE LAWS IN THE EU: THE EMPIRICAL
EVIDENCE
This section presents the available empirical knowledge about the extent and
intensity of the already existing horizontal regulatory competition between
the 27 different legal forms for private limited liability companies of the
member states. Since the Centros jurisprudence of the ECJ, free choice of
different legal forms, and therefore direct regulatory competition, has
become easier. This jurisprudence was therefore an important step from the
former pure decentralization approach without direct regulatory competition
(type 2) to the pure decentralization approach with direct regulatory
competition (type 3). The crucial question, however, is whether this has led
to a process of horizontal regulatory competition ± independent of the
question of its benefits or problems. In that respect, to what extent SMEs
with their specific problems respond to differences between the legal forms
of different member states, and whether member states have incentives to
compete for incorporations of companies by modifying their legal forms, has
to be analysed.
Kirchner et al. discuss different direct and indirect costs on the part of
companies which might decrease the potential for horizontal regulatory
161
19 For example, see W. Kerber and S. Grundmann, `An Optional European Contract
Law Code: Advantages and Disadvantages' (2006) 21 European J. of Law and
Economics 215, regarding the optional European contract law.
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competition in the EU.
20
The main types are mobility costs, switching costs,
and transaction costs. Costs resulting from different, that is, unfamiliar legal
and adjudication systems, as well as costs resulting from the need to
establish under a foreign language, are seen as additional factors potentially
decreasing the working of horizontal regulatory competition.
21
This holds in
particular when it comes to SMEs which are characterized by a general
shortage of managerial resources and are rather limited in their potential to
exploit scale economies. In addition to the costs of setting up a company
under a foreign legal system, the on-going costs of complying with a
member state's regulatory regime also have to be taken into account.
22
For a fully effective process of regulatory competition, it is also necessary
that member states strive to offer new or improved forms of corporate laws,
that is, at least some member states must have incentives to modify their
legal forms in order to attract additional companies to establish under their
rules. Franchise taxes paid by the companies to the respective state of
incorporation and successful lobbying by local lawyers specializing in
corporate law are key factors in the United States evidence.
23
However, in
the EU, such franchise taxes are prohibited and, so far, there is no empirical
evidence on the lobbying impact of law firms specialized in corporate law.
Nevertheless, we also observe in the EU a number of reforms of national
private limited liability corporate laws over the last few years, which may be
motivated by concerns about the international competitiveness of national
law.
24
Accordingly, for the time being, it is an open question as to what
exactly motivates member states to modify their legal forms so as to attract
both start-ups and companies incorporated under a `foreign' legal form to
establish under their corporate law regime.
162
20 C. Kirchner, R.W. Painter, and W. Kaal, `Regulatory Competition in EU Corporate
Law After Inspire Art: Unbundling Delaware's Product for Europe' (2005) 2
European Company and Financial Law Rev. 159.
21 J. Armour, `Who Should Make Corporate Law? EC Legislation Versus Regulatory
Competition' (2005) 58 Current Legal Problems 369; W. Bratton, J. McCahery, and
E. Vermeulen, `How Does Corporate Mobility Affect Lawmaking? A Comparative
Analysis' (2009) 57 Am. J. of Comparative Law 347; M. Gelter, `The Structure of
Regulatory Competition in European Corporate Law' (2005) 5 J. of Corporate Law
Studies 247; E. Kieninger, `The Legal Framework of Regulatory Competition Based
on Company Mobility: EU and US Compared' (2004) 6 German Law J. 741; L.
KloÈhn, `Supranationale Rechtsformen und vertikaler Wettbewerb der Gesetzgeber im
europaÈischen Gesellschaftsrecht. PlaÈdoyer fu
Èr ein marktimitierendes Rechtsform-
angebot der EU' (2012) 76 RabelsZ (Rabel J. of Comparative and International
Private Law) 276.
22 M. Becht, C. Mayer, and H. Wagner, `Where Do Firms Incorporate? Deregulation
and the Cost of Entry' (2008) 14 J. of Corporate Finance 241.
23 Bratton et al., op. cit., n. 21; Gelter, op. cit., n. 21; Kieninger, op. cit., n. 21; KloÈhn,
op. cit., n. 21.
24 See C. Teichmann, `Modernizing the GmbH: Germany's Move in Regulatory
Competition' (2010) 7 European Company Law 20 (regarding reforms of the German
GmbH).
