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 THE INDEPENDENT DIRECTOR
IN CHINESE CORPORATE GOVERNANCE

BY DONALD C. CLARKE*

ABSTRACT

Corporategovernance (gongsi zhili) is a concept whose time has

come in China, and the institution of the independent director is a major
partof this concept. Policymakers in several countries such as the United
Kingdom andJapanhave turnedto independentdirectorsas an important
element of legal andpolicy reform in the field of corporategovernance. In
August 2001, the China SecuritiesRegulatory Commission (CSRC) issued
its Guidance Opinion on the Establishment of an Independent Director
System in Listed Companies. Covering all companies listed on Chinese
stock exchanges (but not Chinese companies listedoverseas),it constitutes
the most comprehensive measure taken to date by the CSRC--orindeed by
any Chinese governmental authority-to regulate internal corporate
governance through the institution of the independent director.
This articlediscusses the institutionof independentdirectors,and
the Independent DirectorOpinion specifically, as a potentialsolution to
Chinese corporategovernance problems. It begins by discussing special
features of the Chinese corporate landscape and the most prominent

*Professor of Law, George Washington University Law School; B.A., Princeton

University; M.Sc., University of London; J.D., Harvard University. I would like to give special
thanks here to several persons and institutions for their valuable assistance in the preparation of
this article: Professor Paul Gewirtz and Yale Law School's China Law Center for their generous
hosting of me on two occasions; the Fulbright Program for the award of a research fellowship in
China; Tsinghua University Faculty of Law for its hosting of me as a visiting scholar and the
helpfulness of its staff in many areas; the Beijing office of Paul, Weiss, Rifkind, Wharton &
Garrison for its generous provision of facilities; and the University of Washington School of Law
for accommodating my travel schedule and other indulgences during the period when most of this
article was written. I would also like to thank Professor Curtis Milhaupt of Columbia Law School
and Professor Tang Xin of Tsinghua University's Faculty of Law for their time in discussing
issues of Japanese and Chinese law respectively; and Charles Ching of Yale Law School, Li
Xingxing of Tsinghua University Faculty of Law, and Wei Xiao of the George Washington
University Law School for their research assistance. Special thanks are due to Sarah O'Sullivan
of the George Washington University Law School for the extensive hours she put into research
and other assistance with this article. Needless to say, none of the above is responsible for any
errors that may persist.
A note on references: Authors' surnames and given names are provided in the order
appropriate to the language in which the work is published. Where the surname comes first, it is
underlined to avoid confusion.
Some sources cited in this article were unavailable for review by The Delaware Journal
of Corporate Law but have been verified by the author.
 DELAWARE JOURNAL OF CORPORATE LAW [Vol. 31

problems in the areaof corporategovernance. It then proceeds to identify

differing conceptions of what is broadly termed "the independent
director"--theoutside director, the disinteresteddirector,and the (more
narrowly defined) independent director-anddiscusses the approaches
taken in several differentjurisdictions.
The article canvasses empirical research on the relationship
between independent directorsand corporateperformance in the United
States, as well as in China, and finds that the research yields similar
conclusions: there is no strong link. The articleconcludes by arguingthat
proponents of the institution of independent directors misconceive the
nature of the corporate governance problem in China, as well as the
functioning of independent directors in the United States, and have not
taken into account specific features of the Chinese institutional
environment-particularlythe legal environment-thataffect the viability
of any proposed solution.

TABLE OF CONTENTS

Page

I. INTRODUCTION .................................. 127

II. CORPORATE GOVERNANCE INCHINA .................. 130
A. Listed Companies in China .................. 130
B. CorporateGovernance in General ............ 143
C. CorporateGovernance in China ............. 145
III. INDEPENDENT DIRECTORS AS A SOLUTION TO CORPORATE
GOVERNANCE PROBLEMS ............................ 150
A. Functions of the Non-ManagementDirector .... 150
B. Conceptions of the Non-ManagementDirector .. 153
C. The Independent Directorin China ........... 167
IV. REGULATORY RESPONSES ......................... 175
A. Stock Exchange Initiatives .................. 176
B. Regional Government Initiatives ............. 178
C. Central Government Ministry Initiatives ....... 180
D. CSRC Initiatives .......................... 183
E. The CSRC Guidance Opinion on the Establishment
of an Independent Director System in Listed
Companies .............................. 190
V. CAN INDEPENDENT DIRECTORS FUNCTION AS HOPED? ... 201
A. EmpiricalResearch ....................... 202
B. Why Don't Independent DirectorsSeem to Work? 205
VI. CONCLUSION ................................... 216
2006] CHINESE CORPORATE GOVERNANCE

Figure 1 .............................................. 218

Figure 2a ............................................. 219
Figure 2b ............................................. 220
Figure 2c ............................................. 221
Figure 3 .............................................. 222
Figure 4 .............................................. 223
A ppendix 1 ........................................... 224

I. INTRODUCTION

Corporate governance (gongsizhili) is a concept whose time seems

definitely to have come in China.' In part, this is simply a reflection of the
increasing attention being paid to the subject in academic, professional, and
business circles in the West, and of the increasing integration of Chinese
intellectual life with global trends. But the flood of speeches, articles, and
conferences on corporate governance in China today would not be
occurring if the concept did not seem to promise a way of thinking about,
and remedying, a host of perceived flaws in China's legal and economic
institutions.
Policymakers in several countries have turned to independent
directors as an important element of legal and policy reform in the field of
corporate governance. In the United States, insider-dominated boards have
been rare for years,2 and although the New York Stock Exchange (NYSE)
has required that independent directors constitute a board majority in
domestic companies only since 2004, 3 as of 2001 approximately 75% of

'I searched a database of Chinese periodicals in law, economics, and related subjects
(the Zhongguo Qikan Quanwen Shujuku [Chinese Periodicals Full-Text Database], at
http://www.cnki.net) to see in how many articles the most common Chinese term for corporate
governance, gongsi zhili, appeared in the title. In 1994, the year the Company Law came into
effect, there were nine such articles. In 1995, there were 14. In 1999, the number was 107; in
2002, 643; and in 2004, 899. As of early March 2006, this database recorded 933 article titles
mentioning "corporate governance" in 2005.
2
See Sanjai Bhagat & Bernard Black, The Uncertain Relationship Between Board
Composition and Firm Performance,54 Bus. LAW. 921, 921 (1999) ("In the 1960s most [large
American companies] had a majority of inside directors; today, almost all have a majority of
outside directors and most have a majority of 'independent' directors.").
3
See NEW YORK STOCK EXCHANGE, LISTED COMPANY MANUAL § 303A.01 (2003),
availableat http://www.nyse.com/listed [hereinafter LISTED COMPANY MANUAL]. In the wake
of widely-publicized failures of corporate oversight, the chairman of the Securities and Exchange
Commission (SEC) issued a public statement in 2002 requesting that the New York Stock
Exchange (NYSE) and the National Association of Securities Dealers (NASD) review and modify
corporate governance standards. See Securities and Exchange Commission, Release No. 34-
48745, NASD and NYSE Rulemaking: Relating to Corporate Governance (Nov. 4, 2003)
(discussing the history of the new NYSE rules and citing Commission Press Release No. 2002-23
(Feb. 13, 2002)). In response, the NYSE generated corporate governance reform proposals now
 DELAWARE JOURNAL OF CORPORATE LAW [Vol. 31

NYSE-listed companies already had such majorities.4 With the rise of

takeover activity since the 1980s, disinterested' directors have played an
increasingly important role in related state-level litigation, and the modest
role for independent directors contemplated in the listing rules of the
NYSE 6 has given way, in the wake of Enron and other corporate scandals,
to federal mandates for listed companies under the Sarbanes-Oxley Act
(SOA). 7 Britain's own set of corporate scandals led to the Cadbury Report,
which recommended, along with subsequent similar reports and studies, a
greater role for outside and independent directors,' and the last decade has
seen a number of corporate law reforms in Japan designed to enhance the
9
role of directors and auditors not tied to management.
The increasing worldwide interest in independent directors has not
gone unnoticed by Chinese policymakers. Indeed, Chinese interest pre-
dated the corporate scandals that led to federal-level corporate governance
reforms in the United States, possibly because of the many similar scandals
that had already occurred among Chinese companies listed on one of the
country's two stock exchanges.' In August 2001, the China Securities
Regulatory Commission (CSRC) attracted attention with the issuance of its
Guidance Opinion on the Establishment of an Independent Director System

included in Section 303 of the Listed Company Manual. See id.

4
See Joann S. Lublin, NYSE ConsidersRules to Boost Power ofBoards Fosteringthe
Independence OfDirectorsCouldImprove Governance,Advisers Say, WALLST. J., June 3,2002,
at A2 (citing report by Investor Responsibility Research Center). In a 2003 survey of its 150
members, the Business Roundtable, an organization of large American corporations, found that
80% had boards that were at least 75% independent, and that 90% had boards that were at least
two-thirds independent. See Press Release, The Business Roundtable, The Business Roundtable
Releases Corporate Governance Survey (July 15, 2003), available at http://www.brt.org/
press.cfm/970.
5
The difference between disinterested, independent, and outside directors is discussed
infra Part III.B.
6
See infra note 109 and accompanying text.
7
See infra notes 106-07 and accompanying text.
8
See infra notes 120-23, 131 and accompanying text. As of 2001, outside directors
were a board majority in 53% of companies on the London Stock Exchange. See MOTOMI
HASHIMOTO, COMMERCIAL CODE REVISIONS: PROMOTING THE EVOLUTION OF JAPANESE
COMPANIES 14 (Nomura Research Institute, NRI Papers, No. 48, May 1, 2002) (citing
CORPORATE GOVERNANCE 2001 (PIRC ed., Dec. 2001)). In 2004, however, Pensions Investment
Research Consultants reported a board majority of independent directors in well under 15% of
LSE-listed companies. See Pensions Investment Research Consultants Ltd. (PIRC), Presentation
of Corporate Governance Annual Review 2004 (Nov. 18, 2004), available at http://www.
pirc.com.
9
See infra notes 134-39 and accompanying text.
'°The two Chinese stock exchanges are in Shanghai and Shenzhen.
2006] CHINESE CORPORATE GOVERNANCE

in Listed Companies (Independent Director Opinion)." Covering all

companies listed on Chinese stock exchanges (but not Chinese companies
listed overseas), the Opinion constitutes the most comprehensive measure
taken to date by the CSRC or any Chinese governmental authority to
regulate internal corporate governance through the institution of the
independent director. It is also portrayed unapologetically as a borrowing
from United States corporate governance law and practice, 12 and as such
implicates many issues relevant to legal transplants.'
Despite its scope, the Opinion was not the first Chinese regulatory
document 4 to call for the appointment of independent directors, and the
idea had been under discussion for some time in academic journals and the
financial press. Although the institution of independent directors has been
mooted largely as part of a solution to governance problems in listed
companies, the problems in question are not necessarily unique to listed
companies. As Chinese economic reform continues and the government
abandons the traditional ways of managing state-owned enterprises, and as
individual wealth increasingly makes possible the accumulation of private
assets on a scale too large to be managed by an individual owner, there will
increasingly exist corporate entities in one form or another that are run by
professional managers who do not own the assets, and yet are uncon-
strained by the disciplines that functioned reasonably well under the system

"China Securities Regulatory Commission, Guanyu Zai Shangshi Gongsi JianliDuli

Dongshi Zhidu de Zhidao Yijian [GuidanceOpinion on the Establishmentof an Independent
DirectorSystem in Listed Companies] § 1(1), issued Aug. 16, 2001 [hereinafter Independent
Director Opinion or Opinion].
2
1 See, e.g., Gao Yong, DuliDongshiZhiduyu ShangshiGongsiZhili [The Independent

Director System and Corporate Governance in Listed Companies], JINGJI TIZHI GAIGE
[ECONOMIC SYSTEM REFORM], No. 1, 2002, at 8, 8; Ma Gengxin, Wanshan Woguo Shangshi
Gongsi Duli DongshiZhidu Jianshede Sikao [Some Thoughts on Perfecting the Construction
of the Independent Director System in China's Listed Companies], 20 ZHENG-FA LUNTAN
[POLITICAL-LEGAL FORUM], No. 6,2002, at 61,61; Yan Hai & Chen Liang, Duli Dongshi Zhidu
Yanjiu [A Study of the Independent DirectorSystem], HUADONG ZHENG-FA XUEYUAN XUEBAO
[JOURNAL OF THE EAST CHINA INSTITUTE OF PoLmCs AND LAW], No. 4, 2001, at 23, 24.
3
1 On legal transplants in corporate law, with many intriguing parallels to China, see

Hideki Kanda & Curtis Milhaupt, Re-Examining Legal Transplants:The Director'sFiduciary

Duty in JapaneseCorporateLaw (Columbia Law School Center for Law and Economic Studies,
Working Paper No. 219, 2003), availableat http://ssrn.com/abstract=391821.
"T'he admittedly clumsy term "regulatory document" includes all rules of a normative
character issued by Chinese legislative, governmental, and judicial agencies, as well as quasi-
governmental variations thereon. The nature of the Chinese legal system makes such a term
necessary, although this article is not the place to demonstrate the point systematically. See
generally Perry Keller, Sources of Orderin ChineseLaw, 42 AM. J. CoMP. L. 711,711-12 (1994)
(characterizing Chinese legislation as being in a state of "chronic disorder").
 DELAWARE JOURNAL OF CORPORATE LAW [Vol. 31

of state planning. 5 Thus, Chinese scholars and policymakers have been

searching for new mechanisms of corporate governance and accountability
not just for listed companies, but for all concentrations of assets managed
by non-owners.
This article will discuss the institution of independent directors,
and the Independent Director Opinion specifically, as a potential solution
to Chinese corporate governance problems. I will argue that proponents of
the institution misconceive the nature of the corporate governance problem
in China, as well as the functioning of independent directors in the United
States, and have not taken into account specific features of the Chinese
institutional environment, particularly the legal environment that affects the
viability of any proposed solution. The discussion of independent directors
will, I hope, shed light on a number of broader issues in Chinese corporate
governance, including such questions as the basic approach to the
regulation of corporate activity.
Part II of this article examines basic issues of corporate governance
generally as well as in China. It introduces some basic facts about the
system as well as the principal problems seen by commentators. Part III
looks at the specific institution of independent directors as a proposed
solution, and canvasses regulatory responses, including the Independent
Director Opinion. Part IV pulls these strands together, discussing first the
empirical evidence regarding the effect of the presence of independent
directors on the board of directors, and then the policy implications for
corporate governance of what we know about corporate structure and the
legal system in China. Part V offers a conclusion.

H. CORPORATE GOVERNANCE IN CHINA

A. Listed Companies in China

As this article is concerned primarily with the governance of

Chinese companies listed on one of the country's two stock exchanges, an
introduction to the relevant features of such companies is essential before
turning to issues of corporate governance both in general and in China.

' 5On constraints on management behavior under the system of state planning, see
generally EDWARD S. STEINFELD, FORGING REFORM IN CHINA: THE FATE OF STATE-OWNED
INDUSTRY (Cambridge Univ. Press 1998).
20061 CHINESE CORPORATE GOVERNANCE

1. Who Are They?

Chinese companies may be listed on one of China's two stock

exchanges in Shanghai and Shenzhen. They may also be listed on overseas
exchanges, typically in Hong Kong or New York. As of the end of 2005, 6
there were 1381 companies listed on China's two domestic markets.'
To be listed and thus able to raise money directly from the public,
a company must take the corporate form of a joint stock company (gufen
youxian gongsi) (JSC) under the Company Law'T-a form intended for
large corporations with widely dispersed stock ownership. Thus, a
traditional state-owned enterprise (TSOE) 8 must reorganize itself to be
listed. The vast majority of listed companies are, in fact, reorganized
TSOEs. Of 1088 listed companies on both exchanges at the end of 2000,
over 900 were originally TSOEs, 19 and of 1160 listed companies at the end
of 2001, approximately 1103 were originally TSOEs. 2° A recent study
concluded that approximately 84% of listed companies were, viewed solely
from the standpoint of equity ownership and not taking account of informal
mechanisms of influence, directly or indirectly under state control.'

'6English-language statistics are available at the CSRC's Web site at http://www.csrc.

gov.cn/en/homepage/indexen.jsp.
7
See Zhonghua Renmin Gongheguo Gongsi Fa [Company Law of the People's
Republic of China], as amended Oct. 27, 2005, ch. 4 [hereinafter Company Law]. Such
companies are sometimes referred to as "companies limited by shares." The pre-amendment
version of the Company Law, adopted in 1993 and effective from July 1, 1994 through Dec. 31,
2005, is referred to hereinafter as 1993 Company Law.
8
By "traditional state-owned enterprise" I mean the kind of state-owned enterprise that
existed prior to the Company Law: something like a cost center or a division within the loosely
organized firm of China, Inc. There was no formal law governing industrial TSOEs until 1988,
and there is still no formal law governing commercial TSOEs. See generally Donald C. Clarke,
CorporateGovernance in China: An Overview, 14 CHINA ECON. REv. 494, 496 (2003).
19See On Kit Tam, EthicalIssues in the Evolution of CorporateGovernance in China,
37 J. Bus. ETHICS 303, 305 (2002).
2
°See STEPHEN GREEN, CHINA'S STOCK MARKET: EIGHT MYTHS AND SOME REASONS
To BE OPTIMISTIC (The China Project, Royal Institute of International Affairs and Cambridge
University, Feb. 2003). Jiang Qiangui, the chairman of the State Economic and Trade Commision
(SETC), was recently quoted as saying that "the vast majority of listed companies are reorganized
state-owned enterprises." Guojia JingMao Wei Fuzhuren JiangQiangui:Zuo Shangshi Gongsi
Chengxin Fuze de Konggu Gudong [SETC Vice Chairman Jiang Qiangui: Be a Sincere and
Responsible Listed Company Controlling Shareholder], JiNGII RIBAO [ECONOMIC DAILY],
Jan. 30, 2003, available at http://www.chinainfobank.com.
21
See Guy S. Liu & Pei Sun, Identifying Ultimate ControllingShareholdersin Chinese
Public Corporations:An Empirical Survey 2 (Royal Institute of International Affairs, Asia
Programme Working Paper No. 2, 2003).
 DELAWARE JOURNAL OF CORPORATE LAW [Vol. 31

2. Capital Structure

As JSCs, listed companies are allowed under the Company Law to

have only one class of shares. It is crucial to understand, however, that
there are nevertheless several different types of shares, distinguished by
rules about their ownership and trading.22 First, there are several types of
shares known as circulating shares that may be traded freely and publicly
on various stock markets. A-shares may be listed on a domestic stock
exchange and owned and traded by any domestic individual, entity, or
specially approved foreign institutional investor. 23 B-shares are also listed
on domestic stock exchanges and until recently could be bought only by
foreigners using foreign currency; they may now be purchased by domestic
investors as well with foreign currency. Other letter-designated shares
include H-shares (listed in Hong Kong), N-shares (represented by
American Depositary Receipts listed in New York), L-shares (listed in
London), and so on.
Second, there are several types of shares known as non-circulating
shares that are subject to more severe trading restrictions. These are state
shares (guojiagu), which may be owned only by state organs; legal person
shares (faren gu), which may be owned only by organizations with formal
legal personality, such as companies; and employee shares, which generally
represent accumulated profits in a state enterprise prior to its public share

