We reached out to Barzuza to discuss her discoveries about Nevada corporate law, the fascinating legislative history and the marketing strategy the state embarked on, and what the future might hold.

Q. When did Nevada make this change to its corporate law?

A. It started in 1987, when Nevada adopted its exculpation statute. Nevada’s law was then significantly more protective of directors and officers than Delaware’s exculpation clause, because Nevada allowed firms to waive liability for directors and officers not only for breaches of duty of care, but also for breaching the duty of loyalty and of good faith. The only thing they couldn’t opt out of was liability for “fraud, intentional misconduct or knowing violation of law.”

Then in 2001, Nevada made “no liability” mandatory and in 2003 changed it to be the default rule. In 2002, Nevada raised its negligible annual incorporation tax 10,000% – higher than most states, but still significantly cheaper than Delaware’s tax – and started to market itself aggressively as “business friendly.”

Q. Why did the legislature limit liability for breach of duty of loyalty?

A. In the legislative history, they said, “We need to differentiate Nevada from Delaware, otherwise everyone is going to incorporate in Delaware. If we want to attract firms, we have to offer more protection from liability.”

Some representatives said, “This is terrible, all the ‘scoundrels’ are going to come here, it’s going to become a ‘hole in the wall,’” and so forth. But eventually they were convinced to support these changes because they were promised that the additional tax fees would fund salary increases for public school teachers.

Q. How is it that nobody noticed this until your paper?

A. There was a strong assumption in the literature that Nevada copies Delaware law, and even adopted all of its cases. All the papers around that time cited the same original source for the proposition that Nevada was just importing Delaware law wholesale. Yet, the source paper by William Carry merely said that “Nevada was trying to become Delaware of the West.”

And what’s funny is that the editors at [satirical publication] The Onion, of all places, picked up on what Nevada was doing and poked fun at it. Shortly after this change in the corporate law, The Onion wrote a satirical headline saying, “Nevada to Phase Out Laws Altogether.” The story suggested that car theft, murder and rape would be legalized over a five-year period.

Q. And it would appear some directors and officers picked up on this, too?

A. Well, Elon Musk has, and others are now following. … Nevada has long been second to Delaware in attracting out-of-state incorporations. After the legislature made “no liability” the default rule, we started seeing an increase in companies incorporating in Nevada.

Q. How do these numbers compare to Delaware’s lure for corporations?

A. Delaware’s corporate law still attracts around half of all publicly traded companies. Of the other half, most incorporate in their home state. But Nevada attracted close to 10% of out-of-state corporations, second only to Delaware.

Q. Why should this matter to investors or consumers?

A. I think it’s excessive protection that in some cases could be taken advantage of. Nevada adopted the law with the intention of attracting firms that are interested in more lax corporate law. Some of these firms may be ones that could benefit from regulation the most.

Q. What would be an example of the types of problems regulators have found with Nevada companies?

A. In my paper with David Smith from UVA’s McIntire School of Commerce, “What Happens in Nevada? Self-Selecting into Lax Law,” which was published in the Review of Financial Studies, we found that Nevada “attracts firms that are 30% to 40% more likely to report financial results that later require restatement than firms incorporated in other states, including Delaware.”

Q. What is the significance of accounting restatements?

A. It is indicative of aggressive or sloppy accounting, weak corporate control, manipulation of earnings or even fraud. It reduces a company’s credibility and tends to result in hits to their stock price.

Q. So how can Delaware compete to retain its corporate residents without going down the same path?

A. Most large companies don’t have a reason to go to Nevada. National law firms will continue to advise you to go to Delaware. Delaware attracts more than half of publicly traded companies. All the law firms are working in Delaware; all the financial firms are working in Delaware. Their courts are extremely efficient and the judges are experts in corporate law.

Firms go to Nevada if they’re interested in more protection, either because they are exposed to litigation, or because their state provides less protection, or both.

Elon Musk already moved Twitter, which is a private company, into a new holding company he established in Nevada – X Holdings Inc. – and there are discussions that he’s trying to move Tesla there, though he will need to get shareholder vote for the move because it is a public company.

Q. What does that tell you about Musk’s motivation?

A. Firms may have different motives for moving to Nevada. There’s a Tesla shareholders case in Delaware against Musk where the plaintiffs argue that he exerted too much influence on the Tesla board to award him a large compensation and bonus package. The court has previously found that he’s the controlling shareholder even though he owns less than 23% of the company, which under Delaware law exposes him to more litigation and higher judicial scrutiny. So that could be a motivation for him to move his firms to Nevada, where there’s much more limited liability for self-dealing transactions.

Q. Isn’t Nevada’s liability for “intentional misconduct” still a meaningful bar for bad actors?

A. Well, theoretically it could be, but the legislative intention to limit liability has been clear, and the courts follow this intention and state it explicitly in their verdicts. On top of that, in 2017, Nevada passed another amendment to its law stating Nevada rules should be applied by courts in a way that is consistent with state legislators’ intent, and not with Delaware law.

Q. What other types of things have directors and officers been held liable for in Delaware that they would be immune from in Nevada?

A. In Delaware, there is now a line of cases about liability for oversight failure. For example, with Boeing there was a plane crash and the court found that the board didn’t fulfill its oversight duties sufficiently to prevent other crashes from the same cause. So those cases aren’t dismissed in Delaware, but they would be in Nevada.

Q. What’s next?

A. With TripAdvisor and Elon Musk’s moves in the news, we could see firms migrating to Nevada and potentially more shareholder suits to block firms from moving to Nevada. I think maybe Delaware will face concerns over losing more firms, especially ones with controlling shareholders. And maybe that will result in Delaware catering a little bit more to controlling shareholders – maybe they’ll be less quick to define shareholders as controlling shareholders.