ß2014 The Author. Journal of Law and Society ß2014 Cardiff University Law School
However, even if no dynamics are triggered on the supply side, it would
suffice if companies respond to the existing differences in legal form among
member states. By a pure selection effect, the average quality of the legal
forms in use in the EU would improve. If all SMEs choose those legal forms
which they deem best for them through free choice of law, the `market
shares' of the superior legal forms would increase and those of inferior ones
be reduced. In addition to that, through the combination of legal forms from
different member states, new hybrid forms of private company laws can
emerge. One prominent example is the Limited & Co. KG as a new
combination of the United Kingdom private company limited by shares with
the German Kommanditgesellschaft (`KG') as an alternative legal form to the
well-known German GmbH & Co. KG. The result is a new hybrid form,
which is different from both the German and the English form.
25
Such
inventions of new legal forms through the combination of several already
existing national forms is one possible outcome of horizontal regulatory
competition through pure choice by firms, which does not require any active
competition by the member states.
However, there is some evidence that member states do indeed compete
for companies to establish under their corporate law, for example, in regard
to minimum capital requirements. This is shown by the manifold differences
as well as changes in the minimum capital requirement (MCR) for private
limited liability companies within the EU.
26
In 2011 the average MCR was
¨7,000 with the median ¨3,000. However, in five countries only ¨1 has to be
paid as MCR, while the highest MCR is ¨35,000. Since 2003, MCRs have
been reduced in ten member states. In some ± like Austria ± such a reform is
currently on the political agenda. In addition, some countries have intro-
duced new legal forms for start-ups. For example, in 2009, Germany intro-
duced the Unternehmergesellschaft with a ¨1 MCR to supplement the
Gesellschaft mit beschra
Ènkter Haftung (GmbH), the German private limited
liability company, as a low-cost alternative for start-ups.
27
There is empirical evidence in the German context that companies indeed
react to cost differences resulting from differences in MCR when deciding in
which member state to establish. The MCR in Germany is ¨25,000, while the
British MCR and the German Unternehmergesellschaft MCR are only ¨1.
28
According to data from the German business register (Gewerberegister) from
2005 to 2012, on average 4,700 companies registered each year as a British
163
25 For a detailed analysis of its benefits and problems, see Schaper, op. cit., n. 16, pp.
268±303.
26 For details and additional references, see M. Eckardt, `The European Private
Company: Do We Need Another 28th Private Legal Form in the EU? On Regulatory
Com pet iti on o f Cor por at e Law ' (20 12) 2 0 Est ni sch e Ges pr a
Èche u
Èber
Wirtschaftspolitik 39.
27 Teichmann, op. cit., n. 24.
28 Eckardt, op. cit., n. 26.
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private company limited by shares in Germany, with a peak of 8,643 in 2006.
With the introduction of the German Unternehmergesellschaft, the number of
newly registered British private companies limited by shares dropped
significantly by 38 per cent from 2008 to 2009, with a further decreasing
tendency from 2010±12. Compared to that, the Unternehmergesellschaft has
proved to be a success. In 2012 only 1,496 companies registered as British
private companies limited by shares, which is only about one third of its
average between 2005 and 2012. In contrast to that, 15,344 businesses
registered as an Unternehmergesellschaft, which amounts to 17 per cent of all
companies newly registered as a GmbH.
29
Bratton et al. have found similar
evidence present for the Netherlands, where companies reacted to the
relatively high MCR of ¨18,000 in a similar way.
30
In addition to reductions in MCR in recent years, member states have also
been concerned with reducing other costs resulting from their legal forms as
well as administrative procedures for start-ups. Between 2007 and 2012 the
overall costs of starting a new business changed in 16 of the 27 member
states, declining by 27 per cent from an average of ¨485 to ¨353. Over the
same period, the time required for performing all the necessary admini-
strative tasks of establishing a company (that is, of setting up a new legal
entity) declined by 52 per cent from 11 to 5 days on average. This is due to
reforms undertaken by 15 of the 27 member states.
31
These reforms might be
motivated at least in part through the raised awareness of these cost issues
for SME brought about by the Small Business Act.
32
There is also some econometric evidence available confirming these
descriptive findings. Becht et al. analyse whether the ECJ's decisions on
freedom of establishment for companies indeed led to a migration of com-
panies to member states with lower costs of establishing.
33
They use a data
set of all limited liability companies newly established in the United
Kingdom between 1997 and 2005, based on the central business register.