22
For a fuller account of share types, see CARL E. WALTER & FRASER J.T. HOWIE,
PRIVATIZING CHINA: THE STOCK MARKETS AND THEIR RoLE IN CORPORATE REFORM 71-87 (John
Wiley & Sons 2003).
23
Some analysts define A-shares broadly as shares available only to domestic investors,
and include all the non-circulating shares described in the following paragraph in the text. This
seems confusing to me for several reasons and I shall adopt the narrower definition here. First,
popular usage of the term "A-shares" almost always refers to tradeable shares listed on stock
markets. Second, state shares and employee shares (which have their origin in the corporatization
of traditional state-owned enterprises) are by definition domestically held, so giving them a second
label seems redundant. Third, legal person shares may, following the lifting of a prohibition
lasting from 1995 to 2003, be sold to foreign entities, subject to appropriate approvals. See China
Securities Regulatory Commission, Ministry of Finance, and State Economic and Trade
Commission, Guanyu Xiang Waishang Zhuanrang Shangshi Gongsi Guoyougu he Farengu
Youguan Wenti de Tongzhi [Notice Regarding Transfer to ForeignInvestors of State-Owned
Shares and Legal PersonShares ofListed Companies], issued Nov. 1, 2002. Circulating shares
recently became available to certain foreign entities qualifying as Qualified Foreign Institutional
Investors. See China Securities Regulatory Commission and People's Bank of China, Hege
JingwaiJigou Touzizhe JingneiZhengquan Touzi GuanliZanxingBanfa [ProvisionalMeasures
on the Administration of Investment in Domestic Securitiesby Qualified Foreign Institutional
Investors], issued Nov. 5, 2002, effective Dec. 1, 2002. Whether tradeable shares can be owned
by foreigners and whether legal person shares can be owned by foreigners are two different policy
decisions that will likely be made separately; labeling both types by the same name does not seem
to serve any useful purpose.
2006] CHINESE CORPORATE GOVERNANCE

offering and are deemed formally owned by the collective body of

enterprise employees. These shares are not tradeable at the time of listing
and are generally managed by either an investment management committee
or a staff union.24
It should be noted that the state share/legal person share distinction
is well established in law and statistics but is conceptually problematic.
Legal persons that hold shares can be state-owned and state-controlled, so
in some sense many legal person shares should be seen as state shares.25
That said, it must be added that the various government bodies holding
state shares do not act with one mind and may pursue conflicting
objectives. Some government bodies may well be purely profit seeking,
while others seek to use their share ownership to influence the company to
fulfill certain government objectives such as full employment.
By the same token, apparently some shares classified as state shares
are in fact held not by government agencies but by companies (e.g., parent
companies of corporate groups) that are controlled by the government
agency in charge of that industry. 26 These should technically be called
legal person shares, but they are called state shares because their voting and
use is in some sense directly controlled by government. The principles
governing the classification of shares as legal person shares or state shares
are neither clear nor uniform.27 The bottom line of the state share/legal
person share distinction, therefore, is that it does not tell us much about the
nature of the ultimate controlling shareholder.28

3. Who Owns Them?

Until quite recently, the mean shareholding percentages across

companies was typically about 30% for each of the state, legal persons, and

24
See Zhongguo (Hainan) Gaige Fazhan Yanjiu Yuan Keti Zu [China (Hainan) Reform
and Development Institute Project Group], Tiaozheng Zhili Jiegou, Lizu Zhidu Chuangxin:
Haikou GuantouChang Qiye GaigeAnliDiaoyan[Adjust the GovernanceStructureon the Basis
of InstitutionalRenovation: A CaseStudy of EnterpriseReform in the Haikou CanningFactory],
in ZHONGGUO GONGSI ZHIL JIEGOU [THE STRUCTURE OF CORPORATE GOVERNANCE IN CHINA]
309, 322-23 (China (Hainan) Reform and Development Institute ed.,Waiwen Chubanshe 1999);
Daqing Qi et al., Shareholding Structure and CorporatePerformance of PartiallyPrivatized
Firms: Evidence from Listed Chinese Companies, 8 PACIFIC-BASIN FIN. J. 587, 592-93 (2000).
25See Yin Wenquan, Qiye JituanShangshi Gongside Guquan Jiegou Gaizao [Reform
in the Equity Structure of Listed Enterprise Group Companies], in ZHONGGUO GONGSI ZHILI
JIEGOU [THE STRUCTURE OF CORPORATE GOVERNANCE IN CHINA], supra note 24, at 98-111.
26
See, e.g., id. at 99-100.
27
See id. at 99.
28
This point is explored in detail in Liu & Sun, supra note 21, at 8.
 DELAWARE JOURNAL OF CORPORATE LAW [Vol. 31

A-share holders, with 10% going to foreigners and employee shares.29

Although this rough average seems robust over several studies, one study
finds that the standard deviation is large, showing that there are large
variations in the formal ownership mix across firms.3 °
A recent study, however, calls this stylized fact into question. Lu
and Wu find that as of the end of 2002, state shares represented as much as
47.2% of outstanding shares of listed companies, down from 51.31% at the
end of 1992.31 It seems unlikely that state share ownership dipped to
somewhere around 30% in the 1990s and then rose again. Lu and Wu
further put legal person shareholdings at 11.31% and circulating shares
(including B-shares and H-shares) at 34.67%.32 Thus, the rough figure for
circulating shares seems confirmed by all studies, whereas the figure for
state and legal person shares is in question. Since Lu and Wu's figure for
legal person shares seems abnormally low, it may be that by "state shares"

29
See Qi et al., supra note 24, at 593. Xu and Wang come to a similar conclusion for
ownership as of the end of 1995, see Xiaonian Xu & Yan Wang, Ownership Structure and
CorporateGovernance in Chinese Stock Companies, 10 CHINA ECON. REv. 75, 76 (1999), and
Yin reports that as of the end of 1997, the mix was 32% state shares, 30% legal person shares, and
35% tradeable shares, see Yin, supra note 25, at 98. (Note, however, that many legal person
shares are held by institutions that are themselves state-owned.) Zhang and Sun report a mix of
34% state shares and 34% circulating shares against 20.9% domestic legal person shares for 1998,
with the remainder being held by foreigners, founders, and employees. See Zhang Zongxin & Sun
Yewei, Guquan Jiegou Youhua yu Shangshi Gongsi Zhili de Gaijin [The Optimization of Share
CapitalStructureand the Improvement of CorporateGovernance in Listed Companies], JINGJI
PINGLUN [EcON. REV.], No. 1, 2001, at 36, 36. Ren Haichi reports a figure of 60% state-owned
shares (guoyou gu) and 35% circulating shares for all listed companies as of the end of June 2002
(note that the term "state-owned" includes both state shares and legal person shares belonging to
entities owned by the state). See Ren Haichi, Ruhe Youhua Woguo Shangsi Gongsi Ziben Jiegou
[How to Improve the Capital Structure of China's Listed Companies], SHANGHAI JINRONG
XUEYUAN XUEBAO [J. SHANGHAI INST. FIN.], No. 2, 2004, at 60,60.
CSRC statistics as of the end of December 2005 put the value of circulating shares at
1.06 trillion yuan, and the value of all shares of listed companies at 3.24 trillion yuan. See CSRC
Web site, http://www.csrc.gov.cn. While it is not economically realistic to value non-listed shares
at the same price as listed shares, see infra note 51, doing so does permit the conclusion that a
reasonable weighted average percentage for circulating shares is about 33%.
Publicly issued (that is, tradeable) shares must account for at least 25% of all shares
at the time of a public offering unless the par value of the company's stock exceeds 400 million
yuan, in which case they must account for at least 10%. See Zhonghua Renmin Gongheguo
Zhengquan Fa [SecuritiesLaw of the People's Republic of China], as amended Oct. 27, 2005,
art. 50. This rule was, prior to the October 2005 revisions to both the Securities Law and the
Company Law, set forth in Article 152 of the Company Law.
3
See Xu & Wang, supra note 29, at 80 (table).
31
See Ld Hui & Wu Xingming, Shangshi GongsiGuquan liegou yu GongsiZhili [The
Stock OwnershipStructure and CorporateGovernance of Listed Companies],JINGJITIZHI GAIGE
[REFORM OF THE ECONOMIC SYSTEM], No. 4, 2004, at 88, 88.
32
See id.
2006] CHINESE CORPORATE GOVERNANCE

(guojia gu) they actually mean "state-owned shares" (guoyou gu), a term
that includes legal person shares owned by state-owned entities.
While individuals, as noted above, are not permitted to hold state
shares or legal person shares, institutions are allowed to hold A-shares. It
is very difficult, however, to know the degree of institutional ownership of
A-shares. According to one source, for example, as of the end of 1998,
there were 19.9 million stock accounts at the Shanghai stock exchange. Of
these, 99.75% were for individuals, with institutions holding only 0.3%.
Individuals held 93.15% of A-shares by value. 33 By the end of 2001, the
reported number of A-share accounts on both exchanges was up to an
astonishing 60 million,34 equal to about one in five urban residents between
the ages of 15 and 64. 3' Anthony Neoh, the former chairman of Hong Kong
Securities and Futures Commission and a prominent advisor to the CSRC,
however, was reported in December 2001 to have asserted that because of
duplicate registrations and dormant or abandoned accounts, the real number
was closer to 10 million.36 Despite these cautions, media outlets were still
reporting, without qualification, account totals of 70 million in January
2005."7 Walter and Howie, on the basis of a variety of data, put the number

33
See Hu Ruyin et al., Zhongguo Shangshi Gongsi Zhili Mianlin de Wenti yu Duice
[Corporate Governance Problems Confronting Chinese Listed Companies and Measures to
Address Them], in GUO FENG & WANG RAN, GONGSI FA XIUGA ZONGHENG TAN [AN ALL-
AROUND DiscusSION OF REFORM OF THE COMPANY LAW] 172, 184 (Falii Chubanshe 2000)
(citing the Shanghai Stock Exchange as their source). The authors state that the figures for the
Shenzhen Stock Exchange are similar. This claim is borne out by SHENZHEN ZHENGQUAN
JIAOYISUO SHICHANG TONGJI NIANJIAN 2000 [SHENZHEN SECURITIES EXCHANGE MARKET
STATISTICS YEARBOOK 2000] 9 (Shenzhen Securities Exchange ed., Zhongguo Jinrong Chubanshe
2001) (showing 19 million accounts in 1998) and CHINA SECURITIES ASSOCIATION, ZHONGGUO
ZHENGQUAN SHICHANG NIANBAO 2000 [CHINA SECURITIES MARKET ANNUAL REPORT 2000] 47
(Zhongguo Jinrong Chubanshe 2000) (showing 39 million accounts for both exchanges in 1998).
34
See Woguo Zhen Gumin Buguo Yiqian Wan [True Shareholders in China Not More
than Ten Million], TIANJIN RIBAO [TIANJIN DAILY], Dec. 13, 2001, at 3.
31I have calculated this figure from the numbers provided in ZHONGGUO TONGJI
ZHAIYAO 2001 [CHINA STATISTICAL ABSTRACT 2001] 36-37 (State Statistics Bureau ed.,
Zhongguo Tongji Chubanshe, 2001).
36
See Woguo Zhen Gumin Buguo Yiqian Wan [True Shareholdersin China Not More
than Ten Million], supra note 34.
37
See 7000 Wan Gumin QunianMeihu Junping Kuisun 2045 Yuan [70 Million Stock
Investors Lost 2045 RMB Per Person on Average Last Year], BEIJING XIANDAI SHANGBAO
[BEHING MODERN BUSINESS NEWS], Jan. 5, 2005, available at http://finance.sina.com.cn/
stock/y/20050105/00011270285.shtml. One reason for the persistence of this grossly inaccurate
number may be the interests of the securities industry. It has attempted to resist regulation by
frightening the government with an argument amounting in effect to the claim that regulation
would pierce a bubble of (unwarranted) public confidence, cause market prices to plummet, and
send 70 million investors on to the streets in protest. A senior official in the Shanghai Stock
Exchange cited this number at a meeting attended by the author in 2004; his subordinates readily
admitted in subsequent conversations that everyone (including the official and others in the
 DELAWARE JOURNAL OF CORPORATE LAW [Vol. 31

of actual holders of shares at five to ten million, and estimate the number
of active traders to be only about one million.38
The presence of official and unofficial investment funds
complicates the picture further. Recent research suggests that as much as
40% to 50% of the value of circulating shares is controlled by official and
unofficial investment funds;39 when one then adds in the value of A-shares
controlled by other institutions, the amount in the hands of individuals
appears to be far less.
Overall and within the non-circulating share block, ownership
concentration is high in Chinese listed companies. Xu and Wang found
that as of 1995, the five largest shareholders in their sample (all firms listed
on the Shanghai and Shenzhen stock exchanges) accounted for 58% of
outstanding shares, as compared with 57.8% in the Czech Republic, 79%
in Germany, 33% in Japan, and 25% in the United States.4 ° Chen found
that the largest single shareholders held on average 48% of outstanding
shares, and that the largest ten shareholders held on average nearly 64% of
the outstanding shares. 4 Moreover, of the 12 largest companies on the
Shenzhen stock exchange, 11 had a single shareholder owning over 50%,
and in four of the largest companies, a single shareholder owned over
70%.2 Perhaps the best overall picture is that of Lou and Yuan, who report
that as of May 10, 2001, 177 out of 1206 listed companies (15%) were
more than 66% owned by a single shareholder; 510 (42%) were more than
50% owned; 742 (62%) were more than 37.5% owned; and 888 (74%) were
more than 30% owned.4 3

audience) knew the real number was nowhere near this.

3
See WALTER & HOWIE, supra note 22, at 140.
39
See id. at 150; Barry Naughton, The Politics of the Chinese Stock Market, CHINA
LEADERSHIP MONITOR, No. 3, 2002, availableat http://www.chinaleadershipmonitor.org.
'See Xu & Wang, supra note 29, at 76. The authors state cryptically that their figures
for China were calculated by themselves and are not "directly comparable" with the figures for
other countries, but they do not specify how their method of calculation differed from that used
in the studies from which they source their figures for other countries, and in any case they
specifically make the comparison in several places.
4
See Jian Chen, OwnershipStructureas CorporateGovernanceMechanism: Evidence
from Chinese Listed Companies, 34 ECONOMICS OF PLANNING 53, 61 (2001).
42
See Ning Ao et al., Guanyu Wanshan Shangshi Gongsi Zhili Jiegou de Ruogan
Cuoshi [On Several Measuresto Improve the Governance Structure in Listed Companies], in
GUO & WANG, supra note 33, at 235. The authors do not indicate how size was measured (i.e.,
whether by gross assets, some measure of market capitalization, or something else).
43
See Lou Fang & Yuan Hongqi, Duli Dongshi Zhidu: Xifang de Yanjiu he Zhongguo
Shijian Zhong de Wenti [The Independent DirectorSystem: Western Research andProblems in
Chinese Practice], GAIGE [REFORM], No. 2, 2002, at 51, 55. The authors' figure for the
proportion of companies more than 50% owned by the largest shareholder is difficult to reconcile
with the figure of 890 out of 1190 listed companies provided for the previous month in Wang
20061 CHINESE CORPORATE GOVERNANCE

Within the A-share (circulating shares) block, the pattern is similar.

In companies listed on the Shezhen Stock Exchange, for example, about 9%
of the shareholders own about 58% of the A-shares." Few large
shareholders are individuals. In a 1997 sample of 300 companies listed on
the Shenzhen Stock Exchange, only 42 companies listed individuals among
their five largest shareholders.4 5 Individual investors among the ten largest
shareholders still controlled only a small amount of stock: individual
holdings rarely exceeded 0.5% of the total, and the aggregate holdings of
such individuals constituted about 3.4% of total outstanding shares of the
sample companies.
Where state share ownership exists it appears to be concentrated.
Out of 541 listed companies with some state share ownership in 1999, in
312 the state shareholder was the only shareholder with a stake exceeding
5%. In over 87% of the 541 companies, the state held a controlling interest
either through a majority holding or a dominant holding. 46 Lin provides a
different angle on the issue, finding that in 1997, 97% of all listed
companies were state-owned, state-controlled, or had significant state share
ownership, and that 75% of the outstanding (not necessarily all listed)
shares of listed companies were directly or indirectly owned by the state
(indirect ownership presumably including ownership through state-owned
or state-controlled companies of legal person shares).47 Such direct or
indirect ownership continued in subsequent years. By the end of June
2002, state-owned shares (i.e., state shares and legal person shares owned
by state-owned entities) accounted for at least 70% of the outstanding
shares of over half of the largest 112 listed companies.4"
There are several problems with the studies on share ownership
that must be taken into account before attempting to read any significance
into the results. First, political authorities retain many channels of control,
both lawful and customary, through which internal corporate matters (for

Changbo & Feng Hualan, Lun DuliDongshiZhiduyu JianshihuiZhiduXiangJiehe de Jian Guan

Moshi [On the Monitoring Model Combining the Independent DirectorSystem and the System
of the Board of Supervisors], SHENGCHANLI YANJIU [RESEARCH IN PRODUCTIVE FORCES], No.
1, 2002, at 119, 121. Liu also provides the figure of 890 out of 1124 listed companies for the
same period. Liu Zhongwen, Shangshi Gongsi Yigu Duda Hai Yao Chixu Duojiu? [How Long
Will the Situation of "One Big Stockholder" Lastfor Listed Companies?], MEITAN QIYE GUANLI
[COAL ENTERPRISE MGMT.], No. 7, 2004, at 13, 13. None of the authors provides a source for
these numbers; I do not know who is right.
"See WALTER & HOwIE, supra note 22, at 133-34.
45
See Xu & Wang, supra note 29.
'See Zhang & Sun, supra note 29, at 36.
47
See Cyril Lin, Corporatisationand Corporate Governance in China's Economic
Transition, 34 ECONOMICS OF PLANNING 5, 24 (2001).
4See Ren, supra note 29, at 60.
 DELAWARE JOURNAL OF CORPORATE LAW [Vol. 31

example, the selection of the chief executive officer) may be influenced

even in the absence of a controlling share ownership.
Second, and on the other hand, a high proportion of state shares
does not necessarily mean highly concentrated ownership in a practical
sense. A given proportion of state shares would mean a given
concentration of ownership only if the state shares were all held by the
same body and subject to the same will. In fact, state shares can be held by
different bodies formally representing the state but pursuing very different
agendas.4 9 At the same time, however, effective concentration of
ownership in the hands of a single state body could be higher than the
statistics show, because as discussed above, the line between state shares
and legal person shares is often difficult to draw in terms of the motivations
and objectives of the shareholder. A governmental body could exercise
influence both through directly held state shares and through legal person
shares held by a controlled entity.5"
Third, the averaging of ownership concentration across companies
can create severe distortions, depending upon how it is done. A simple
averaging technique will yield an average ownership concentration of 50%
from a tiny company that is 90% owned by its largest single shareholder
and a huge corporation that is 10% owned by its largest single shareholder.
Clearly, this averaging is not very helpful. Weighting by numbers of shares
is equally unsatisfactory, because there is no reason why both companies
could not, for example, have the same number of shares outstanding
(although they would of course have different values). Finally, the most
obvious technique, weighting by the value of the company, has some
serious problems when applied to China because it is not clear how such
value should be measured. A simple market capitalization measure-
multiplying the market value of one share by the number of outstanding
shares-will certainly yield a number, but the meaningfulness of that
number is questionable. As noted earlier, only a small proportion of

49
This point is specifically made in Zheng Changde & Chen Zhe, Sichuan Shangshi
Gongsi Zhili Jiegou de Shizheng Fenxi [An EmpiricalAnalysis of the CorporateGovernance
Structure of Sichuan Listed Companies], XINAN MINZU XUEYUAN XUEBAO: ZHEXUE SHEHUI
KEXUE BAN [BULLETIN OFTHEXINAN MINORITIES INSTITUTE: PHILOSOPHY ANDSOCIAL SCIENCE
EDITION], No. 12, 2001, at 176, 180.
50 Zhang and Sun, for example, speak of shares that are state-owned "in nature" but
have been transferred from a state asset management organ to a state-owned group company. See
Zhang & Sun, supra note 29, at 38. Chinese government agencies themselves use inconsistent
(but not irrational, given their particular policy missions) definitions of share types. When legal
person shares are owned by a state-owned enterprise or other institution owned or controlled by
the state, they are called "state-owned legal person shares"; they are counted as state shares by the
State Assets Administration Bureau (such term to include its successor organizations) but as legal
person shares by the CSRC. See Lin, supra note 47, at 23.
2006] CHINESE CORPORATE GOVERNANCE

corporate shares-roughly one third-is tradeable on the public markets,

and it is by no means clear that the non-circulating shares should be valued
at the same price. Chen and his colleagues suggest that the market value
of non-circulating shares is far below that of circulating shares, sometimes
by as much as 90%. 1 The true discount may be even steeper, because the
price of non-circulating shares should reflect in many cases a control
premium; in general, a controlling block of shares simply cannot be
purchased on the stock market, and therefore control over a listed company
is transferred through the sale of non-circulating shares.
Despite all these issues, the bottom line is that concentrated
ownership, and therefore control, by a single state shareholder is quite
common in Chinese listed companies. A study of corporate governance
conducted in 2002 by the CSRC and the State Economic and Trade
Commission (SETC) found that of 1015 controlling shareholders in the
1175 listed companies studied, 77% could be considered state organs
(guojia xingzhi), while in 390 companies a single state shareholder held
over half of the shares.5 2 Using a different approach that traced the ultimate
ownership of both state shares and legal person shares, a recent study 53
found
that 84% of listed companies were ultimately under state control.

4. Relationship Between Ownership Structure and Performance

Some studies of Chinese listed companies have attempted to

correlate ownership structure with performance, measured in various ways.
In general, performance seems to be positively correlated with concentrated
ownership, at least to some point, and negatively correlated with dispersed
ownership.54 ("Concentrated ownership" must be understood here to mean
concentrated ownership by state agencies or legal persons because
concentrated ownership by individuals is virtually unknown.) The
explanation typically offered is that large shareholders reduce the free rider

"See Chen Zhiwu et al., Faren Gu Paimai Shizheng Yanjiu [Empirical Research into
Auctions of Legal Person Shares] (2000), at http://www.fsi.com.cn/fsi900/fsinews902/
902011212.pdf.
52
The study is reported in Guojia Jing Mao Wei Fuzhuren Jiang Qiangui: Zuo
Shangshi Gongsi Chengxin Fuze de Konggu Gudong [SETC Vice ChairmanJiangQiangui: Be
a Sincere and Responsible Listed Company Controlling Shareholder], supra note 20.
53
See Liu & Sun, supra note 21, at 2-3. Legal person shares counted toward state
control if the controller of the legal person shareholder was, directly or indirectly, a state
institution.
4
See, e.g., Lii & Wu, supra note 31, at 89-90 (reviewing various studies); Chen, supra
note 41, at 69; Qi et al., supra note 24, at 594; Sun Yongxiang & Huang Zuhui, Shangshi Gongsi
de Guquan Jiegou yu Jixiao [ShareholdingStructure and Performance in Listed Companies],
JINGJI YANJIU [ECON. RESEARCH], No. 12, 1999, at 23-30; Xu & Wang, supra note 29, at 86-87.
 DELAWARE JOURNAL OF CORPORATE LAW [Vol. 3 1

problem of small, dispersed shareholders and make better monitors of

management. 5 The same studies, however, find that performance is
negatively related to the proportion of state shares and positively related to
the proportion of legal person shares in the total capital stock.56 Thus, it is
not simply any large shareholder that will do. The large shareholder must
be an institutional shareholder that is separate enough from the state so as
not to be counted as a holder of state shares.
Several theories have been proffered to explain why companies
with a high percentage of legal person shares perform better than
companies with a high percentage of state shares. Generally, the
explanation is that state control causes poor performance-first, because

55
The poorer performance may also be the result of institutional deficiencies. Individual
dispersed shareholders are more dependent on institutional support such as a well functioning
legal system and an active and well informed financial press, whereas large blockholders can rely
on their own strength. Djankov and Murrell show that the performance of state-owned enterprises
after privatization is worse in those whose owners are less concentrated. See Simeon Djankov &
Peter Murrell, Enterprise Restructuring in Transition:A Quantitative Survey, 11 J. ECON.
LrrERATURE 739, 741, 759 (2002).
6
See, e.g., Chen, supranote 41, at 68; Qi et al., supranote 24, at 604-05; Xu Xiaonian,
Gongsi Zhili Jiegou: Zhongguo de Shijian yu Meiguo de Jingyan [The Structure of Corporate
Governance: China's PracticeandAmerica'sExperience](Zhongguo Renmin Daxue Chubanshe
2000); Xu & Wang, supra note 29, at 88. Lin and Dong have a similar result although they do
not label it as such. They note that performance is better when the leading shareholder is a
company limited by shares or a limited liability company (two corporate forms under China's
Company Law), and find worse performance in companies whose dominant shareholder is a so-
called "group company" (jituan gongsi) or "general company" (zong gongsi). See Lin Ling &
Dong Hong, Faren Zhili Jiegou yu Jingying Jixiao: Lai Zi Gao Keji Shangshi Gongsi de
Shizheng Fenxi [Legal Person Governance Structure and OperationalResults: An Empirical
Analysis ofHigh Technology Listed Companies], in Guo &WANG, supra note 33, at 204-34. The
latter two entities are typically not organized under the Company Law, but are instead
commercial-sounding names for what are essentially government agencies. Thus, they should be
considered state shareholders. Indeed, entities with such names are frequently listed as the holders
of shares designated "state shares" (guojia gu) in company reports. See, for example, the report
for Guangdong Baolihua Industry Co. Ltd. in ZHONGUO SHANGSHI GONGSI JIBEN FENXI [CHINA
LISTED COMPANY REPORTS] 282 (Zhongguo Faxue Jishu Chubanshe 1999) (naming Guangdong
Baolihua Group Company as holder of 71.8 million state shares (guojia gu)) or for Wenergy Co.
Ltd. in SHANGSHI GONGSi JIRBEN FEN [CHINALISTED COMPANY REPORTS] 194 (Zhongguo Faxue
Jishu Chubanshe 1999) (naming Anhui Provincial Energy Investment General Company as holder
of 468 million state shares).
Interestingly, Lin and Dong report that there is no apparent relationship between
performance and the proportion of shares publicly listed. See Lin & Dong, supra,at 208. This
necessarily implies, however, that there is no relationship between performance and the proportion
of shares not publicly listed: state shares and legal person shares (with some very small
exceptions). Therefore, their analysis would suggest that the key variable is not the proportion
of state or legal person shares overall, but their proportions relative to each other.
2006] CHINESE CoRPORATE GOVERNANCE

the state is necessarily an ineffective monitor of management,57 and second,

because the state pursues goals other than profit maximization."
The second explanation seems more plausible than the first. It is
no secret that one of the very purposes of state ownership of enterprises is
to enable the state to use its ownership, and thereby control, to cause the
enterprise to engage in activities that a profit-maximizing firm would avoid,
such as the sale of essential products at below-market prices, enforcement
of state birth control policies among employees, or pursuit of an urban full-
employment policy.
It is not clear, on the other hand, why the state must be a more
ineffective monitor than a non-state institutional share owner. Certainly,
the state official that performs the actual monitoring gets no personal
benefit from doing the job well, but the same could be said of a CalPERS
employee charged with monitoring the fund's holdings in a particular
company.59 In practice, of course, there are many reasons why the state
may do worse. First, the monitoring individuals may well be locally
employed and salaried, while the formal ownership of the shares is lodged
in a higher level of government. A monitor responsible to local
government will not object to corporate policies such as high employment
that are beneficial to local government at the expense of the central state
shareholder. Second, a monitor working in a government agency may be
less able to distinguish good from bad corporate policy than a monitor in
a business-oriented institutional shareholder.6' Third, an individual
monitoring on behalf of the state is much less likely to have someone at
some point above him in the chain of command making a strong demand
for good corporate performance in companies held by the state.

57
See Zhang & Sun, supra note 29, at 37; X.L. Ding, The Illicit Asset Stripping of
Chinese State Firms, CHINA J., No. 43, 2000, at 1; Yingyi Qian, EnterpriseReform in China:
Agency Problemsand PoliticalControl,4 ECON. OF TRANSITION 427, 428 (1996).
58
Qi and his colleagues note that correlation does not equal causation: it may be that
the state invests in poorly-performing firms, while non-state institutional shareholders invest in
well-managed ones. They test for causality by looking at changes in ownership proportions in a
given firm over time, and find that as legal person shareholding increases, so does performance.
See Qi et al., supra note 24, at 607-09.
59
For a discussion of the incentives facing human money managers employed by
institutional investors, see Bernard S. Black, Agents Watching Agents: The Promise of
InstitutionalInvestor Voice, 39 UCLA L. REV. 811, 876-83 (1992).
'For a fuller discussion, see Qi et al., supra note 24, at 594-95. See also Pamela Mar
& Michael N. Young, Corporate Governance in Transition Economies: a Case Study of Two
Chinese Airlines, 36 J. OF WORLD Bus. 280, 282 (2001) ("[A]lthough Chinese SOEs [(state-
owned enterprises)] have concentrated ownership (i.e., the state) the potential positive effect of
such an arrangement is absent because of the dispersal of state representation ....In short, many
SOEs are simply monitored inadequately or ineffectively.").
 DELAWARE JOURNAL OF CORPORATE LAW [Vol. 31

Putting aside the question of the difference between legal person

shareholders and state shareholders, it remains to be discussed why
concentration of ownership in the hands of legal person shareholders might
be positively correlated with performance. As noted above, the usual
argument is that concentration of shareholdings gives the shareholder an
incentive to monitor management that is absent in a small shareholder,
since the benefit of monitoring is too attenuated to be worth the cost.6 On
the other hand, it is also reasonable to be concerned that as a shareholder's
influence over the corporation rises, the reduced risk of expropriation of
shareholders by management is replaced by the increased risk of
expropriation of minority shareholders by majority shareholders. As
Shleifer and Vishny note, "[un large corporations of most countries, the
fundamental agency problem is not the Berle and Means conflict between
outside investors and managers, but rather than between outside investors
and controlling shareholders who have nearly full control over the
62
managers.
The prospect of dominant shareholders exploiting minority
shareholders, rather than that of Berle-and-Means managers enjoying on-
the-job consumption at the expense of all shareholders, is certainly the one
that seems most worrisome to Chinese commentators (except where the
state is the dominant shareholder, where the concern is of ineffective
monitoring leading to mismanagement and asset-stripping).
Research on U.S. firms indicates that the relationship between firm
performance and ownership concentration is an inverted V: as concen-
tration rises, performance rises at first, but then declines as concentration
rises still further.63 The explanation, according to Shleifer and Vishny, is
that "as ownership gets beyond a certain point, the large owners gain nearly

6
As will be discussed below, the usual substitutes for shareholder monitoring as a
means of disciplining managers-shareholder litigation, the managerial labor market, the input
and product market, and the market for corporate control-do not, with the exception of the input
and product market, function at all well in China. Indeed, even the Wall Street Rule is hard to
apply in the case of legal person shareholders because their shares are so illiquid.
62
Andrei Shleifer & Robert W. Vishny, A Survey of CorporateGovernance, 52 J. OF
FiN. 737 (1997). Others make a similar finding in a detailed study of several East Asian
economies: "[Tihe salient agency problem in [East Asian] economies is expropriation of outside
shareholders by the controlling shareholder." Mara Faccio et al., Dividends and Expropriation,
91 AM. ECON. REv. 54, 55 (2001).
63
See, e.g., John McConnell & Henri Servaes, Additional Evidence on Equity
Ownership and CorporateValue, 27 J. FIN. ECON. 595 (1990); Karen Wruck, Equity Ownership
Concentrationand Firm Value, 23 J. FIN. ECON. 3 (1989). But see Harold Demsetz & Kenneth
Lehn, The Structureof CorporateOwnership:Causes and Consequences,93 J. POL. ECON. 1155
(1985) (finding no significant correlation between ownership concentration and profit rates for
511 large corporations).
20061 CHINESE CoRPORATE GOVERNANCE

full control and are wealthy enough to prefer to use firms to generate
private benefits of control that are not shared by minority shareholders. "' 64
This pattern has not been observed in Chinese firms-possibly
because virtually all listed firms have at least 30% public shareholding,
making it hard to find examples of highly concentrated ownership, and
possibly because the studies simply have not yet been done. If anything,
the opposite pattern has been observed. One study found that performance,
as measured by the ratio of market value to book value, followed a U-
shaped curve as ownership concentration by legal person shareholders
increased. The study's authors hypothesized that individual investors at
first feared expropriation by such shareholders-that they would use their
influence to expropriate-but believed that as their stake rose, the interests
of the legal person shareholders would become more congruent with
theirs." In other words, a controlling shareholder's ability to expropriate
would remain constant whether it owned 51% or 91%, but its incentive to
do so would decline as its financial interest in the corporation increased.
Another study found that performance peaked when the largest shareholder
held 30% to 50% of the stock, and was worst when no shareholder held
more than 30%.66
Until further research is done, probably the most that can be safely
said is that concentrated ownership by non-state shareholders is probably
by and large a good thing that should not be discouraged by the law-there
is some evidence that it is valued by the market 67 -and that public
shareholders are probably capable of taking the possibility of dominant-
shareholder expropriation into account.

B. CorporateGovernance in General

The concept of corporate governance is extremely broad, and a

number of definitions of varying degrees of complexity and scope are
possible. Perhaps the simplest definition-in words, if not in scope-is
found in the report of the Committee on the Financial Aspects of Corporate
Governance (the Cadbury Report), which defines corporate governance as

64Shleifer & Vishny, supra note 62, at 759.

65
See Xu & Wang, supra note 29, at 91.
6See Lin & Dong, supra note 56, at 205.
67
See Qi et al., supra note 24, at 609; Xu & Wang, supra note 29, at 95. A problem
with both of these studies is that they appear to assume that a given proportion of legal person
shareholding is more concentrated than the same proportion of individual shareholding. This is
probably true as an empirical matter, but it is not a necessary characteristic of legal person
ownership.
 DELAWARE JOURNAL OF CORPORATE LAW [Vol. 31

"the system by which companies are directed and controlled."6 8 Margaret

Blair supplies a very broad definition, calling it "the whole set of legal,
cultural, and institutional arrangements that determine what publicly traded
corporations can do, who controls them, how that control is exercised, and 69
how the risks and returns from the activities they undertake are allocated. ,
A slightly narrower definition is used by institutional economists
such as Oliver Williamson, who in his chapter on corporate governance sets
out to examine the relationship between the firm and each of what he calls
its constituencies: labor, capital (equity and debt), suppliers, customers, the
community, and management. 7° This conception of corporate governance
essentially attempts to cover everyone who participates in some way in the
process by which a firm's product is produced and sold. It sees these
parties (with the exception of "the community") as engaging in voluntary
interactions with the firm, and the question it poses is: What are the terms
on which they interact, and why do those terms look the way they do?
"Governance," in the work of Williamson and others writing in a similar
vein, refers to the institutional structure parties set up to deal with the
inevitable incompleteness of their contracting, and attempts to explain
voluntary relationships in those terms.
Finally, the narrowest definition-and the one adopted in this
article-centers around the relationship between stockholders, the board of
directors, and senior management, 7 ' and deals with "the ways in which
suppliers of finance to2 corporations assure themselves of getting a return
7
on their investment.
One of the key tensions within any system of corporate governance
is the necessary tradeoff between authority and accountability. On the one
hand, managers must be allowed a certain amount of leeway to make
decisions and even to make mistakes; this is why they are hired to manage
in the first place. Protection for minority shareholders cannot go too far
because they may use their power to block the majority from undertaking
reasonable and justified measures unless they are paid off. Unlimited

68
FINANCIAL REPORTING COUNCIL, LONDON STOCK EXCHANGE, REPORT OF THE
COMMITTEE ON THE FINANCIAL ASPECTS OF CORPORATE GOVERNANCE 2.5 (Gee & Co., Ltd.
1992), available at http://www.ecgi.org/codes/code.php?codeid=132 [hereinafter CADBURY
REPORT].
69
MARGARET M. BLAIR, OWNERSHIP AND CONTROL: RETHINKING CORPORATE
GOVERNANCE FOR THE TWENTY-FIRST CENTURY 3 (The Brookings Inst. 1996).
70
See OLIVER E. WILLIAMSON, THE ECONOMIC INSTITUTIONS OFCAPITALISM 298 (The
Free Press 1985).
"See Mark J. Roe, Path Dependence, PoliticalOptions, and Governance Systems, in
COMPARATIVE CORPORATE GOVERNANCE: ESSAYS AND MATERIALS 165, 168 (Klaus J. Hopt &
Eddy Wymeersch eds., Walter de Gruyter 1997).
"Shleifer & Vishny, supra note 62, at 737.
2006] CHINESE CORPORATE GOVERNANCE

protection for minority shareholders simply erases the distinction between

small stakes and large stakes, and subjects all corporate decisionmaking to
second-guessing by the body-perhaps a court-charged by the law with
providing the protection.
On the other hand, it is equally clear that managers cannot be left
wholly unaccountable. If they were, they would have no incentive to
maximize anyone's interests but their own, and others would therefore have
no incentive to commit resources to their management, leading to the
collapse of the enterprise. Dooley sums up the paradox by positing two
models of corporate governance: the Authority Model, which is concerned
with giving directors and officers sufficient power to manage the
corporation, given that the shareholders cannot and do not expect to do so,
and the Responsibility Model, which is concerned with ensuring the
accountability of directors and officers to shareholders and perhaps
others.73 As he points out, "[N]either Model exists in pristine form in the
real world."74 Elements of both are needed in a functioning regime of
corporate governance.75 But as he also points out, "Authority and
Responsibility are both essential values because each responds to one of the
two principal kinds of costs incurred in operating as a firm. Unfortunately,
these values are also antithetical, and more of one means less of the
76
other."

C. CorporateGovernance in China

Any one of the definitions of "corporate governance" canvassed

above could be serviceable depending on its intended purpose. For the
purposes of this article, however, I will define corporate governance as the
set of rules and practices regulating relationships among participants in a
post-traditional Chinese business enterprise and governing decisionmaking
within that enterprise. By "post-traditional" enterprise I mean any
enterprise that is no longer bound tightly within the traditional state
planning system and operated by its administrative superior agency
essentially as a division within a larger enterprise.77 It is an enterprise in

13See Michael P. Dooley, Two Models of CorporateGovernance,47 Bus. LAW. 461,

463 (1992).
741d.
7"See id. at 463-64.
' 61d. at 464.
7"Most such enterprises are governed by China's Law on Industrial Enterprises Owned
by the Whole People (Quanmin Suoyouzhi Gongye Qiye Fa), adopted Dec. 2, 1986 [hereinafter
the State-Owned EnterpriseLaw].
 DELAWARE JOURNAL OF CORPORATE LAW [Vol. 31

which voluntary, contractual relationships are important and top-down

commands from government are less important.
This definition makes clear my understanding that current
discussions in China do not focus on the state-owned enterprise in its
traditional form. Instead, these discussions take for granted that this form
is on the way out.78 They do deal with state ownership of industrial and
commercial enterprises, but in the capacity of a stockholder or equity owner
of a company organized under the Company Law, not in the capacity of
controller of a traditional state-owned enterprise governed (at least
formally) by the State-Owned Enterprise Law.
Corporate governance in the post-traditional enterprise has caught
the attention of policymakers and academics for a good reason. At the
macroeconomic level, the focus of state economic reform policy has been
to move from a system of regulation by direct command to a system of
regulation by government adjustment of market signals. By the same token,
the focus of reform policy at the microeconomic level has been to move
from a system of governance of firms through direct administrative
commands to a system of governance that works by establishing institutions
that operate in relation to each other to produce the desired result. Thus,
for example, the state ideally seeks to make enterprises more efficient no
longer by ordering state-owned enterprise managers to reach certain profit
targets, but by putting the power to select managers in the hands of
directors who represent profit-oriented shareholders.7 9
At least in form, state-owned enterprise reform has seen significant
progress. Over 80% of small and medium state-owned enterprises have
been transformed from a traditionally structured enterprise into a corporate
entity under the Company Law or some other organizational law or
regulation, and over 1200 large enterprises have restructured themselves

7
This does not mean that state ownership of enterprises is on the way out. The
government has explicitly declared its firm commitment to retaining control over enterprises in
several sectors: national security-related industries, natural monopolies, sectors providing
important goods and services to the public, and important enterprises in pillar industries and the
high-technology sector. See Heli Buju Tiaozheng Jiegou, Fazhan Zhuangda Guoyou
Jingi-FangGuowuyuan Guoyou Zichan Jiandu Guanli Weiyuanhui Zhuren Li Rongrong
[Rationally Lay out StructuralAdjustment, Develop a GreatState-Owned Economy: A Visit with
the Chairmanof the State Council's State Asset Supervision and Management Commission, Li
Rongrong], JINGJI RIBAO [EcON. DAiLY], Internet ed., June 13, 2003.
79
On the policies behind reform in the state-owned enterprise sector, see generally
Clarke, supra note 18.
2006] CHINESE CORPORATE GOVERNANCE

into joint stock companies and raised funds through a public issue of shares
and subsequent listing on one of China's two stock exchanges."0
The operation of the board of directors of such companies presents
complex problems. Chinese discussions of the board typically focus on two
areas of concern. It is important to understand the distinction between them
in order to assess the potential effectiveness of independent directors in
addressing them.
One prominent complaint about the current regime governing the
powers and responsibilities of enterprise managers is that there is too much
"insider control" (neibu ren kongzhi).' Because control of the firm must
rest with some person or persons, and those persons are virtually insiders
by definition, it is necessary to unpack this complaint a little. What is
usually meant is insider control unfettered by effective accountability
mechanisms, with the result that assets belonging to the corporation are
converted through various subterfuges into the personal property of
management. This asset-stripping, a familiar phenomenon in transition
economies, is made possible by the devolution of considerable managerial
authority to the enterprise level coupled with the legalization of new forms
of trade and new privately-controlled entities to which the stripped assets
can, by means of controlled transactions, be transferred. The complexity
of property relations and ownership forms has outstripped the state's
capacity to monitor, which remains designed for the simple structures of an
earlier day, when private ownership of significant property was not
allowed, and transfers between enterprises were physical and not
financial.82 The result is the phenomenon of the "absent owner" (suoyouzhe
quewei): it is not collective action problems that prevent effective
shareholder monitoring, since there is a large and possibly sole shareholder,
but rather organizational problems internal to that shareholder.