With the information available, they distinguish between domestic Ltds and
non-domestic Ltds, the latter being companies which are established under
United Kingdom corporate law as Ltds, but intended to have their principal
place of business outside the United Kingdom. As a proxy for classifying
such non-domestic Ltds they use the state of residence of a company's
164
29 For more details, see M. Eckardt, `The Societas Privata Europaea (SPE) ± Could it
Promote the Internationalization of SMEs?', AndraÂssy Working Paper no. 27 (2012),
at .
30 Bratton, op. cit., n. 21.
31 Own calculations based on data from European Commission, `2007 Country by
Country assessment ± overview table', at
sme/files/support_measures/start-ups/onestop2006_en.pdf> and `2012 Country by
Country assessment ± overview table', at
sme/business-environment/files/2012-country-fiches_en.pdf>.
32 European Commission, op. cit. (2008), n. 2.
33 Becht et al., op. cit., n. 22.
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directors. In this way, they get a sample of 2.14 million limited liability
companies, with 78,000 non-domestic firms established between 1997 and
2005 in the United Kingdom. One third of these are German limited com-
panies, that is, they have directors residing in Germany. By applying
difference-in-difference tests they find that after Centros there was a signifi-
cantly stronger inflow of establishments from other EU member states than
from non-EU member states in the United Kingdom. Additionally, there was
a significantly higher number of establishments from EU member states with
high setting-up costs, particularly in respect of MCR. Thus, according to
Becht et al., horizontal regulatory competition is operating in the EU.
34
A similar series of studies by Hornuf and Braun et al. confirm these
trends.
35
They used a difference-in-difference approach for analysing the
causal impact resulting from reforms in statutory rules concerning minimum
capital requirements. Their studies take into account reforms in France,
Germany, Hungary, Poland, and Spain between 2003 and 2008. Applying the
same methodology as Becht et al.,
36
they found that a reduction in minimum
capital requirements leads to a significant increase in new establishments in
the respective country.
Econometric studies for the United States confirm the finding that the cost
of establishment matters. By using ordinary least squares, HaÈusermann found
that differences in establishment fees between states in the United States
significantly affect the number of limited liability companies found in a
state.
37
His study uses state-level data from 2004 to 2009. In addition, there
is some, but not uniform, evidence that differences in substantive law and in
adjudication also play a role for SMEs in where to establish, as is the case for
publicly-held companies.
38
Gevurtz analysed the motives a company has for
choosing a state to establish itself in that is not its principal business
location.
39
By performing a qualitative analysis based on 50 interviews with
private attorneys, he found that Delaware was chosen due to its superior
legal infrastructure and because it had advantages in the eyes of majority
owners or managers of limited liability companies. Furthermore, there is
165
34 id.
35 L. Hornuf, Regulatory Competition in European Corporate and Capital Market Law:
An Empirical Analysis (2012); R. Braun, H. Eidenmu
Èller, A. Engert, and L. Hornuf,
`Does Charter Competition Foster Entrepreneurship? A Difference-in-Difference
Approach to European Company Law Reform' (2013) 51 J. of Common Market
Studies 399.
36 Becht et al., op. cit., n. 22.
37
D. HaÈusermann, `For a Few Dollars Less: Explaining State to State Variation in
Limited Liability Company Popularity' (2011), at .
38 J. Dammann and M. Schu
Èndeln, `Where are Limited Liability Companies Formed?
An Empirical Analysis' (2010), at ; B. Kobayashi
and L. Ribstein, `Delaware for Small FRY: Jurisdictional Competition for Limited
Liability Companies' (2011) University of Illinois Law Rev. 91.
39 F. Gevurtz, `Why Delaware LLCs?' (2012), at .
ß2014 The Author. Journal of Law and Society ß2014 Cardiff University Law School
some evidence that horizontal regulatory competition for private limited
liability companies, mostly SMEs, does not lead to a dominant market share
for a single state in the United States, which is in contrast to the findings for
publicly-held companies.
40
At least based on limited empirical studies, a preliminary assessment of
the empirical evidence about horizontal regulatory competition in regard to
limited liability company laws for SMEs within Europe shows that different
costs of establishment matter to SMEs. Importantly it indicates that a con-
siderable number of firms seem to use the possibilities of a free market in
choice of law. In turn, member states also seem to engage in regulatory
competition by modifying and improving their legal forms. This is somewhat
puzzling as their incentives are much more unclear since there seem to be no
direct pecuniary incentives, like franchise fees in the United States.