8
See STOYAN TENEV & CHUNLINZHANG, CORPORATE GOVERNANCE AND ENTERPRISE
REFORM IN CHINA: BUILDING THE INSTITUTIONS OF MODERN MARKETS, at xi (World Bank and
the International Finance Corporation 2002).
81
See, e.g., Liu Yunpeng, CongXiandai Qiye Lilun yu ChanquanLilun Kan Zhongguo
de Gongsi Zhili Wenti [Looking at Chinese Corporate Governance Issuesfrom the Standpoint
of the Theory of the Modern Firm and the Theory of PropertyRights], in ZHONGGUO GONGSI
ZmiLmJou [THESTRUCrUREOFCORPORATEGOVERNANCEIN CHINA] 119, 129 (China (Hainan)
Reform and Development Institute ed.,Waiwen Chubanshe 1999); Xiu Meizheng, Qiye Chongzu
yu Gongsi Zhili Jiegou [EnterpriseReorganizationand CorporateGovernance Structure],in id.
at 83, 83.
82
See Ding, supra note 57.
3
The same phenomenon has been noted among institutional investors in Western
countries, who are often criticized for being unduly passive even when "they have strong
reservations about strategy, personnel, or other potential causes of underperformance." DEREK
HIGGS, REVIEW OF THE ROLE AND EFFECrIVENESS OF NON-EXECUTIVE DIREcrORS 15.22 (The
Stationery Office 2003), available at http://www.dti.gov.uk/cld/nonexecreview.
 DELAWARE JOURNAL OF CORPORATE LAW [Vol. 31

If management commits waste and fraud at the expense of

shareholders, this is obviously of direct concern to the state because of its
large stake in the enterprises being looted. But it is also a government
concern where the state is not a significant shareholder because in addition
to damaging individual (and institutional) shareholders, mismanagement
and asset-stripping will, by discouraging investment in corporations, raise
the cost of capital in the economy generally and hinder growth.
A second complaint is that management may respond all too well
to a board under the control of a dominant shareholder (yigu duda), which
will use its power to exploit minority shareholders through such devices as
manipulating prices in transactions with controlled entities.84 Indeed, when
corporate governance failings are specifically studied, they typically relate
to abuse by the dominant shareholder of its position, not to the depredations
of management at the expense of shareholders as a whole. 85 For example,
a 2002 study of corporate governance by the CSRC and the SETC revealed,
on the basis of self-reporting alone, that 40% of listed companies engaged
in related-party transactions with their top ten shareholders. 86 A related-
party transaction is not, of course, necessarily a transaction on unfair terms
to the company, but given the lack of institutional safeguards that might
ensure fair terms, there are legitimate grounds for concern. The
CSRC/SETC study further found that 676 listed companies had had their
funds misused by their parent company (the controlling shareholder) in the
amount of almost US$12 billion.87
The concern of the government in this case is once again that the
public may lose faith in corporate stock as an investment, raising the cost

"See, e.g., Gu Gongyun, GongsiFaXiugaiYingJiejuedeRuoganShiji Wenti [Several

PracticalProblems thatShould Be Solved in a Revision of the Company Law], in Guo & WANG,
supra note 33, at 57, 60.
"SAt least one article laments at the same time the overconcentration of stock in the
hands of large shareholders and the inability of shareholders to monitor management because of
the dispersion of voting power brought about by the many varieties of share types. See Zheng &
Chen, supra note 49, at 180.
86
See Guojia Jing Mao Wei Fuzhuren JiangQiangui:Zuo Shangshi Gongsi Chengxin
Fuze de Konggu Gudong [SETC Vice ChairmanJiang Qiangui:Be a Sincere and Responsible
Listed Company ControllingShareholder],supra note 20. Other empirical studies of related-
party transactions include Meng Hui et al., ShangshiGongsi GuanlianJiaoyiXingwei Jianguan
de Shizheng Yanjiu [An EmpiricalStudy of the Monitoring of Related-Party Transactions in
Listed Companies], JINGJI Yu GuANu YANJIfu [ECONOMICS AND MANAGEMENT RESEARCH], No.
1, 2004, at 61, and Wang Ruiying et al., Woguo Shangshi Gongsi GuanlianJiaoyi de Shizheng
Yanjiu [An EmpiricalStudy of Related-PartyTransactionsin Listed Companies],CAIMAO JINGJI
[FINANCE & TRADE ECONOMICS], No. 12, 2003, at 29.
87
See Guojia Jing Mao Weifuzhuren Jiang Qiangui:Zuo Shangshi Gongsi Chengxin
Fuze de Konggu Gudong [SETC Vice ChairmanJiang Qiangui:Be a Sincere and Responsible
Listed Company ControllingShareholder],supra note 20.
2006] CHINESE CORPORATE GOVERNANCE

of capital throughout the economy."8 Thus, policymakers are concerned

with the consequences of both underconcentration and overconcentration
of share ownership.
The picture is further complicated by the fact that although the state
has an interest in preventing dominant shareholder exploitation of minority
shareholders when it is a passive shareholder, it may itself be guilty of such
exploitation when it is the dominant shareholder.8 9 Indeed, the entire
project of retaining majority state ownership, and therefore control, in

88The view of the government and most Chinese commentators-that public confidence
in corporate governance procedures and the honest functioning of the securities markets is
essential to the ability of firms to raise money from public investors, and therefore essential to the
economy as a whole-is shared by most foreign commentators, but appears to rest more on
intuition and common sense than on solid evidence. First, considerable funds have in fact been
raised from public investors-US$86 billion by the end of 2002, see Li Qing, Chu Du Shang
Fulin [A PreliminaryReading of Shang Fulin], CA1lING [FIN. & ECON,], Nos. 3-4, 2003, at 36,
36, and US$141 billion by the end of January 2005, see China Securities Regulatory Commission,
TongjiXinxi [StatisticalInformation],Biao2-2: ZhengquanShichang Chouzi TongjiBiao [Table
2-2: Table of Capital Raising in the Securities Market], available at http://www.crsc.
gov.cn---even in the probable absence of substantial public confidence in corporate governance
procedures. Of course, perhaps this amount would have been much higher had the public had
more confidence, but the relatively high price-to-earnings ratio prevailing on the Chinese stock
market (on average ranging from 40 to 50, see WALTER & HOWIE, supra note 22, at 136,
considerably higher than the low-20s average prevailing on the New York Stock Exchange)
suggests that public investment is being limited by supply, not by demand. Second, it is not clear
that well-functioning securities markets really are, at least at present, essential to the economy as
a whole. In 2001, for example, enterprises raised US$14 billion from share issues, but borrowed
more than ten times that amount-US$157 billion-from banks. Figures from 2002 suggest that
the stock market is actually in decline as a source of capital: IPOs and share rights issues raised
only US$8.9 billion from January to September 2002, down 30% from the same period in the
previous year, while bank financing rose 55% (well above the rate of growth) to $170 billion
(over the same period). Overall, the stock market provided about 5% of official corporate
financing. See GREEN, supra note 20. Listed companies themselves are of significant but not
overwhelming importance in the economy, accounting for 8% of GDP and 17% of enterprise
income tax receipts in 2001. See Zhongguo Shangshi Gongsi de Zonghe Jixiao Zhengzai
Fashengzhe Zhi de Bianhua [Overall Results of Chinese Listed Companies Undergoing
QualitativeChange], ZHONGGUO ZHENGQUAN BAo [CHINA SEC. NEWS], Nov. 1, 2002.
For an argument that weak corporate governance, insofar as it saps the confidence of
investors in their ability to forestall managerial expropriation, can exacerbate financial crises, see
Simon Johnson et al., CorporateGovernance in the Asian FinancialCrisis, 58 J. FIN. ECON. 14 1,
142 (2000).
89
Mar and Young, for example, report that China Southern Airlines and China Eastern
Airlines, both of which are publicly listed but in which the dominant shareholder is a state agency,
can be forced to purchase aircraft they may not want from the state: "[Wihen [the Civil Aviation
Authority of China] buys too much [aircraft], they have to put them somewhere." Mar & Young,
supra note 60, at 297 (quoting a Hong Kong industry analyst). The potential for a conflict of
interest is explicitly recognized by one commentator, who proposes that dominant state
shareholders voluntarily refrain from policies that hurt minority shareholders so as not to
discourage investment in the securities markets. See JianEmQiangui, GongsiZhili yu Guoyou Qiye
Gaige, ZHONGGUO ZHENGQUAN BAO [CHINA SEC. NEWS], Internet ed., June 12, 2001. See,
however, the remarks of Xiang Bing infra at text accompanying note 167.
 DELAWARE JOURNAL OF CORPORATE LAW [Vol. 31

particular firms or sectors has as its purpose the use of that control to
achieve objectives other than profit maximization-for example, full
employment or strategic control of a particular industry that for some
reason cannot be achieved through regulation. 9 The ideological j ustifica-
tion for retaining state majority ownership cannot lie in simple profit
maximization for the state, since there is no a priori way of knowing
whether profits would be maximized by keeping the state's holdings in a
particular firm or by selling them, and indeed firms without dominant state
ownership have been shown in several studies9" to outperform firms with
dominant state ownership. Thus, as long as state policy requires the state
to stay as an active investor in firms of which it is not the sole shareholder,
meaningful legal protection for minority shareholders is going to mean
either constraints on the state's ability to do precisely those things for which
it retained majority ownership, or else a defacto separate legal regime for
enterprises in which the state is the dominant shareholder.

IUt. INDEPENDENT DIRECTORS AS A SOLUTION

TO CORPORATE GOVERNANCE PROBLEMS

One institution of corporate governance that has recently come to

prominence as a potential solution to many of the problems of Chinese
corporate governance is the independent director. Like many legal
borrowings, the independent director is viewed by different parties as a
solution to different specific concerns. Those problems may or may not be
related to the problems that led to the development of a concept of
independent director in the jurisdiction from which the borrowing takes
place.

A. Functions of the Non-Management Director

To understand more fully the functions and potential of the

independent director in China, it is useful to canvass other conceptions of
the independent director. To do so, we must first seek a more general term,
for not all jurisdictions place a great deal of importance on directors who

The notion that state control will be maintained in particular sectors with the specific
intent of "influencing and guiding" the use of social capital-i.e., causing it to be used in ways
that serve the state's interests, which are not necessarily those of small investors-was expressed
in an interview by Jiang Qiangui, vice chairman of the SETC. See Guojia Jing Mao Wei
FuzhurenJiang Qiangui:Zuo ShangshiGongsi Chengxin Fuze de Konggu Gudong [SETC Vice
Chairman Jiang Qiangui: Be a Sincere and Responsible Listed Company Controlling
Shareholder], supra note 20.
91
See, e.g., Chen, supra note 41; Qi et al., supra note 24; Xu & Wang, supra note 29.
2006] CHINESE CORPORATE GOVERNANCE

might plausibly be called "independent." Different jurisdictions and

corporate governance norms speak variously of directors who are "non-
interested, 9' 2 "independent, ' 93 "outside,"'9 4 "non-executive," 95 "non-
employee, '96 and "disinterested." 97 Each of these terms is defined
differently and implies a different role for the director it describes, yet they
are frequently discussed together as if they were all describing the same
thing, and conclusions about directors of one type are applied to directors
of another.98
The generic term I shall use here is "non-management" director
(NMD), because it captures the one element all of the above terms have in
common: the director in question is not a member of the current senior

92
See Investment Company Act (ICA) (codified in relevant part at 15 U.S.C. § 80a-
2(a)(19) (2000)).
93
See Securities Exchange Act of 1934 (SEA) § 10A (codified at 15 U.S.C.
§ 78f(m)(3)(B) (2000)). The provision in question comes from Section 301 of the Sarbanes-Oxley
Act of 2002 (SOA). Sarbanes-Oxley Act of 2002 § 301 (codified at 15 U.S.C. § 78f (2002)).
94See SHOHO [COMMERCIALCODEOFJAPAN], art. 188(2)(7.2) (2002) (using the term
shagaitorishimariyaku-literally,"director from outside the company").
95
See CADBURY REPORT, supra note 68, at 22.
96See Rule 16b-3 under the Securities Exchange Act promulgated by the Securities and
Exchange Commission (SEC). 17 C.F.R. § 240.16b-3(b)(3)(i) (2005).
97
See, e.g., DEL. CODE ANN. tit. 8, § 144 (2001); MODEL Bus. CORP. ACT § 8.31
(2005).
98
Miwa and Ramseyer, for example, use data on outside directors in Japan to refute
what they take to be the conventional wisdom about the role of independent directors. For
statistical convenience, however, they follow what they say is the Japanese custom of defining as
an "outsider" anyone who has a past or concurrent career outside the firm. This would include,
for example, partners at law firms whose major client was the firm in question, who would not
qualify under most definitions of "independent." Indeed, they explicitly note that the vast majority
of outside directors take such directorships as full-time jobs with the firm on whose board they
sit. See Yoshiro Miwa & J. Mark Ramseyer, Who Appoints Them, What Do They Do? Evidence
on OutsideDirectorsfrom Japan 11-14 (Harvard Univ., John M. Olin Center for Law, Economics
and Business, Discussion Paper No. 374, 2002), available at http://papers.ssm.com/
abstractid=326460. The conventional wisdom about independent directors may indeed be
wrong, but no conclusion derived from a study of this kind of outside director can rigorously
demonstrate it. The definition of "outside director" (shagaitorishimariyaku)in Japanese law is
somewhat stricter than the Miwa-Ramseyer definition (see infra text accompanying note 134), and
the distinction between outside directors and independent directors is well understood. See Shagai
Torishimariyaku to Dokuritsu Torishimariyaku [The Outside Directorand the Independent
Director], YASASHII KEIZAI YOGO NO KAISETSU [EASY EXPLANATIONS OF ECONOMIC TERMS],
at http://www.nikkei4946.contoday/0305/11.html (Japan Economic News website).
Two prominent Delaware judges, Chancellor William Chandler and Vice Chancellor
Leo Strine of the Delaware Court of Chancery, specifically warn against the danger in
adjudication of confusing independence (or the lack of it) with disinterestedness (or the lack of
it). See WILLIAM B. CHANDLER III & LEO E. STRINE, JR., THE NEW FEDERALISM OF THE
AMERICAN CORPORATE GOVERNANCE SYSTEM: PRELIMINARY REFLECTIONS OFTWO RESIDENTS
OFONE SMALL STATE 62 (New York University Center for Law and Business, Working Paper No.
CLB 03-01, 2003), availableat http://papers.ssrn.com/abstract=367720.
 DELAWARE JOURNAL OF CORPORATE LAW [Vol. 31

management team.99 This negative feature is, however, consistent with

several different positive features, some of which are mutually inconsistent,
and each of which contemplates a different conception of the role of the
non-management director.
Before canvassing these conceptions, however, it will be useful to
set forth some general ideas about the possible functions of NMDs in a
corporate governance system. The particular conceptions of different
jurisdictions can then be analysed in terms of which function or functions
they seem to value, and whether those functions are in fact likely to be
fulfilled.
The role of NMD can be analyzed according to whether the NMD
is perceived as a substitute for external regulation or as an implementer of
it. In American corporate law, for example, the NMD primarily functions
as a substitute for external regulation. Courts and legislatures are wary of
becoming too involved with the business decisions of corporate manage-
ment. Thus, even the apparently fundamental and unobjectionable idea that
transactions between a corporation and a director should be on terms that
are fair to the corporation is not imposed on corporations as a substantive
rule of law in Delaware or in the Model Business Corporation Act (MBCA)
if the corporation's board has disinterested directors and a majority of them
have, after full disclosure, approved the transaction. 0
One could also imagine NMDs as implementers of external
regulation. In such a case, the relevant standard of behavior would be set
externally, not by the NMDs themselves, and they would be expected to
help implement those standards. This could be done in a number of ways:
through exercising their voting power on the board to induce the company
to act in compliance with the standards, through using their access to
information to alert the authorities to non-compliance, or through using
their access to information to certify compliance.
Each of these methods, however, poses difficulties. If one is to rely
on NMDs to exercise their voting power in favor of compliance with
external standards, then there needs to be some reason for believing that
NMDs will be more likely to do so than non-NMDs. Both kinds of
directors can be subject to sanctions for voting to violate clear legal
obligations. If the purpose is to encourage corporations to act in
accordance with principles that do not constitute legal obligations (for
example, "maximize local employment"), then it is unlikely that NMDs

99This is, of course, what is usually meant by "non-executive" director. On the other
hand, some people say "non-executive" when they really mean "independent" or "outside." I am
deliberately creating a new term here so that what I mean by it can be kept clear.
"°Seeinfra discussion at text accompanying notes 143-46.
2006] CHINESE CORPORATE GOVERNANCE

elected by, and owing fiduciary duties to, profit-maximizing shareholders

will produce this result. An entirely different constituency would have to
be given the power to elect NMDs.
If the state relies on NMDs to use their access to information to
alert it to corporate non-compliance with legal standards, then once again
we face the problem of selecting directors who will internalize this duty.
Moreover, directors whose job it is to inform on the company will find their
access to information considerably decreased. Again, it is perfectly
conceivable to have a rule that requires directors and others with 10
knowledge of certain types of violations to report them to the authorities, '
but there does not seem to be any reason to distinguish NMDs from non-
NMDs in this respect.
Finally, it is possible to use NMDs to certify that certain standards
have been complied with-for example, that the annual report is accurate,
or that the balance sheets have been prepared in accordance with proper
accounting standards. In the United States, this job is generally left to
independent professionals, and their duty of care is enforced, among other
ways, by allowing persons to rely on the certification and to sue if that
reliance results in damages. There is no particular reason why NMDs could
not perform this function, but there is no particular reason why they should.
If NMDs are required to back up their certification with their personal
wealth, few may be willing to take on the job. If they are not, then they
have little incentive to be responsible. A separate firm that specializes in
the information in question-an accounting firm or a law firm, for
example-can get access to the same information if the company is willing
to grant it (and it would have to do so), and can better bear the risk of the
occasional error leading to liability. Moreover, certification of information
by a large organization with a reputation to consider is more likely to be
reassuring to users of that information than certification by an unknown
person of unknown resources.

B. Conceptions of the Non-Management Director

Differing conceptions of the NMD's role are not usually mere

abstract ideas. Different conceptions imply different structures within
which such directors are to fulfill their contemplated role. The following
discussion will not, therefore, simply canvass different definitions of the

'01See, for example, 12 C.F.R. § 208.62 (2005), which requires U.S. banks to file
reports of suspected criminal activity with the Federal Reserve Bank and subjects directors and
officers, among others, to disciplinary action if the bank fails to do so.
 DELAWARE JOURNAL OF CORPORATE LAW [Vol. 31

NMD. °2 It will also bring out how those different definitions relate to the
different functions of the director. By understanding the broad range of
possible roles for non-management directors, we can understand more fully
the actual institution of the independent director in China.

1. The "Independent" Director

A major theme in corporate governance writing is the need for non-

management directors on the board to serve as a check on management in
the interests of shareholders. In other words, non-management directors are
there to help shareholders solve the agency problem. If such directors are
to monitor management effectively, they must be independent of
management. From this contemplated role stems the typical definition of
independent director: one who has no need or inclination to stay in the good
graces of management, and who will be able to speak out, inside and
outside the boardroom, in the face of management misdeeds in order to
protect the interests of shareholders.
A competing conception of the director who is independent of
management holds that the director's duty is to protect the interests of a
number of different groups, not just shareholders, and indeed sometimes to
act against the interests of shareholders in order to protect, for example,
employees." 3 The latter view of the role of the independent director---one
who is independent of profit-seeking shareholders as well as independent
of management-has not, however, found fertile soil in American corporate
law scholarship or practice. The dominant view has been that directors

"°2For a convenient table showing different conceptions of what I call the NMD, see
CALIFoRNIA PuBuc EMPLOYEES' RETIREMENT SYSTEM (CALPERS), CORPORATE GOVERNANCE
CORE PRINcIPLES AND GUIDEUNES: THE UNITED STATES, app. B-2 ("Variations on a Theme-
'Independent Director') (1998), available at http://www.calpers-governance.org/principles/
domestic/us/pageOl .asp.
l03For a discussion of these competing concepts, see Victor Brudney, The Independent
Director-HeavenlyCity or Potemkin Village?, 95 HARv. L. REv. 597, 602 (1982). The
"shareholder versus stakeholder" debate has been going on for over seventy years. See Adolph
A. Berle, CorporatePowers as Powers in Trust, 45 HARV. L. REv. 1049, 1049 (1932) (arguing
that directors should serve shareholder interests) and E. Merrick Dodd, ForWhomAre Corporate
Managers Trustees?, 45 HARV. L. REv. 1145, 1160 (1932) (arguing directors should serve other
groups including employees, managers, and society in general). For recent contributions, see
William T. Allen, OurSchizophrenic Conception of the Business Corporation,14 CARDOZO L.
REV. 261, 276-77 (1992) (discussing for whose benefit directors hold power); William T. Allen
et al., The Great Takeover Debate: A Meditationon Bridging the ConceptualDivide, 69 U. CHI.
L. REv. 1067, 1067 (2002) (discussing the debate); Stephen M. Bainbridge, DirectorPrimacy:
The Means and Ends of CorporateGovernance, 97 Nw. U. L. REV. 547,605 (2003) (arguing for
director primacy); Margaret M. Blair & Lynn A. Stout, A Team ProductionTheory of Corporate
Law, 85 VA. L. REV. 247, 253-54 (1999) (arguing that directors should take non-shareholder
interests into account).
2006] CHINESE CORPORATE GOVERNANCE

who are responsible to many constituencies are in effect responsible to

none, and that while many of those who deal with the firm, such as
customers, workers, and suppliers, can protect themselves through contract
and the threat of terminating their association with the firm, the
shareholders are uniquely unable to do so because their investment is sunk
and cannot be withdrawn. °4
Both conceptions share the idea that the directors expected to
perform their designated function cannot do so unless they are
systematically independent of management. This idea is familiar to
corporate law practitioners and scholars in the United States, but
interestingly, its reach is limited almost exclusively to federal law as
applied to corporations whose stock is listed on a national exchange.' 5
Section 301 of the SOA requires that all members of a listed company's
audit committee be independent directors,1°6 and states:

In order to be considered to be independent for purposes

of this paragraph, a member of an audit committee of an
issuer may not, other than in his or her capacity as a

See, e.g., HENRY HANSMANN, THE OWNERSHIP OF ENTERPRISE 56 (Harvard Univ.

...
Press 1996); Henry Hansmann & Reinier Kraakman, The End of Historyfor CorporateLaw, 89
GEO. L.J. 439, 440-41 (2001). Gilson and Kraakman go beyond emphasizing the independence
of the non-management director in order to stress the desirability of her lack of independence
from shareholders: "[W]hile most recent efforts addressing the governance role of the board have
urged increasing the independence of outside directors from management, we advocate increasing
the dependence of outside directors on shareholders. In our view, corporate boards need directors
who are not merely independent, but who are accountableas well." Ronald J. Gilson & Reinier
Kraakman, Reinventing the Outside Director:An Agenda for InstitutionalInvestors, 43 STAN.
L. REv. 863, 865 (1991). A recent World Bank publication makes the same point, see TENEV &
Z7ANG, supra note 80, as does (rarely among Chinese commentary) .e Yiping & Yu Yin,
Zhongguo Tuixing Waibu Dongshi Jizhi Zhiyi [DoubtsAbout China'sPromotion ofthe Outside
Director Mechanism], ZHEJIANG SHENG ZHENG-FA GuANu GANBU XUEYUAN XUEBAO
[BULLETIN OFTHE ZHEJIANG PROVINCE POLITICAL-LEGALADMINISTRATIVE CADRES ACADEMY],
No. 5, 2001, at 25, 29. The Higgs Report points up the need for such accountability: a majority
(52%) of the non-executive directors surveyed never discussed company business with investors,
and only one in five non-executive directors in FrSE 100 companies did so at least once a year.
See HIGGS, supra note 83, 15.5. This seems to be taking independence a bit too far.
"051deal below with state corporate law and its different concept of "disinterested
director." The Investment Company Act, a federal statute, also contains what is essentially a
requirement for independent directors in investment companies, whether or not they happen to be
listed. The relevant section is discussed briefly below. Finally, note that because this is an article
about comparative corporate law and is not intended to be an exhaustive discussion of post-SOA
reforms in American corporate governance, I discuss such reforms in general terms only and do
not note the numerous exceptions and qualifications to the general rules set forth here.
" 6Strictly speaking, the SOA requires that the SEC adopt rules requiring national
securities exchanges and national securities associations to prohibit the listing of the securities
of any issuer that does not comply with the standards for independence of audit committee
members set forth in Section 301.
 DELAWARE JOURNAL OF CORPORATE LAW [Vol. 31

member of the audit committee, the board of directors, or

any other board committee-

(i) accept any consulting, advisory, or other

compensatory fee from the issuer; or

(ii) be an affiliated person of the issuer or any

subsidiary thereof. 7

Stock exchange rules must also, of course, be considered. For the

sake of brevity I will look only at the NYSE's rules.0 8 The NYSE's former
(that is, prior to SOA-associated reforms) and current rules on independent
directors make an informative contrast. Under the former rules,
independent directors were required only for audit committees, and were
those who had "no relationship to the company that may interfere with the
exercise of their independence from management and the company.""
Certain per se disqualifications"' could be waived by a board determination
that the director's exercise of independentjudgment would not be affected.
These rules were more flexible than those of the SOA. It was not
so critical to maintain a strict distribution between independent and non-
independent, possibly because independent directors were not required to
play so important a role. For example, the audit committee had to be
composed entirely of independent directors, but it did not need to have the
exclusive authority to hire, monitor, or terminate the outside directors.
In response to the requirements of the SOA, the NYSE adopted
rules that mirror the SOA's independence requirements for audit committee
members, but that retain some flexibility with respect to other independent
directors." '

'"Sarbanes-Oxley Act of 2002 § 301 (codified at 15 U.S.C. § 78j- l(m)(3)(B) (2005)).

'O8For pre-SOA Nasdaq rules on independent directors, see NASDAQ, NASDAQ
MARKETPLACE RULES § 4200(a)(15) (2002). For the post-SOA rules, see Securities Exchange Act
Release No. 34-47516, 68 FED. REG. 14451, 14451-56 (Mar. 25, 2003).
'OgNEWYORK STOCKEXCHANGE, LISTEDCOMPANY MANUAL § 303.01(3)(2)(a) (1999).
"'Specifically, independence was foreclosed if the director (1)had been employed by
the issuer or its affiliates in the past three years, (2) was an immediate family member of a person
employed as an executive officer of the issuer or its affiliates in the last three years, (3) was
employed as an executive of another company where any of the issuer's executives sat on the
compensation committee, (4) had a direct business relationship with, or was a partner,
shareholder, or executive officer of an organization that had a direct business relationship with,
the issuer, unless the issuer's board made an affirmative determination that the relationship would
not interfere with the director's exercise of independent judgment. See id. § 303.0 1(B)(3)(b)-(d).
"'See LISTED COMPANY MANUAL, supra note 3, § 303A.00.
2006] CHINESE CORPORATE GOVERNANCE

Unlike the SOA, the NYSE rules (except where they mirror SOA
requirements) do not contemplate specific mandatory powers for
independent directors. Their duties may be limited simply to making
recommendations to the board as a whole. Independent directors must,
however, constitute a majority of the board as a whole." 2 The theory
behind the NYSE rules seems to be that corporate decisionmaking will be
improved if a majority of the board can be structured so that a particular
motivation, that of pleasing management, is absent. The rules do not
attempt to ensure that a particular motivation is present.
While "independence" has generally proven fairly easy to
conceptualize, if more difficult to define in precise legislative language,
one area in which substantial disagreement exists even in principle is that
of the significance to be given to stock ownership by the putatively
independent director. Those who see the independent director primarily as
a defender of shareholder interests against management will naturally see
more share ownership as better, because it will more closely align the
interests of the director with the shareholders as against management.' 13
Those who view the independent director as someone whose judgment
should be untainted by any financial interest in the company are suspicious
of share ownership." 4

112
The requirement for independent directors is subject to an exception for controlled
companies, except with respect to the audit committee. See LISTED COMPANY MANUAL, supra
note 3, § 303A.00. Controlled companies are those in which more than 50% of the voting power
is controlled by a single individual, group, or company.
113
In general, ownership of stock by directors, and by independent directors in
particular, appears to be positively correlated with company performance. See Sanjai Bhagat et
al., Director Ownership, Corporate Performance, and Management Turnover, 54 Bus. LAW.
885, 885 (May 1999); Eliezer M. Fich & Anil Shivdasani, The Impact of Stock-Option
Compensationfor Outside Directorson Firm Value, 78 J. Bus. 2229 (2005); and the review of
several studies in R. Franklin Balotti et al., Equity Ownership and the Duty of Care:
Convergence, Revolution, or Evolution, 55 Bus. LAW. 661,672 (2000). For a contrary view, see
Lawrence D. Brown & Marcus L. Caylor, Corporate Governance and Firm Performance 8 (Dec. 7,
2004), at http://ssrn.com/ abstract=586423 (finding "no evidence that operating performance or
firm valuation is positively related either to stock option expensing or to directors receiving some
or all of their fees in stock").
4
1 As will be discussed below, Chinese legislation and academic commentary generally

adopts the suspicious approach and disfavors stock ownership by independent directors. See, e.g.,
Independent DirectorOpinion, supra note 11, § 1(1) (forbidding any relationship with a large
shareholder that would impair independence); id. § 3(2) (denying independent status to holder of
1% of company's shares or one of top ten shareholders or relative of the latter); People's Bank of
China, Guanyu Gufenzhi Shangye Yinhang Duli Dongshi he Waibu Jianshi Zhidu Zhiyin
[Guidelines on the System of Independent Directorsand Outside Supervisorsfor Commercial
Banks Under the Shareholding System], issued and effective June 4, 2002 [hereinafter
Commercial Bank IndependentDirectorGuidelines), art. 2 (denying independent status to holder
of 1% of company's shares or employee of shareholder); Ma, supra note 12, at 62; Yan & Chen,
supra note 12, at 26.
 DELAWARE JOURNAL OF CORPORATE LAW [Vol. 31

It is not altogether clear which view Congress took in the SOA. As

we have seen, Section 301 of the SOA amends Section 10A of the
Securities Exchange Act (SEA) by providing that an independent director5
on the audit committee may not be an "affiliated person" of the company." 1
The SEA, for its part, states that "affiliated person" in the SEA shall have
the meaning given to it by the Investment Company Act (ICA)." 6 Finally,
the ICA defines "affiliated person" in part as anyone owning 5% or more
of the securities of the company. Thus, Congress-assuming it was aware
of this definitional chain-could be seen as viewing substantial ownership
of securities as undesirable in independent directors.
The SEC, however, while retaining the ICA stock ownership
threshold for independent directors of investment companies, has been
much friendlier to shareholding by independent directors in other
circumstances, and has created an explicit safe harbor for shareholding
under 10%. Moreover, it has stated that shareholding of 10% or more will
not automatically be construed to constitute an "affiliation" sufficient to
prevent a director from being found "independent."

Some commentators appear to take both positions at once. Derek Higgs, in his recent
report on non-executive directors commissioned by the British Department of Trade and Industry,
agrees in Para. 12.26 that "shares could be helpful in aligning the interests of the director with the
long-term interests of shareholders," but opposes in Para. 12.27 the holding of options by directors
"because of the risk of undesirable focus on share price rather than underlying company
performance." HIGGS, supra note 83, I 12.26-12.27. It is not clear why directors who own
shares will be less focused on share price than directors who own options, or why shareholders
would not want a director to be focused on share price. The notion of a generally knowable
distinction between long-term share price and short-term share price is illusory, because the share
price at any given time reflects the market's best guess as to the discounted present value of all
income (not just income over the short term) that can be earned by the share, whether through
dividends or ultimate sale, and thus incorporates all long-term share prices to the extent they can
be estimated. A director privy to inside information might well have reason to believe that the
current share price does not reflect the valuation the market would place on the stock were the
information public, but any undesirable incentives created by this information asymmetry do not
depend on whether the director holds stock or options. In any case, while recognizing the
beneficial effect of share ownership by directors, the Higgs Report views significant share
ownership as disqualifying a director from being considered independent. See id. at 37.
Two Chinese commentators take the opposite position from Higgs: independent
directors should not be allowed to own stock, but should be allowed to have stock options. For
reasons that are not clear, the authors believe that the independent directors' stock-based incentive
structure should not match that of management, and so add the proviso that the stock options
should operate differently from those held by management. See Yan & Chen, supra note 12, at
28. Other commentators oppose stock options as well. See Zhao Yu, Wanshan Duli Dongshi
Zhidu Dde Ruogan Sikao [How to Improve The System of IndependentDirector], Feb. 7, 2005,
reprintedfrom CAIKUAI TONGXUN [FIN. & ACcT. BULL.], available at http://doc.esnai.com/
showdoc.asp?docid=7093&uchecked=true.
... Sarbanes-Oxley Act of 2002 § 301, amending Securities Exchange Act §1OA
(codified at 15 U.S.C. § 78j-1(m)(3)(B)(ii) (2005)).
" 6 See Securities Exchange Act § 3(a)(19).
2006] CHINESE CORPORATE GOVERNANCE

The NYSE is also friendly to shareholding by independent

directors. Where audit committee members are concerned, it simply
incorporates by reference the requirements of federal law. But where its
own requirement for a majority of independent directors is concerned-a
requirement not imposed by federal law-it imposes no limits on
shareholding whatsoever. Indeed, in proposing its rule change, the NYSE
specifically noted the views of commentators that share ownership should
be viewed as desirable, and stated that "as the concern is independence
from management, the Exchange does not view ownership of even a
significant amount of stock, by itself, as a bar to an independence find-
17
ing."1
Although the SEC's rulemaking has not been actively hostile to
shareholding by independent directors, it is important to note a fundamental
difference in approach between the SEC and both the exchanges in their
proposed rules. Both the exchanges require company boards to have a
majority of independent directors except when the company is a "controlled
company," i.e., when a single person, group, or company controls more
than 50% of the voting power. 8 In other words, they see independent
directors as a protection for shareholders specificallyagainstmanagement,
not against other shareholders. A shareholder who controls a company
does not need an external rulemaker to protect him from a management
team that he himself has the power to appoint. Minority shareholders may
well need protection from controlling shareholders, but the exchanges are
apparently willing to leave this task to other bodies of law, such as federal
securities law requiring disclosures and state corporate law mandating
certain fiduciary duties.
The SEC's approach, however, is different. As we have seen, an
"affiliated person" cannot be "independent," and the SEC defines
affiliation, among other things, in terms of control. Under the SEC's
principle, when stock ownership is enough to lead to control, affiliation
exists and independence disappears. The NYSE's approach might be
characterized as finding that when stock ownership is enough to lead to
control, the director is super-independent of management-so much so that
the need for paternalistic protection by a rule disappears. Thus, the SEC's
view of the proper role of independent directors seems consistent with the
second view canvassed earlier: that they should have ties neither with

i..Notice of Filing of Proposed Rule Change and Amendment No. 1Thereto by the New
York Stock Exchange, Inc., Exchange Act Release No. 34-47672, 68 FED. REG. 19051, 19053
(Apr. 17, 2003), availableat http://www.sec.govlruleslsro/34-47672.htm.
8
1 See NASD MANUAL: MARKETPLACE RULES 4350(c)(5), available at www.nasdaq.

com; LISTED COMPANY MANUAL, supra note 3, § 303.OOA.

 DELAWARE JOURNAL OF CORPORATE LAW [Vol. 31

management nor with the fortunes of the company itself. Yet this view of
independent directors seems to see them as ideally having no consistent
incentives whatsoever. While clearing away visible ties to management
interests, it fails to substitute a tie to the interests of any other constituency.
Consequently, it is hard to see how such directors can be expected to act in
any predictable way other than in avoiding obvious (and punishable)
illegalities; the purpose of having them on the board suddenly seems
obscure. The lack of any serious underlying theory of independent director
motivation is startlingly manifest." 9
Independent director requirements in other majorjurisdictions have
been considerably less exacting, although still important. In the United
Kingdom, for example, there does not exist, strictly speaking, any
independent director requirement at all. Instead, companies listed on the
London Stock Exchange are required by its listing rules to disclose, in their
annual report and accounts, a statement of how they have applied the

'For an excellent discussion of the implicit or explicit attitude toward equity

ownership by independent directors in the various statutes and regulations discussed above, which
takes a somewhat different view on some issues, see CHANDLER& STRINE, supra note 98. As is
well known, Fama and Jensen argued that independent directors automatically have an incentive
to protect shareholder interests, because those who are executives in other businesses and
participants in the managerial labor market have an incentive to develop reputations as experts
in decision control. See E.F. Fama & M.C. Jensen, Separationof Ownershipand Control,26 J.L.
& ECON.301, 315 (1983). This view has been challenged, in my view convincingly, by Bebchuk
and his colleagues, here in the context of CEO compensation:
First, the signal provided by independent directorships is likely to be quite
noisy, particularly when the board is large and responsibilities are diffuse.
Second, and relatedly, the managerial labor market is more likely to focus
on the manager's performance in his primary role rather than in his
independent directorships. Third, there are likely to be a considerable
number of independent directors who are interested less in establishing
reputations as "expert decisionmakers" than in keeping their current board
seats and perhaps joining other boards . .. CEOs have considerable
influence in the choice of independent directors and will tend to prefer
candidates who are unlikely to challenge their compensation. Thus, for a
director aspiring to additional board positions, the "market" for directors
creates incentives not to challenge the CEO on the issue of his compensation
but rather to accommodate the CEO's wishes.
Lucian Arye Bebchuk et al., ManagerialPower and Rent Extractionin the Design of Executive
Compensation, 69 U. CHIL. L. REv. 751, 771 (2002) (footnotes omitted). Needless to say, these
doubts about incentives become even stronger when there is a deliberate attempt to remove any
incentive to act in the interests of shareholders.
For an interesting theory of director motivation that makes a good case for considering
altruistic behavior, see Lynn A. Stout, On the ProperMotives of CorporateDirectors (Or, Why
You Don't Want to Invite Homo Economicus to Join Your Board), 28 DEL. J. CORP. L. 1 (2003).
2006] CHINESE CORPORATE GOVERNANCE

principles in Section 1 of the Combined Code. 20 A company that has not

complied must specify the provisions of the code with which it has not
complied. Section 1 of the Combined Code's Code of Best Practice
provides that non-executive directors should constitute not less than one
third of the board, 121 but these are not the same as independent directors,
who should constitute a majority of the non-executive directors. The
Combined Code clearly distinguishes them (without rigorously defining
them) by stating:

The majority of non-executive directors should be

independent of management and free from any business or
other relationship which could materially interfere with the
exercise of their independent judgement. Non-executive
directors considered by the board to be independent
22
in this
sense should be identified in the annual report.