Therefore, we can conclude that the Centros jurisprudence that legally
enabled the transition to the pure decentralization approach with direct
regulatory competition (type 3) indeed triggered a process of regulatory
competition between the corporate laws of member states. However, despite
this evidence, we cannot assume that a dynamic and smoothly working
regime of horizontal regulatory competition between the national legal forms
yet exists. There are still serious legal problems as well as considerable
(migration) costs due to the differences in languages and national legal
systems.
41
In the next section we consider the role the SPE might play in
overcoming these problems.
THE EUROPEAN PRIVATE COMPANY (SPE):
ADVANTAGES AND DISADVANTAGES
According to the draft statute of the EU Commission, the European Private
Company is a new legal form for a private limited liability company with a
legal personality.
42
SMEs within the EU could choose it in addition to the
already existing 27 national legal forms for private companies. It is
especially designed to promote SMEs doing business across borders within
the EU. According to the literature on the internationalization of SMEs and
166
40 Gelter, op. cit., n. 21; M. Kahan and E. Kamar, `Price Discrimination in the Market
for Corporate Law' (2001) 86 Cornell Law Rev. 1205; M. Kahan and E. Kamar, `The
Myth of State Competition in Corporate Law' (2002±3) 55 Stanford Law Rev. 679;
M. Manesh, `Delaware and the Market for LLC Law: A Theory of Contractibility and
Legal Indeterminacy' (2011) 52 Boston College Law Rev. 189.
41 For general assessments of (the possibility of) regulatory competition in Europe, see
Heine and Kerber, op. cit., n. 10; Kirchner et al., op. cit., n. 20; Bratton et al., op. cit,
n. 21; Schaper, op. cit., n. 16; KloÈhn, op. cit., n. 21.
42
Council of the European Union, `Proposal for a Council Regulation on a European
Private Company ± Political agreement'(23 May 2011) Interinstitutional File 2008/
0130 (CNS) at .
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on the economics of corporate law, the following aspects are important for
an internationalization-friendly legal form for SMEs.
43
First, it should be
inexpensive, requiring few resources for establishment and for meeting its
regular tax and accounting obligations. Second, it should provide secure
ownership rights, including limited liability so as not to endanger the parent
company by doing business internationally. In addition, it should also
provide secure property rights for creditors so as to reduce problems of
getting access to outside finance and to lower extra risk charges. Third, it
should reduce principal-agent problems due to information asymmetries.
This holds for business partners, customers, and foreign authorities to whom
the company statute should provide clear information about the company.
Fourth, information and consultation costs for SMEs about legal and
administrative questions should be low, which requires a relatively simple
legal form. Fifth, competence rules should exist so that it can be decided
easily and at low costs whether EU, the home or the host country legal rules
apply in any particular case.
The SPE draft regulation comprises 48 articles, which are grouped in ten
chapters with three annexes.
44
Its structure follows the life cycle of a
company, stating property rights, decision-making rights, information rights
as well as competence rules for the main stakeholders, that is, for owners,
management, employees, creditors, and the public. Eckardt has argued that
the proposed SPE statute is well suited to fulfill the role of an inter-
nationalization-friendly legal form for SMEs. Nonetheless, there might be
some complications regarding co-determination regimes practiced in certain
member states such as Germany but these would only concern enterprises
with 500 or more employees. So, the draft SPE regulation seems to provide a
viable legal form for the typical SME with fewer than 250 employees.
45
All
in all, the SPE is a relatively simple legal form: on the one hand, it gives the
owners broad scope for individual and flexible regulation of the articles of
association; on the other, it contains a number of competence rules, where it
states when the law of the country of establishment has to be applied. This
increases l egal certa inty, which i s a prerequis ite for its su ccessful
implementation.
46
To what extent would the introduction of the SPE change
the overall regime of corporate laws in Europe in regard to private limited
liability companies? Since the proposed statute does not imply any kind of
minimum or partial harmonization of existing national legal forms, it
remains basica lly a decentrali zation approa ch with direct reg ulatory
competition (type 3), supplemented by the SPE as an additional offer at
EU level (pure vertical competition). lt is dominated by free choice of law
167
43 See Eckardt, op. cit., n. 29, with additional references.
44 Council of the European Union, op. cit., n. 42.
45 Eckardt, op. cit., n. 29.
46 For a detailed discussion on specific issues of the SPE, see the papers in Hirte and
Teichmann, op. cit., n. 5, and Lewis and Buzdrev, op. cit., n. 5.