Whereas the SOA contemplates a specific role for independent

directors only on the board's audit committee, the Combined Code
contemplates a role for them on the remuneration committee as well, which
is to be composed solely of independent directors. 123 Both committees are
to make recommendations to the board, but the board is not obliged to
follow their recommendations.
Before leaving the subject of independent directors, it is worth
examining their role in the German corporate governance system in order
to show that independence from management does not necessarily lead to
protection of shareholder interests. German law mandates a dual-board
system for large publicly-held corporations. Each corporation has an
elected supervisory board (Aufsichtsrat),which appoints a managing board

12
°See FINANCIAL SERVICES AUTHORITY (UNITED KINGDOM), THE LISTING RULES
12.43A, available at http://www.fsa.gov.uk. The "Combined Code" refers to the "Principles
of Good Governance and Code of Best Practice," a document compiled by the Committee on
Corporate Governance and derived from its own final report (the Hampel Report), the Greenbury
Report, and the Cadbury Report. FINANCIAL SERVICES AUTHORITY (UK), PRINCIPLES OF GOOD
GOVERNANCE AND CODE OF BEST PRACTICE, availableat http://www.fsa.gov.uk [hereinafter
COMBINED CODE]. On the relationship between mandatory state regulation and self-regulation
in the United Kingdom, see generally BRIAN R. CHEFFINS, COMPANY LAW: THEORY, STRUCTURE,
AND OPERATION 364-420 (Clarendon Press 1997).
21
1 COMBINED CODE, supra note 120, Code of Best Practices § 1.A.3.1.
1221d. § 1.A.3.2.
123See id. § 1.B.2.2. As I am strictly distinguishing here between independent directors
and non-executive directors, who may or may not be independent, I save for the following section
a discussion of the nominating committee under the Combined Code, which is to be composed of
non-executive directors.
 DELAWARE JOURNAL OF CORPORATE LAW [Vol. 31

(Vorstand) composed of senior corporate managers. The role of the

supervisory board is that of overseeing the management of the company, 24
but its role is limited to just that. Its major powers are the power to appoint
and dismiss members of the managing board and the power to represent the
company in its dealings with members of the management board.125 The law
explicitly allocates managerial power to the managing board.' 26
Shareholders can even overrule supervisory board decisions through a
three-fourths majority vote."'
Since the managing board is, by definition, composed of corporate
managers, an examination of independent directors in German corporations
must focus on the supervisory board. German corporate law aims to ensure
the independence of its members from company management by excluding
both legal representatives of enterprises controlled by the company in
question and legal representatives of other corporations whose supervisory
boards include members of the management board of the company in
question. 2'
It is by no means intended, however, that supervisors should be
independent of all outside influence and should exercise their judgment in
pristine isolation from the world around them. On the contrary, as many as
one half may, under the German system of co-determination, be employee
representatives whose explicit remit is to protect the interests of employees.
Others may be representatives of banks and other businesses who are
"chosen for the very reason that they are not independent; that is, because
they or the particular constituency they represent has an existing financial
or similar relationship to the company."' 29 German corporate law in this
sense seems clearer about the functions of independent directors (or their
equivalent) than U.S. federal law, which mainly seeks to ensure that a
certain number of directors not be beholden to management.

' 24See AKTIENGESSELSCHAFTEN [LAwON STOCKCORPORATIONS] § 111(1), translated

in COMMERCIAL LAWS OF THE WORLD: GERMANY (rev. ed. 1995).
'See Walter Oppenhoff & Thomas 0. Verhoeven, Stock Corporations,in BUSINESS
TRANSACTIONS INGERMANY ch. 24, § 24.03 (Bemd ROster ed., Matthew Bender 2003).
.26See AKTIENGESSELSCHAFTEN [LAW ON STOCK CORPORATIONS], supra note 124,
§ 76(1).
27
' See id.§ 111(4).
'See id. § 100(2).
129Thomas J. Andr6, Jr., Cultural Hegemony: The Exportation of Anglo-Saxon
Corporate Governance Ideologies to Germany, 73 TUL. L. REV. 69, 152 (1998) (emphasis
omitted).
2006] CHINESE CORPORATE GOVERNANCE

2. The "Outside" Director

The concept of outside director is often confused with that of

independent director, but it makes sense to distinguish the two, because
they can play different roles. By "outside director" I mean any director
who is not a company employee, 3 ' without regard to whether she meets a
standard of independence. The Cadbury Report envisages "a board made
up of a combination of executive directors, with their intimate knowledge
of the business, and of outside, non-executive directors, who can bring a
broader view to the company's activities."'' Cheffins notes in a similar
vein that one function of outside directors is that of "providing full-time
executives with support and assistance as they carry out their managerial
tasks, which entails offering
32
specialized advice and fostering links with
other organizations."
While outside directors as defined above are not part of the
American corporate law scene, at least in terms of mandatory requirements,
they do have a role to play in British corporate governance. As noted
above, the Combined Code, the degree of compliance with which must be
disclosed by companies listed on the London Stock Exchange, calls for one
third of the board to be composed of outside directors.'3 3
Japanese corporate law also uses the concept of "outsideness" for
directors and auditors (kansayaku). An outside director is defined as

13°"Outside director" and "non-executive director" are often used interchangeably. I do

not use the term "non-executive" director here because on its face such a term could include
directors who were employees, but not executives-for example, worker representatives. Such
directors would be neither outside directors, in the sense of being able to bring some special
expertise to the board not otherwise available to the company, nor independent directors, in the
sense of feeling free to oppose management. Because the role of such employee directors is very
different from the role of non-employee non-executive directors, I do not favor using a term that
on its face encompasses them both.
31
' CADBURY REPORT, supra note 68, 4.1.
CHEFFINS,supra note 120, at 96.
112
1
"The Combined Code calls them "non-executive directors," but specifically
contemplates that some will not meet a criterion of independence. See COMBINED CODE, supra
note 120. Although the Combined Code does not specifically exclude employees from the scope
of non-executive directors, such seems to be the intention. Something akin to a legislative history
of these provisions of the Combined Code can be found in the Cadbury Report, from which they
are largely taken. Dahya and McConnell, in their study of outside directors in British companies,
state that they consider a director an outsider "if he/she is listed as a 'non-executive' director,
he/she is not related to the company's controlling family, and he/she was not employed by the
company historically." Jay Dahya & John J. McConnell, Outside Directors and Corporate Board
Decisions 9 (Aug. 29, 2003), available at http://www.mgmt.purdue.edu/centers/ciber/
publications/pdf/2003-008%2OMcConnell.pdf.
 DELAWARE JOURNAL OF CORPORATE LAW [Vol. 31

[a] person who is currently a director but who is not

executing any company business, who has not in the past
been a director, manager or other employee executing any
business of the company or its subsidiaries, and who
currently is neither executing any business of a subsidiary
nor is a manager134or any other employee of the company or
its subsidiaries.

Note that this concept of outsideness does not exclude persons such as
lawyers, suppliers, and others who may do large amounts of business with
the company.' 35
The distinction between independence and outsideness seems to be
well understood in Japan. The Revised Corporate Governance Principles
of the Japan Corporate Governance Forum differentiate the two, 136 and a
website operated by the Nihon Keizai Shimbun (the Wall Street Journalof
Japan) contains a list of definitions of economic terms where the distinction
is spelled out clearly. 137 Prior to recent corporate law reforms, the concept
of outsideness might, however, have been more appropriate than one of
independence. The only purpose it served was to define what sort of
director could be subject to a more forgiving standard of care'38 and,
therefore, it is reasonable to focus on those who are not intimately
acquainted with the affairs of the company as opposed to those who are not

134 SHOHO [COMMERCIAL CODE OF JAPAN], art. 188(2)(7.2) (2002), as adapted from
translation in HASHIMOTO, supra note 8, at 9.
35
' Note also that this definition is not the definition of outsideness used in Miwa and
Ramseyer's study of outside directors and corporate performance in Japan. Their definition
includes anyone with past or concurrent careers at other institutions, apparently notwithstanding
past employment at the company in question. See Miwa & Ramseyer, supra note 98, at 11.
36
' See JAPAN CORPORATE GOVERNANCE FORUM, REVISED CORPORATE GOVERNANCE
PRINCIPLES (Oct. 26, 2001), available at http://www.ecgi.org/codes/code.php?codeid=70.
Principle 6.3 states: "The majority of directors on the nominating committee and the compensation
committee should be outside directors, and there should be one or more independent directors. The
majority of audit committee members should be independent directors." Principle 4 states:
1. An outside director is someone who is not and has never been a
full-time director, executive, or employee of the company or its parent
company, subsidiaries or affiliates (collectively, the "Company etc.").
2. An independent director is someone who can make decisions
completely independently from the managers of the Company etc., and
therefore necessarily does not hold any interest with respect to the company.
37
1 See Shagai Torishimariyaku to Dokuritsu Torishimariyaku[The Outside Director
and the Independent Director], supra note 98.
13 8
5ee SHOHO [COMMERCIAL CODE OF JAPAN], art. 266(18) (2002) (providing that
shareholders may by resolution reduce an outside director's maximum liability to the company to
twice her annual director's income, as opposed to four times the annual income for ordinary
directors and six times the annual income for representative directors (daihydtorishimariyaku)).
2006] CHINESE CORPORATE GOVERNANCE

dependent in some way upon management's favor. In the 2002 corporate

governance reforms that became effective in April 2003, however, outside
directors are expected to play a role more akin to that expected of
independent directors in U.S. federal securities law: companies may opt
into a U.S.-style corporate governance structure in which outside directors
are required to be present on nominating committees, audit committees, and
compensation committees.' 39

3. The "Disinterested" Director

Far more important than federal law in the United States for
purposes of internal corporate governance is state law, and this for the most
part-at least in terms of economic impact-means the law of Delaware.
U.S. corporation law at the state level does not generally provide for the
institution of independent directors as such or define them. 140 Instead, state
corporate statutes focus on particular conflict-of-interest
transactions-transactions, for example, between a corporation and one of
its directors or officers, or between a corporation and another entity in
which one of its directors or officers has an interest, or the taking by
corporate officers of business opportunities that arguably belong to the
corporation-and provide that certain consequences will follow depending
on whether those with decisionmaking power who have a conflict of
interest recuse themselves from the decisionmaking process.
Modern state statutes typically operate by displacing the common
law rule on conflict-of-interest transactions-that they may be set aside at
the instance of any stockholder141-and permitting them provided certain
conditions are met. These conditions usually pertain to disclosure of the

"'See HASHIMOTO, supra note 8, at 10.

"4Alimited exception can be found in Michigan, where corporations may, subject to
certain requirements, designate one or more directors as "independent directors," upon which
certain statutory consequences follow. See Scott J.Gorsline, Statutory "Independent"Directors:
A Solution to the Interested Director Problem?, 66 U..DET. L. REV. 655, 659 (1989); Cyril
Moscow et al., Michigan'sIndependent Director,46 BuS. LAW. 57, 57 (1990).
41
' See, e.g., Wardell v. R.R. Co., 103 U.S. 651, 658 (1880) ("The law, therefore, will
always condemn the transactions of a party on his own behalf when, in respect to the matter
concerned, he is the agent of others, and will relieve against them whenever their enforcement is
seasonably resisted."). Note that the law did not prohibit such transactions. Like many "rules" of
company law, this rule is simply the provision of a private cause of action, not an outright
prohibition. The common law rule made conflict-of-interest transactions very vulnerable to attack
by shareholders.
 DELAWARE JOURNAL OF CORPORATE LAW [Vol. 31

conflict of interest and approval of the transaction by disinterested

decisionmakers, whether directors or shareholders.'
The Delaware General Corporation Law (DGCL) announces in
Section 144 that a transaction in which a director or officer stands on both
sides "43
' shall not be voidable by reason of a conflict of interest if one of the
following conditions are met: (1) the relevant facts are known to the board
and a majority of disinterested directors approve; or (if, for example, the
entire board has a conflict of interest) (2) the relevant facts are known to
the shareholders, and a majority of disinterested shareholders approve; or
(if for any reason neither of the first two occurs) (3) the terms of the
transaction are, as of the time it is authorized by the directors or the
shareholders, fair to the corporation.'"
The Model Business Corporation Act has an entire subchapter
(Subchapter F) devoted to directors' conflicting interest transactions. Like
the Delaware statute, it provides that transactions are not voidable on the
grounds of a conflict of interest provided that there was sufficient 45
disclosure followed by approval of a majority of disinterested directors.
Both the DGCL and the MBCA, then, have a concept of independence, but
it amounts only to disinterest in a particular conflict-of-interest
transaction-something quite different from abstract independence. Both
attempt to deal with such transactions generally through disclosure to, and
approval by, directors who are not involved in the transaction. But they do
not assume that such directors will always be the same person, and do not
require the institution of abstractly independent directors. Instead, they
take a transaction-by-transaction approach, and ask in each case whether
there was approval by directors (or other decisionmakers) who were

42
1 See DEL. CODE ANN. tit. 8, § 144 (2001). It is important to note that if the conditions
are not met, the transaction is not for that reason unlawful. It merely means that a court may
apply the common law rule to the transaction if a shareholder brings suit to set it aside. But the
common law rule is whatever the court says it is, and it is not at all clear that American courts of
the early twenty-first century will find such transactions as offensive per se as did American
courts of the nineteenth century. Thus, modem state corporation statutes provide a safe harbor
for conflict-of-interest transactions, but one cannot assume that transactions falling outside the
safe harbor are necessarily all barred.
"43The statutory definition is more complicated, but this simplified version will do for
present purposes.
'"See DEL. CODEANN. tit. 8, § 144 (2001). The Delaware statute, deliberately or not,
contains no requirement that shareholder approval be by disinterestedshareholders only, but this
requirement has been read into the statute by case law. See, e.g., Marciano v. Nakash, 535 A.2d
400, 405 n.3 (Del. 1987) ("[A]pproval by fully-informed disinterested directors under section
144(a)(1), or disinterested stockholders under section 144(a)(2), permits invocation of the
business judgment rule and limits judicial review to issues of gift or waste with the burden of
proof upon the party attacking the transaction.").
45
1 See MODEL Bus. CORP. ACT subch. F.
2006] CHINESE CORPORATE GOVERNANCE

disinterested in the transactionin question. Recent cases have also stressed

the need for a fact-intensive inquiry.' 46 Although this approach has costs,
it also has hidden savings: the cost of policing an abstract independence
requirement in the many companies where it will never be needed.

C. The Independent Directorin China

As we have seen in the United States, the NMD has traditionally

been seen as the solution to the problem of managerial domination of the
board. 47 This model assumes the existence of the paradigmatic Berle-and-
Means corporation, where powerful managers exploit dispersed and
rationally apathetic shareholders.1 48 This explains why, as far as American
law is concerned, it is generally considered a good thing, not a bad thing,
for NMDs to own stock in the company on whose board they sit. 149 When

146
See, for example, In re Oracle Corp.DerivativeLitigation,in which Vice Chancellor
Strine spoke of Delaware's "flexible, fact-based approach to the determination of directorial
independence," 824 A.2d 917, 937 (Del. Ch. 2003), and added:
This contextual approach is a strength of our law, as even the best minds
have yet to devise across-the-board definitions that capture all the
circumstances in which the independence of directors might reasonably be
questioned. By taking into account all circumstances, the Delaware
approach undoubtedly results in some level of indeterminacy, but with the
compensating benefit that independence determinations are tailored to the
precise situation at issue.
Id. at 941. See also Krasner v. Moffett, 826 A.2d 277, 286 (Del. 2003) (Veasey, C.J.) ("The
independence of the special committee involves a fact-intensive inquiry that varies from case to
case.").
147See, e.g., Barry D. Baysinger & Henry N. Butler, Revolution Versus Evolution in
CorporateLaw: The ALI's Project and the IndependentDirector,52 GEo. WASH. L. REV. 557,
563-64 (1984).
48
1 See ADOLPH A. BERLE & GARDINER C. MEANS, THE MODERN CORPORATION AND

PRIVATE PROPERTY (Macmillan 1933). As has been shown above, China has few, if any, such
listed corporations. Indeed, it is not clear how dominant they are even in the United States. See,
e.g., Randall Morck et al., Management Ownership and Market Valuation: An Empirical
Analysis, 20 J. FIN. ECON. 293 (1988) (finding a modest concentration of ownership even among
the largest U.S. firms); R. La Porta et al., Law and Finance,106 J. POL. ECON. 1113, 1146 (1998)
(finding that ownership of the three largest shareholders in the ten most valuable U.S. companies
has a mean average of 20% and a median of 12%).
149In Unitrin, Inc. v. American General Corp., for example, the Delaware Supreme
Court granted extra deference to the views of outside directors who held "substantial equity
stakes" in a corporation that was the target of a takeover bid, presuming that they would "act in
their own best economic interests" as stockholders and not out of a desire to entrench existing
management. See Unitrin, Inc. v. Am. Gen. Corp., 651 A.2d 1361, 1380-81 (Del. 1995); see also
CHANDLER & STRINE, supra note 98, at 51-53 (favoring stock ownership by independent directors
and questioning the suspicious approach of the SOA); Balotti et al., supra note 113, at 672, 677
(reviewing empirical evidence in support of link between substantial equity ownership and
improved director monitoring and decisionmaking, and arguing in favor of presumption of due
care for directors with substantial equity ownership); J. Travis Laster, Exorcizing The
 DELAWARE JOURNAL OF CORPORATE LAW [Vol. 31

the law's concern includes dominant shareholder exploitation of minority

shareholders, the concept of the abstractly defined independent director
fades away, to be replaced by the notion of a disinterested
director--disinterested not in the abstract, but with respect to a particular
challenged transaction.
The abstractly defined independent director is quite common in
U.S. federal law and the national securities markets, but as discussed above
the concern of the law seems to be to defend the interests of the
shareholders as a whole against management self-seeking, not to defend
minority shareholders against dominant shareholders.
The Chinese literature and regulations contemplate a number of
roles for independent directors. One sees generalities about how they will
reduce corruption, bring an objective view to board meetings, dare to ask
uncomfortable questions, criticize company management, and ensure good
corporate governance practices,150 but specific, measurable goals and
predictions are few. Yet one cannot design and evaluate rules about
independent directors without knowing what problems the institution is
designed to address.
As discussed above, a major perceived problem in Chinese
corporate governance is the dominance of large shareholders. This is
sometimes confused with the problem of insider control, although that
problem stems from the inability of shareholders to supervise management
effectively. Many Chinese commentators appear to view concentrated
ownership as almost perverse and unnatural, and see the stereotypical
Berle-and-Means corporation as the ideal ownership structure. 15'

Omnipresent Specter: The Impact of Substantial Equity Ownership by Outside Directors on