ß2014 The Author. Journal of Law and Society ß2014 Cardiff University Law School
through the firms, albeit limited to some extent by specific aspects where the
country of establishment applies. The fact that there are no convincing
arguments for harmonization is a very positive aspect of the Commission's
draft statute, and remarkable in view of widespread harmonization efforts in
many other legal fields in Europe.
To analyse the potential advantages and disadvantages of such an
additional legal form in comparison to the current situation, we apply the
assessment criteria from the economic theory of legal federalism from the
second section. Since the introduction of the SPE would allow SMEs to
choose between a larger set of legal forms for their private limited liability
company, it seems to be hard to argue that extending choice might have any
negative effects. SMEs remain free to use member-state domestic legal
forms, and utilize their familiarity with these legal forms and the advantages
of the cumulative experience of these well-established corporate law
traditions (dynamic economies of scale). Since SMEs might have very
different expectations of corporate law rules due to different business models
and governance problems, a new and different legal form might better fulfil
the demands of at least some SMEs. Additional options can increase
efficiency and innovativeness. As a consequence, decentralized firm-level
knowledge of the best corporate law arrangement and the need for innovative
and adaptable approaches to corporate structures for small dynamic firms
both favour increased competition between legal business forms. However,
the SPE is more than an additional option: the specific advantages of the SPE
as a legal form especially designed for doing business simultaneously in
several member states of the EU will have a lot of specific advantages for
those SMEs with a clear internationalization strategy. Since it can be used
easily throughout the EU and would likely be known as the only European
legal form in all member states, the SPE will lead to a reduction of
information and transaction costs for establishing firms and doing business
in the entire EU. Economies of scale and scope in regard to setting up
companies as well as in regard to the costs associated with their regular
duties can be realized. Reputation effects might also be very important for
SMEs from member states with otherwise less familiar or less trusted legal
forms. Both the cost advantages mentioned above and these reputation
effects, which reduce costs for the trading partners of SMEs in the legal form
of the SPE, imply lower barriers of entry within the EU and therefore easier
market access. In that respect, the introduction of the SPE as an additional
new legal form might fill a specific, so far unfulfilled, market demand. This
is also positive in regard to the assessment criteria heterogeneity as well as
innovation and adaptability. Therefore, we would argue that one can expect
additional benefits from regulatory competition through the introduction of
the SPE.
47
168
47 See, also, Hommelhoff and Teichmann, op. cit., n. 5, pp. 13±15.
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What kind of problems might arise with the introduction of this additional
legal form? There might be problems due to path-dependency effects.
48
In
the law and economics literature, it is a well-known fact that the quality of
new laws depends on the extent of their application and adjudication.
Therefore, a lot of experience with the SPE and a large number of court
decisions are necessary before the new legal form achieves the same level of
precision and legal quality as the limited liability company laws already
well-established in the member states. Thus, a critical-mass problem
emerges, which results from dynamic economies of scale. If the SPE is
not used by a minimum number of firms, then it might never become
sufficiently competitive in terms of legal quality. As a consequence, the SPE
might fail in the market of legal forms for SMEs. But such a result would not
worsen the situation compared to the current one. However, the opposite
kind of problem might arise in the long run: the SPE might become so
successful that it becomes the dominant legal form for SMEs in the EU. As a
result, most other national limited liability legal forms for SMEs would be
obsolete and thus regulatory competition would be eliminated. Both these
types of problems are well known and discussed in regard to other fields of
law, in which optional European legal rules have been proposed.
49
Whereas
the critical mass problem might become relevant, it is less likely that the SPE
would become the dominant legal form for SMEs in the EU. Since most
SMEs are doing business only in domestic markets, it can be assumed that
they would still use the national legal forms. In any case, it might be
important for safeguarding regulatory competition that ± in the long run ±
member states retain the right to introduce new legal forms.
Another concern is that regulatory competition might lead to race-to-the-
bottom problems. Such problems can only emerge from the mandatory part
of the new legal form, not from its ± much more important ± facilitative part.