Unocal Analysis, 55 Bus. LAW. 109 (1999) (discussing a series of cases in which Delaware courts
have given deference to decisions by directors on the grounds that their substantial equity
ownership aligned their interests with those of other shareholders).
In Stroudv. Grace, the Delaware Court of Chancery addressed a party's argument that
a corporate charter provision requiring independent directors on the board but forbidding them
from owning stock should be invalidated. The court found the provision to be unusual, but not
unlawful. The prohibition in that case stemmed from the particular needs of the dominant
shareholder in a family-controlled close corporation. See Stroud v. Grace, No. 10,719 (Del. Ch.
Nov. 1, 1990), reprinted in 16 DEL. J.CORP. L. 1588 (1991).
15°See, e.g., Li Yining: Shangshi Gongsi Duli DongshiZhi Shang Nan Fahui Zuoyong
[Li Yining: It Is Still Difficult for the Listed Company Independent DirectorSystem to Play Its
ProperRole], CHINA NEWS AGENCY, June 12, 2001.
"'See, e.g., Li Jianming, Gongsihua Gaizao Yilai Woguo Qiye Zhili Jiegou de
Shizheng Fenxi [An EmpiricalAnalysis of the Corporate Governance Structure of Chinese
EnterprisesSince the CorporatizationReform], GAIGE [REFORM], No. 4, 1999, at 34, 41; Ma,
supra note 12, at 62; Zheng & Chen, supra note 49, at 180. One Chinese academic asserts
(incorrectly) that corporate law in the United States prevents large shareholders from dominating
by prohibiting any person from exercising over 20% of shareholder voting rights. See Gu, supra
note 84, at 60.
20061 CHINESE CORPORATE GOVERNANCE

Independent directors will, it is hoped, represent the interests 15 2

of small
shareholders and prevent the recurrence of corporate scandals.
A study conducted by the Shanghai Securities Exchange identified
the following major problems in Chinese corporate governance, several of
which are evidently connected with the exploitation of small shareholders
by large shareholders: (1) irrational shareholding structure; 53 (2) lack of
independence (presumably from management) of the board of directors; (3)
inability of the board of supervisors to play its proper role; (4) relative
weakness of oversight role of creditors; (5) unlimited powers of key
management personnel; (6) low level of transparency and professionalism
in investment decisions; (7) lack of a market for corporate control; (8) lack
of a market for management services; (9) skewed system of incentives; (10)
lack of protection of interests of small shareholders; (11) lack of a system
for accountability; and (12) lack of a shareholder culture and corporate
governance culture.'54 Thus, many of the criticisms of existing independent
directors center around their powerlessness to protect the interests of small
and medium shareholders from the depredations of large shareholders and
management.' 55 They are said to fail in this mission because, among other
things, they are a minority on the board and they are nominated by
56
controlling shareholders.
The emphasis on the need to protect the small shareholder from the
dominant shareholder or shareholders is no doubt due to the shareholding
structure of stock companies in China. Companies with widely dispersed
public ownership where no individual owns a controlling block of shares

'52See, e.g., Jiang, supra note 89; Yan Fuhai, Yang Yao Nan Yi Zhongguo Bing
[Foreign Medicine Can't Cure a Chinese Sickness], FAZHAN [DEVELOPMENT], No. 8, 2002, at
41; Ye Xiangsong & Cao Zongping, Tuixing Duli Dongshi Zhidu, Wanshan FarenZhili Jiegou
[Promote the Independent DirectorSystem, Perfect the Legal-Person Governance Structure],
QiU SHI ZAZHI [SEEKING TRuTH MAGAZINE], No. 6, 2002, at 30-31.
'It is not clear what this is intended to mean, but probably means the presence of
dominant shareholders in large numbers of companies.
'See Shoufen Gongsi Zhili Zhiyin Chutai [First Guide to Corporate Governance
Appears], ZHONGGUO JINGJI SHIBAO [CHINA ECON. TIMES], Nov. 6, 2000. It is not clear what the
study meant by "shareholder culture" and "corporate governance culture" that is not included in
the preceding stated problems.
'55See, e.g., Ruhe Rang ZhongguoDuliDongshiFahui Youxiao de DuliZuoyong [How
to Have the Independent Directorin China Play an Effective Independent Role], JINGJI RIBAO
[ECON. DAILY], June 16, 2001.
'See id. Not surprisingly, nomination by those in control of the company continues.
A survey conducted in early 2003 found that 90% of independent directors had been nominated
by the controlling shareholder or by management. See Jin Xin Securities, Dui Woguo Shangshi
Gongsi Duli DongshiZhidu Shishi Zhuangkuang de Fenxi ji Jianyi [Analysis and Suggestions
Concerningthe Situationof Implementationofthe IndependentDirectorSystem in China's Listed
Companies], Aug. 8, 2003, at http://news 1.jrj.com.cn/news/2003-08-07/000000618234.html.
 DELAWARE JOURNAL OF CORPORATE LAW [Vol. 3 1

are virtually, and perhaps completely, non-existent. Thus, the agency

problem identified by Berle and Means in their classic work, The Modem
Corporationand Private Property,57 "' is not a major concern. As demon-

strated above, Chinese listed companies typically have a few large,

dominant shareholders (often holding unlisted state or legal person shares)
and a minority of small shareholders holding listed shares. Certainly the
perception in the literature seems to be that there is a serious problem of
abuse of power by dominant shareholders, who handpick compliant boards
and management who will operate the company in a way that favors those
dominant shareholders. Thus, the problem to be addressed by the institu-
tion of the independent director is that of abuse of dominant share
ownership at the expense of small shareholders.' 58
A major problem with this approach is that it starts from the notion
that control of the company by any particular large shareholder is itself bad.
The literature is full of lamentations that shareholder votes are mere
formalities because one shareholder owns an overwhelming block. But
directors, independent and otherwise, are supposed to be elected by
shareholders. For the majority shareholder to out-vote minority
shareholders is precisely the intended consequence of the voting system set
forth in China's Company Law'59 and the corporate laws of other countries.
Thus, the complaints of some commentators that companies with dominant
shareholders are not run "democratically,' 6 or lack true collective
decisionmaking, 61 seem based on a conception of the company as a
162
political enterprise, not as an economic one.

57
1 BERLE & MEANS, supra note 148.
58
1 See, for example, the remarks of Laura Cha (Shi Meilun), the deputy head of the
CSRC, who spoke of "egregious behavior" by controlling shareholders of listed companies, as
reported in Richard McGregor, China PlansNew Market Rules, FIN. TIMES, Apr. 19,2001, at 25.
l'"See Company Law, supra note 17, art. 104.
'6°See, e.g., Sun Guangyan, Woguo Ying Ruhe Yinru Duli DongshiZhidu [How China
Should Introduce the Independent DirectorSystem], FAXuE [JURISPRUDENCE], No. 7, 2001, at
65, 65; Wu Jianxiong et al., Duli Dongshi Zenme Yangle-Shangshi Gongsi Tuixing Duli
Dongshi Zhidu Xianzhuang Diaoyan Fenxi [How Are Independent Directors Doing? An
Investigation and Analysis of the CurrentSituation in the Implementation by Listed Companies
of the Independent DirectorSystem], ZHENGQUAN SHIBAO [SECURITIES TIMES], Jan. 10, 2002.
1
'See, e.g., Luo Peixin & Mao Lingling, Lun Duli Dongshi Zhidu [On the System of
Independent Directors],ZHENGQUAN SHICHANG DAOBAO [SECURITIES MARKET HERALD], Feb.
2001, at 48, 50,
62
1 Ma complains that the board represents the interests of only a numerical minority
(shao bufen) of the shareholders. See Ma, supra note 12, at 63. In economic terms, of course,
the board may represent all too effectively the interests of the majority holder. It is the political
conception of the company that makes the number of small shareholders, regardless of their
holdings, significant.
20061 CHINESE CORPORATE GOVERNANCE

Given that large shareholders get to choose directors, it is hard to

see how directors representing minority shareholders could be elected to
the board in the first place unless the basic principles of director selection
were changed. Cumulative voting is a possible solution-it is in fact
encouraged by the Corporate Governance Principles16 3-but this system
will at best elect directors representing a concentrated minority, not a
dispersed minority, and even then such directors will be in a minority on
the board and can always be outvoted.
Obviously, even one isolated director can provide a degree of
protection to minority shareholders by publicizing, or threatening to
publicize, majority shareholder abuses of which he or she becomes aware.
It is not clear, however, if this is the kind of strong protection envisaged by
advocates of the independent director system, some of whom propose that
independent directors should constitute a majority of the board,"6 even
while expecting them to serve the interests of minority shareholders.
This view also ignores the problems with dispersed share
ownership pointed out so long ago by Berle and Means, as well as the
considerable evidence that having a controlling shareholder may be good
for corporate performance.' 65
Finally, this view runs up against the special position the state
wants to reserve for itself when it is the dominant shareholder. 166 The Dean
of the Changjiang School of Business, who serves as an independent
director, was recently quoted as saying, "Ihave never thought that the
independent director is the protector of medium and small shareholders;
never think that. My job is first and foremost to protect the interests of the

163See China Securities Regulatory Commission, Shangshi Gongsi Zhili Zhunze

[Principles of Corporate Governance for Listed Companies], art. 29, issued Jan. 7, 2002
[hereinafter Corporate Governance Principles]. The CSRC never explained how cumulative
voting could be carried out consistently with article 106 of the old Company Law, which
mandated one vote per share. Fortunately, the October 2005 revisions to the Company Law have
eliminated this problem by explicitly permitting cumulative voting. See Company Law, supra
note 17, art. 106.
"USee,e.g., H.u Ruyin et al., Zhongguo Shangshi Gongsi Zhili Mianlin De Wenti Yu
Duice [CorporateGovernanceProblems Confronting Chinese Listed Companies andMeasures
to Address Them], in Guo &WANG, supra note 33, at 172, 188.
65
1 See, for example, TENEV & ZHANG, supra note 80, at 110. See also supra Part

ll.A.4.
16'"The view that independent directors have a role to play in counteracting the
(presumably deleterious) effects of state shareholding is not unique to Chinese commentators.
See, for example, Harry G. Broadman, Lessons From Corporatization and Corporate Governance
Reform in Russia and China 23 (unpublished manuscript, prepared for the International
Conference on Corporate Governance Development in Vietnam, Hanoi, Oct. 11-12, 2001) (calling
for the election of "independent, non-state representatives" to the board of directors).
 DELAWARE JOURNAL OF CORPORATE LAW [Vol. 31

large shareholder, because the large shareholder is the state." '67

A second proposed function for independent directors is to monitor 168
related-party transactions, where there could be a conflict of interest.
Note that if independent directors are to perform this function effectively,
"independence" cannot be an abstractly defined concept referring to
independence from management. A transaction-based approach that looks
at the director's interest in a particular transaction is required; otherwise a
director wholly independent of management would be deemed fit to vote
on a transaction between the company and himself.
A third function for independent directors frequently mentioned is
that of brain trust or consultant. 69 This is an often-touted virtue of outside
directors as well. 7 ° In either case, however, it is not clear why the
company would not do better hiring consultants and other experts for
advice, instead of having them sit on the board until such time as they
might be needed. 7 ' What incentives do such directors have to devote time
and resources to their advisory task? If outside or independent directors
who give valuable advice are compensated any differently from directors
who do not, then they may cease to meet the definition of outside or
independent director. Furthermore, if giving advice is the appropriate role, 17 2
why do the directors need to satisfy any criterion of independence at all?

67
' Xiang Bing, quoted in Duli Dongshi Xiang Huaping? [Are Independent Directors
Just Decorative?],GANG-AO XINXi RIBAO [HONG KONG-MACAo NEWS DAILY], Jan. 1, 2003,
availableat http://www.chinainfobank.com. Note that Xiang made this remark well after the
promulgation of the CSRC's Independent Director Opinion, which specifically rejects his
interpretation of an independent director's responsibilities. See infra Part IV.E.2.
"6SeeYan, supra note 152; Ye & Cao, supra note 152.
69
See, e.g., Wu et al., supra note 160; Yan & Chen, supra note 12, at 26; Ye & Cao,
supra note 152.
170See supratext accompanying note 131.
71
' A few skeptics in the Chinese literature make this point as well. See Han Qiang,
Zhiyi "Duli Dongshi" [Doubts About the "Independent Director"],Nov. 6, 2002, availableat
http://finance.sina.com.cn/ychd/20021106/1301275475.html; Yu Guanghua, Yiding Yao Duli
Dongshi Ma? [Do We Really Need Independent Directors?], 21 SHIUl JINGI BAODAO [21ST
CENTURY ECONOMIC REPORT], July 19, 2002.
72
' Although outside directors are common in Japan, the Revised Corporate Governance
Principles of the Japan Corporate Governance Forum specifically view their advisory function as
secondary: "In Japan, although there is a strong bias towards requesting managerial advice from
outside directors, this phenomenon is, at best, a secondary function, and managers and employees
alike in Japan need to be reminded that the primary role of outside directors is that of
governance." JAPAN CORPORATE GOVERNANCE FORUM, supra note 136, at 7. Miwa and
Ramseyer, however, cast doubt on the primacy of the governance role at least as a descriptive
matter. Noting that outside directors often come from companies and institutions that are
customers of the company in question, they hypothesize that outside directors are useful to
Japanese companies because of their understanding of customer needs. Such directors need not
be in any way independent of management in order to fulfill this function, and indeed such
directors apparently assume full-time employment as company directors-that is, they resign any
2006] CHINESE CORPORATE GOVERNANCE

Finally, a fourth function sometimes mentioned is that of serving

the public interest, I use this broad category to include concepts of the
independent director as a kind of agent of state regulatory bodies.74 or as a
kind of mole operating on behalf of the state to monitor its assets and
prevent managerial waste. As Han points out, however, this is exactly what
the directors appointed by the state shareholder-and in many cases, there
will be a dominant state shareholder perfectly capable of appointing
whatever directors it pleases' 7 5- are supposed to be doing. Why does
there need to be a special independent director to carry out this task?
Where the director serves the "public interest," arguably he or she
should be independent of everyone--dominantshareholders, management,
and indeed all those who have an interest in the company-and follow only
the dictates of his or her conscience.' 75 Assuming accountability to be a
good thing, however, it is hard to see how such a director could properly be
made accountable.' 76 In the real world, of course, any director without
security of tenure will, in the absence of counterincentives and assuming
that the position is desirable, tend to be accountable to whoever was
responsible for appointing him or her.
A final issue to be addressed here concerns the relationship
between the independent director and the board of supervisors in the
Chinese company. Chinese company law provides for a two-tier board
structure, with a board of supervisors (elected by shareholders) as well as
a board of directors, and contemplates a relatively active managerial role

other positions-upon taking their position. See Miwa & Ramseyer, supra note 98.
73
' See, e.g., Yan Zheng, Wo Ruhe Xuezhe Dang "DuliDongshi" [How IAm Learning
to Be an "IndependentDirector'], KAIFANG [OPENING] No. 7, 2002, at 34. Yan is the head of
the Fujian Academy of Social Sciences, which makes him a senior academic of national standing.
He writes with pride of his position as the only independent director on the seven-member board
of the Shuikou Electric Power Generating Company, a limited liability company (youxian zeren
gongsi) with only two shareholders. According to the article, Yan believes he can be legally liable
for his votes at board meetings, yet accepts no fee for his position and is honored to feel that he
is making a contribution to the state. For the story of Lu Jiahao, another academic who despite
no experience in business was asked to serve as an independent director, did so without
compensation, and ended up being fined 100,000 yuan by the CSRC for his troubles, see Wu
Guofang, Cong Lu Jiahao An Fansi Duli Dongshi Zhidu [Reflections on the Independent
DirectorSystem from the Lu JiahaoCase], JIANCHA RIBAO [PROCURATORATE DAILY], Nov. 20,
2002, and Wei Yahua, Duli DongshiBei Fa Di Yi An [The FirstCase of an IndependentDirector
Being Fined], ZHONGGUO L HI WANG [CHINESE LAWYER NET], Dec. 13, 2002, at
http://www.chineselawyer.com.cn/article/2002l2l35599.htm. See also Appendix 1 (discussing
directors' liability in China).
174Mentioned but ridiculed by Han, supra note 171.
175This argument is made in Ye & Cao, supra note 152, at 30.
17
He and Yu point out that there is no reason to think that a director accountable to
nobody will do more for corporate results than an inside director. See He & Yu, supra note 104,
at 29.
 DELAWARE JOURNAL OF CORPORATE LAW [Vol. 31

for the board of directors.'7 7 The oversight role is to be played by the board
of supervisors. Although Chinese commentators often compare China's
two-tier model to Germany's, the Chinese structure differs in a crucial way:
the Company Law expects that the board of supervisors will perform a
supervisory role by simply saying that it will, without actually giving the
board any significant powers' 78 or providing structurally for its indepen-
dence from those it supervises.'79 The German board of supervisors, by
contrast, has the power to appoint and dismiss members of the management
board.
Possibly because of its impotence, the board of supervisors seems
to play no important role in corporate governance in China. In enterprises
dominated by state ownership-a significant number' 8 -the supervisors
are enterprise employees and are subordinate to the head of the

'7See Tang Xin, Zhongguo Shangshi Gongsi Zhili Huanjing De Xin Fazhan [New
Developments in the Governance Environment for Chinese Listed Companies] (Paper for 21st
Century Commercial Law Forum, Tsinghua Univ., Beijing, Nov. 18, 2001).
178The powers of the board of supervisors were set forth in Article 126 of the original
Company Law as follows:
The supervisory board shall exercise the following powers:
(1) examine the finances of the company;
(2) exercise supervision over the actions of directors or the manager
when they are performing their duties, which actions violate laws,
regulations or the articles of association;
(3) request directors and the manager to remedy a situation when the
acts of such directors or manager harm the interests of the company;
(4) propose the convening of special shareholders' meetings; and
(5) other powers stipulated in the articles of association.
Supervisors shall attend board of directors meetings.
The October 2005 revisions to the Company Law brought a modest increase to these
powers, but no qualitative change. See Company Law,supra note 17, art. 54.
As can be seen, the board of supervisors may criticize directors and officers and call
on them to correct their errors, but has no power to require them to do so. See Liu Wen & Wu
Man, Shangshi Gongsi Jianshihuiyu Duli Dongshi de "Gongsheng" Wenti [The Problemof the
"Co-Existence"of the Board of Supervisors and Independent Directors in Listed Companies],
CALJING KExUE [FIN. & ECON. Sl.], ZENG KAN [SuPP.], July 2002, at 99; Wang & Feng, supra
note 43; Wang Yuhong & Kang Jianhui, QianghuaJianshihuiZhineng, JianquanGongsi Zhili
Jiegou [Strengthen the Functions of the Board of Supervisors, Improve the Structure of
CorporateGovernance], XIANDAI QIYE [MODERN ENTERPRISE], No. 10, 2000, at 13, 13; Zhang
Jianwei & Xiang Jing, Jianshihuiyu Duli Dongshi Zhidu de Gongneng Bijiaojiqi Jiazhi Qushe
[A Comparisonof the Functionsof the Board ofSupervisors and Independent Directorsand an
Assessment of Their Values], LUOHE ZHIYE JISHU XUEYUAN XUEBAO (ZONGHE BAN) [J. LUOHE
VOCATIONAL & TECH. INST. (GEN. ED.)], No. 1, 2002, at 52, 54.
'The board of supervisors is elected by shareholders, and there is no reason to expect
the interests that dominate director voting to fail to dominate supervisor voting.
'SSee supra Part II.A.3.
2006] CHINESE CORPORATE GOVERNANCE

enterprise. 8 ' Indeed, a recent study 8 2 showing that over half the
companies surveyed maintained supervisory boards with only the legal
minimum number of members suggests that this institution plays no real
role in corporate governance.
Clearly, the hope is that independent directors will be able to play
the monitoring role that the board of supervisors has been unable to play.
Some commentators fear that having two monitoring institutions will lead
to conflicts and duplication of functions, but such fears are generally
expressed only vaguely, without specific examples of harmful conflicts that
could arise.8 3 While vagueness, ambiguity, and confusion are bad,
redundant systems per se are not. Given the weakness of the board of
supervisors, it is not even clear that there is any real redundancy in the first
place. While it may be unfortunate that JSCs are saddled with a poorly
thought-out structure that serves no useful purpose, its existence does not
make the institution of independent directors any more or less effective.