However, a small risk of race-to-the-bottom problems does already exist
with respect to the current horizontal regulatory competition between the
legal forms of different member states. The introduction of the SPE as an
additional option would not increase it significantly, although it cannot be
excluded that some mandatory rules of the SPE might lead to lower
standards than the regulatory standards of the limited liability company laws
prescribed in some member states. An already existing solution to this
problem is that, in regard to certain governance issues, national legal systems
require the application of the host-country rule. Although we would have, in
general, free choice of law ± and thus direct regulatory competition ±
between all legal forms available, there would be exceptions regarding
certain issues, which would still be solved by applying the domestic (host-
169
48 See Heine and Kerber, op. cit., n. 10, regarding path dependency effects in corporate
law.
49 For example, European contract law: Kerber and Grundmann, op. cit., n. 19.
ß2014 The Author. Journal of Law and Society ß2014 Cardiff University Law School
country) rules.
50
Therefore, well-designed competence rules could take
account of such race-to-the bottom problems.
However, these problems hint at a more general difficulty. Company laws
always work within the context of a number of other sets of legal rules (such
as tax law, accounting and auditing rules, securities law). Since many of
these complementary laws are not harmonized within the EU, there might
always be difficult interface problems, if legal rules from different member
states are combined, either as legal forms from other member states or the
SPE. This might lead to legal inconsistencies and thus to conflicts ± resulting
in manifold cost problems. However, with free choice of law, these kinds of
problems already exist in the current situation. The introduction of the SPE
will not increase them. On the contrary, a wide diffusion of the SPE
throughout the EU might lead to more standardized interface solutions and
therefore contribute to a reduction of such interface problems. A more
critical problem in regard to the consistency of the resulting company law
might emerge because all legal questions regarding the SPE have to be
adjudicated on by national courts. The absence of an integrated European
court system might lead to different decisions about the SPE in different
member states. This would endanger the development of a uniform
jurisprudence in regard to the SPE and cast doubt on the advantages of a
uniform European legal form for SMEs. Solving this problem might be
crucial for the success of the SPE in the long run.
CONCLUSIONS
Since Centros and subsequent rulings, the regime of corporate laws in
Europe has evolved in a fundamental way. Although it is rather incomplete
and imperfect, a two-tiered system of corporate laws has emerged. This two-
tiered system is characterized by a considerable degree of free choice of law.
This opens up the possibility of some horizontal regulatory competition
between the company laws of the member states. An important additional
development is the introduction of new legal forms at the EU level, such as
the European Corporation (SE) and the European Cooperative Society
(SCE), which can be chosen in addition to the national legal forms. Since
these legal forms refer extensively to national company law rules, they
provide only to a small extent a real alternative to the national legal forms
such as, for example, the German Aktiengesellschaft. In that respect, there is
scepticism about the degree of vertical competition in regard to these
supranational legal forms. In contrast to this, the proposal regarding the
European Private Company (SPE), would allow for much more vertical
170
50 As regards employee participation rights or the restructuring, winding up, and nullity
of a SPE, see Council of European Union, op. cit., n. 42.
ß2014 The Author. Journal of Law and Society ß2014 Cardiff University Law School
competition between such a European legal form and the national ones.
51
Therefore, in regard to limited liability companies, a two-tiered system
would emerge based upon a decentralization approach with direct horizontal
and vertical competition without any harmonization efforts.
Our analysis of the advantages and problems of the introduction of such
an additional legal form for SMEs shows clearly that it might render many
benefits without considerable disadvantages when compared with the
existing situation of only horizontal competition between the legal forms
of the member states. The summary of the empirical studies about the current
state of horizontal regulatory competition in the third section suggests that
firms do indeed respond to cost differences resulting from different legal
forms by migrating to member states with less `expensive' legal forms.
Moreover, member states react to such movements by modifying and
improving their legal forms, too. Therefore, horizontal regulatory com-
petition in regard to limited liability company law seems to be working
already. However, its extent and intensity seems rather weak still. The
introduction of an additional European legal form for SMEs, such as the
SPE, can be expected to reduce information and transaction costs and spur
further regulatory competition. As a result, its advantages of more efficiency
and innovation can be reaped. The risks associated with such an additional
legal form ± for example, race-to-the-bottom problems ± seem to be quite
small or even, in our view, negligible. The strongest concerns refer to the
problem that the SPE, as any new legal form, has in overcoming a critical-
mass problem in the form of attracting a minimum number of applications,
and solving the various difficulties of matching the many complementary
legal rules of the different national legal systems. This includes, in particular,
its uniform adjudication by the national court systems.
171
51 Schaper, op. cit., n. 16, pp. 165±7.
ß2014 The Author. Journal of Law and Society ß2014 Cardiff University Law School
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