IV. REGULATORY RESPONSES

In Western studies of corporate governance, the dominant

explanation for the current corporate landscape is a Darwinian one: the
structures and institutions we see are presumed to be the efficient ones that
survived in the course of competition with less efficient forms, and the
challenge is to explain the source of that efficiency. 4 This approach has

'See Jiang, supra note 89; Gao, supra note 12, at 9. Wang and Feng write:
The actual situation is that the great majority of the supervisors are
representatives of the union and of the congress of staff and workers, and
the chairman of the union has the right to call meetings. Because the
chairman of the union works under the leadership of the Party secretary and
the Chairman of the Board of Directors, it is impossible for him to be
independent. His livelihood and that of the staff and worker representatives
is in the hands of management; if one day they should dare to offend
management and exercise the sacred functions given to them by the law,
perhaps the day after proposing to inspect the finances of the company they
wouldn't even have theirjob at the company, and therefore wouldn't be able
to continue to represent the staff and workers.
Wang & Feng, supra note 43, at 120.
182
Lin & Dong, supra note 56, at 225.
3
' See, for example, Ma supra note 12, at 63, who fears at the same time that
duplicative functions could result in (1) insufficient monitoring on a theory of buckpassing, and
(2) excessive monitoring on a theory of too many cooks spoiling the broth. This seems little more
than guesswork; the author does not provide any analysis of the incentives facing independent
directors and supervisors that would lead to either result.
'"See, e.g., Oliver E. Williamson, The Economics of Organization:A TransactionCost
Approach, 87 Am. J. Soc. 548,573-74 (1981); Oliver E. Williamson & William G. Ouchi, The
Markets and Hierarchies Program of Research: Origins, Implications, Prospects, in
 DELAWARE JOURNAL OF CORPORATE LAW [Vol. 31

been cogently criticized as tautological and Panglossian '-whatever is,

is efficient-and certainly Chinese governmental authorities have not been
willing to wait to see which institutions of corporate governance survive in
market competition. Instead, they have taken active steps to encourage or
require companies and other business entities to establish internal
governance procedures that will, in the view of the authorities, produce
desirable business decisions. This Part will review several of such
initiatives to the extent they bear on the issue of independent directors, and
will conclude with an examination in detail of the CSRC's Independent
Director Opinion.

A. Stock Exchange Initiatives

Stock exchanges can be an important source of corporate

governance norms that are law-like in nature. The stock exchanges in
Shanghai and Shenzhen are not independent self-regulating institutions;
rather, they were established by government, are protected by
government,18 6 and serve governmental purposes. Unlike the National

PERSPECTIVES ON ORGANIZATION DESIGN AND BEHAVIOR at 347,389 (Andrew H. Van de Ven &
William F. Joyce eds., Wiley 1981). On evolutionary theories of economic change in general, see
RICHARD R. NELSON & SIDNEY G. WINTER, AN EVOLUTIONARY THEORY OF ECONOMIC CHANGE
(Harvard Univ. Press 1982); Armen Alchian, Uncertainty, Evolution, and Economic Theory, 58
J. POL. ECON. 211 (1990); and Sidney G. Winter, Jr., Economic "NaturalSelection" and the
Theory of the Firm, 4 YALE ECONOMICS ESSAYS 225 (1964).
'See, e.g., Mark Granovetter, Economic Action and Social Structure: The Problem
of Embeddedness, 91 AM. J. Soc. 481,503 (1985) ("The operation of alleged selection pressures
is ... neither an object of study nor even a falsifiable proposition but rather an article of faith.").
See also RATIONAL CHOICE 26 (Jon Elster ed., N.Y. Univ. Press 1986) (questioning the
applicability of the biological analogy to economic activity on the grounds that the economic
environment changes rapidly relative to the speed with which inefficient firms are eliminated from
competition, and that therefore at any given time we are likely to observe efficient and inefficient
firms coexisting).
"86See, for example, 1993 Company Law, supra note 17, art. 144, which required that
all transfers of shares of JSCs-even unlisted ones-be conducted through an approved stock
exchange. It should be added that state authorities never seriously attempted to enforce such an
impractical rule. On September 30, 2001, the CSRC issued a regulation stating its intention to
enforce the rule with respect to listed companies, but the regulation did not purport to cover non-
listed JSCs. See China Securities Regulatory Commission, Guanyu Jiaqiang Dui Shangshi
Gongsi Fei Liutong Gu Xieyi Zhuanrang Huodong Guifan Guanli de Tongzhi [Notice on
Strengthening the Regularization and Management of Transfers by Agreement of Non-
CirculatingShares ofListed Companies], issued Sept. 30,2001. And even that regulation proved
unworkable; less than two years later, a CSRC official was quoted as saying that the CSRC was
not strictly enforcing it. See Liu Xuemei, Nanjing Xin BaiGuoyougu GuapaiZhuanrang Beihou
[The Story Behind the Transfer of the State-Owned Shares of Nanjing Xin Bail, 21 SHIM JINGJI
BAODAO [21ST CENTURY EONOMIC REPORT], June 16, 2003, available at http:/www.
nanfangdaily.com.cnjj/20030616/cj/200306160602.asp. The rule was finally eliminated
legislatively in the 2005 revision to the Company Law. See Company Law, supra note 17, art.
20061 CHINESE CORPORATE GOVERNANCE

People's Congress, they cannot back up their corporate governance

directives by granting investors and others a legal right of action, but they
do possess a powerful, if blunt, weapon: the threat of delisting.
In November 2000, the Shanghai Securities Exchange issued a set
of draft guidelines on corporate governance (SSE Guidelines) for
companies listed on the exchange." 7 The SSE Guidelines stipulate that
each listed company must have at least two independent directors, and that
independent directors should constitute not less than 20% of the board of
directors (30% where the chairman of the board and the general manager
are the same person). Independent directors may be nominated by the
board's nominating committee or by shareholders holding at least 5% of the
stock. Controlling shareholders may not, however, nominate more than one
director, indicating that the SSE Guidelines contemplate independent
directors as a shield against dominant shareholder abuses as well as
management abuses.
The SSE Guidelines contemplate a major role for independent
directors. 8 All subcommittees of the board of directors-including those
for compensation, nomination, and investment decisions, which are
specifically mentioned-are to be composed principally of, and chaired by,
independent directors. It is thus unfortunate that the SSE Guidelines do not
define "independent director."' 89
The substantive prescriptions of the SSE Guidelines are not
mandatory. They are to be enforced, if at all, through the mechanism of
disclosure: listed companies are to disclose the extent to which they have
followed the guidelines and implemented a set of corporate governance
"best practices" on the basis of the SSE Guidelines.
In early 2001, the Securities Regulatory Office of Shenzhen
promulgated the "Guidelines for the Implementation of an Independent
Director System in Listed Companies" (Shangshi Gongsi Duli Dongshi
Zhidu Shishi Zhiyin). These provided detailed rules respecting the
qualifications and functions of independent directors and presumably
applied to companies listed on the Shenzhen Stock Exchange. 9 ' In June
2004, the Shenzhen Stock Exchange promulgated the "Instruction on
Building Trust by Companies Listed on the Shenzhen Stock Exchange

139.
I. 7See Shoufen Gongsi Zhili Zhiyin Chutai [First Guide to Corporate Governance
Appears], supra note 154.
'uSee id.
18'This shortcoming is pointed out in Luo & Mao, supra note 161, at 51.
'90I have been unable to procure the text of these guidelines; this summary is based on
news reports.
 DELAWARE JOURNAL OF CORPORATE LAW (Vol. 31

Small and Medium-Sized Enterprises Board," which called for one third of
directors in listed companies to be independent, with at least one of those
directors a qualified accountant.' 9' The mandatory force of this document,
however, is questionable.

B. Regional Government Initiatives

There have been various corporate governance initiatives involving

independent directors at the level of local government as well.

In May 2000, the Jiangxi provincial government issued a document

calling for an "appropriate number" (shidang shuliang) of
independent directors to be put on the boards of large enterprises
that had been converted to companies under the Company Law,
with the objective of making company decisionmaking more
"scientific and objective."'192

In October 2000, the Fujian provincial government issued a

document on the management of state-owned enterprises under
provincial jurisdiction. Such enterprises are controlled by
provincially established holding companies, and the document
states that such holding companies must have an unspecified
number of independent directors who are experts193or "well-known
personages in society" (shehui zhiming renshi).

In December 2000, the Guangdong provincial government issued

policy guidelines for the administration of state-controlled listed
companies under its jurisdiction. These guidelines called for the
installation of independent directors on the boards of such
companies, and specified that such directors should be responsible

91
' See Shenzhen Stock Exchange, Shenzhen Zhengquan Jiaoyisuo Zhongxiao Qiye
Bankuai Chengxin Jianshe Zhiyin [Instruction on Building Trust by Companies Listed on the
Shenzhen Stock Exchange Small and Medium-Sized EnterprisesBoard], art. 5, issued June 24,
2004, availableat http:/lbusiness.sohu.com12004106125/29/article220712949.shtml.
"9Jiangxi Provincial Government Commission on Reform of the Economic System,
Guanyu JiakuaiTuijin Guoyou Qiye Gufenzhi Gaige Cujin Touzi Zhuti Duoyuanhua de Yijian
[Opinion on Accelerating the ShareholdingReform of State-Owned Enterprisesand Promoting
the Diversificationof lnvesting Bodies] § 2(1), issued May 29, 2000.
193
See Fujian Provincial Government, Guanyu JiakuaiWosheng Guoyou Zichan Guanli
Jianduhe Yunying Tizhi Gaige de Zhidao Yijian [Guidance Opinion on Accelerating the Reform
of the System of Monitoring and Operation of Fujian State-Owned Assets], art. 16, issued
Oct. 18, 2000.
2006] CHINESE CORPORATE GOVERNANCE

to the whole body of shareholders, giving priority to the interests

of small and medium shareholders in case of conflict. 94

Also in December 2000, the government of Hebei Province issued

measures purporting to be mandatory and stating that companies
should have experts in such fields as economics, finance, law, and
securities as independent directors. They decline, however, to
specify a particular proportion of independent directors on the
board, leaving that instead to the articles of association.'9 5

In January 2001, the Shenzhen Municipal Government issued a

document on the reform of SOEs in Shenzhen and calling for
"some" independent directors to be added to the boards of state
96
asset management companies "as appropriate." 1

In March 2002, the Jinan municipal government called for the

gradual introduction of outside directors and independent directors
onto the boards of large enterprises in the city, but did not define
197
or distinguish them.

In July 2002, the Hangzhou municipal government called for

enterprises to improve their governance through having outside
directors (waibu dongshi)and independent directors (duli dongshi),
but made no attempt to distinguish them.'98

"9SeeGuangdong Provincial Government, Guanyu JiaqiangWosheng Guoyou Konggu

ShangshiGongsi GaojiGuanliRenyuan Guanli Wanshan FarenZhiliJiegou de Yijian [Opinion
on Strengthening the AdministrationofHigh-Level ManagementPersonnelin GuangdongState-
Controlled Listed Companies and Perfecting the CorporateGovernance Structure] § 2(l)(2),
issued Dec. 11, 2000 [hereinafter Guangdong Corporate Governance Opinion].
195
See Hebei Provincial Government, Guifan GongsiFarenZhili JiegouZanxing Banfa
[ProvisionalMeasuresfor Standardizing the Governance of Company Legal Persons] art. 19,
issued Dec. 25, 2000.
"9SeeShenzhen Municipal Government, GuanyuJinyibu JiakuaiWo Shi Guoyou Qiye
Gaige he Fazhan de Shishi Yijian [Opinion on Implementing the FurtherAcceleration of the
Reform and Development of Shenzhen State-Owned Enterprises],issued Jan. 11, 2001.
97
' See Jinan Municipal Government, Guanyu Jiakuai Quanshi Gongye Fazhan de
Yijian [Opinion on Accelerating the Citywide Development of Industry] § 2(1), issued Mar. 7,
2002.
98
See Hangzhou Municipal Government, Guanyu Jinyibu Peiyu Fazhan Da Qiye
Jituan de Ruogan Yijian [Several Opinions on Further Fosteringthe Development of Large
Enterprise Groups] § 1(2), issued July 16, 2002, effective July 16, 2002.
 DELAWARE JOURNAL OF CORPORATE LAW [Vol. 31

In August 2002, the Gansu provincial government, in a non-

binding document, called on local enterprises to install indepen-
dent directors and creditor representatives on their boards.' 99

In January 2003, the Beijing municipal government issued a

document prescribing governance standards for enterprises it
owned or controlled. This document called for at least one third of
directors to be persons not employed at the enterprise, and said that
enterprises "may" have independent directors who are both
independent of the enterprise's shareholders and not employed at
the enterprise. 2°

What all these regulations and policy statements tend to have in

common is that they rarely go beyond vague exhortations to install
independent directors, and rarely specify numbers or specific powers. They
seem grounded more in a notion in the minds of the drafters that
independent directors are a good thing and therefore should be
recommended or required. Since virtually all of the regional regulations
apply to enterprises in which the major shareholder is the local
government-the issuing body-it is hard to understand why a system
designed to create opposition would be welcome. 2° ' A possible conclusion
is that the drafters simply have not thought much about the issue, or else do
not expect independent directors to oppose government policies.

C. CentralGovernment Ministry Initiatives

A few central government ministries (and equivalent bodies) have

issued documents calling for independent directors in enterprises under
their jurisdiction. For example, in 2002 the Ministry of Agriculture called
for the restructuring of township and village enterprises into LLCs and

1
See Gansu Provincial Government, Guanyu Shishi Gongye QiangshengZhanliie Jige
Zhongda Wenti de Jianyi [Proposals on Several Important Issues Concerning the
Implementationof the IndustrialProvince-StrengtheningStrategy] § 3(2), issued Aug. 24, 2002.
2
°See Beijing Municipal Government, Guanyu Benshi Guoyou Dazhongxing Qiye
Chubu Jianli Xiandai Qiye Zhidu Pingjia Biaozhun [Standardsfor Assessment of the Initial
Establishmentof a Modern EnterpriseSystem in Beijing Large and Medium-Sized State-Owned
Enterprises] § 1(9), issued Jan. 22, 2003.
20
'Recall that "independence" in Chinese definitions virtually always includes
independence from major shareholders. See supra note 114. A Guangdong provincial
government document applying specifically to listed companies in which the controlling
shareholder is a state body specifically calls for independent directors to put the interests of small
and medium shareholders above those of the controlling shareholder. See Guangdong Corporate
Governance Opinion, supra note 194, and accompanying text.
20061 CHINESE CORPORATE GOVERNANCE

JSCs under the Company Law with "independent directors who are
independent of company shareholders and are not employed within the
company" on their boards.2 °2
The People's Bank of China (PBOC), until recently in charge of
bank regulation in China, in 2002 issued two documents it characterized as
"guidelines": the Commercial Bank Independent Director Guidelines and
the Commercial Bank Corporate Governance Guidelines. Both address the
issue of independent directors in commercial banks with a shareholding
structure. The Independent Director Guidelines prescribe rather stringent
qualifications for such directors 20 3 and view stock ownership 2°4 and lengthy
service (three years) 205 as destructive of the desired independence. They
further provide that each bank must have at least two independent directors
(as well as two outside supervisors), and that a single shareholder may
nominate no more than one independent director or outside supervisor.
Unlike the CSRC, the PBOC is content to check on the qualifications of
independent directors after they have assumed office instead of before. 2°
Like many other independent director rules and policies, the
Independent Director Guidelines do not specify any concrete powers for
independent directors. The only specific power they are given is the ability
of a majority to request that the board of directors call a special
shareholders' meeting, 207 but since they cannot require the calling of such
a meeting, the effect of this power is quite limited. The Corporate
Governance Guidelines, on the other hand, do provide for a somewhat

20
2See Ministry of Agriculture, Dazhongxing Xiang-Zhen Qiye Jianli Xiandai Qiye
Zhidu Guifan [Standardsfor the Establishment of a Modem EnterpriseSystem in Large and
Medium-Sized Township and Village Enterprises] art. 12, issued June 7, 2002, effective July 1,
2002.
203
See, e.g., CommercialBank Independent DirectorGuidelines,supra note 114, art.
1 (calling for at least five years of relevant work experience and the ability to read and analyze
lending data and financial statements).
2
°See id. art. 2; People's Bank of China, Guanyu Gufenzhi Shangye Yinhang Gongsi
Zhili Zhiyin [Guidelines on Corporate Governance for Commercial Banks Under the
ShareholdingSystem] art. 30, issued and effective June 4, 2002 [hereinafter CommercialBank
CorporateGovernance Guidelines].
20
See Commercial Bank IndependentDirector Guidelines,supra note 114, at art. 9.
Michigan's independent director statute bars independent status after three years on the board. See
MICH. COMP. LAWS ANN. § 450.1107(3)(d) (2002). See also supra note 140. The Cadbury
Report expresses the same policy concern without adopting a prohibition: "Non-executive
directors may lose something of their independent edge, if they remain on a board too long."
CADBURY REPORT, supra note 68, at 4.16. See also Gao, supra note 12, at 11 (arguing that
social pressures will make independent directors sympathetic to management); He & Yu, supra
note 104, at 28 (same).
2
"See Commercial Bank Independent DirectorGuidelines, supra note 114, art. 11.
20
'See id. art. 22.
 DELAWARE JOURNAL OF CORPORATE LAW [Vol. 31

larger role. Bank boards are to establish committees to handle, among

other things, related party transactions 2 8 and board nominations. Both such
committees must be chaired by an independent director. 2° Moreover, their
members may not be directors nominated by the controlling shareholder.210
Interestingly, the Corporate Governance Guidelines do have a
concept of disinterested director along with that of independent director.
Directors with a substantial interest (zhongda lihaiguanxi)in a matter may
not vote on it, and resolutions on such matters must be approved by a
majority of directors without a substantial interest. 21 ' This rule does not
appear to have been well thought out: if only disinterested directors may
vote, even a unanimous vote of such directors might be insufficient to
constitute a majority of the board, and the Company Law states that a board
majority is necessary for the passage of any resolution. 212 Company law
statutes in other jurisdictions typically deal with conflicts of interest by
applying quorum and majority requirements to the body of disinterested
directors only, but China's Company Law does not do so, and the PBOC
has no authority to make exceptions to its requirements.
Independent directors are supposed to pay special attention to the
interests of depositors and of small and medium shareholders,2 13 but there
is no mechanism to push them in this direction. The Independent Director
Guidelines state that independent directors should, before taking office,
make a declaration to the board of directors and the board of supervisors
guaranteeing that they have sufficient time and energy to carry out their
duties, and promising that they will perform them with diligence. 214 It is
difficult, however, to see this promise, if made, as a potential source of civil

2
"Approval of the committee on related party transactions is needed only for "large"
transactions, as defined in the company's articles of association. See CommercialBank Corporate
Governance Guidelines, supra note 204, art. 41.
21
9Curiously, the guidelines appear to contemplate that committee members will not all
be directors, since they specify that the chairman (fuze ren) should be a director. See id. art. 40.
21
°See id. It is hard to see how this provision could be workable unless the bank has
a very large board, since each committee must have at least three members. Nor is it clear how
it will be enforced, since the guidelines do not provide any incentives for shareholders or others
to police this requirement and determine whether a particular shareholder is in fact a controlling
shareholder.
21
'See id. art. 41.
2t 2
See Company Law, supra note 17, art. 112 (similar in relevant part to Article 117
of the 1993 Company Law). Article 112 also creates difficulties in requiring a majority of all
directors, not just those present at a board meeting that satisfies quorum requirements, for the
passage of a board resolution.
213
See CommercialBank CorporateGovernance Guidelines, supra note 204, art. 30.
214
See CommercialBank IndependentDirector Guidelines, supra note 114, art. 10.
20061 CHINESE CORPORATE GOVERNANCE

or administrative liability, and the PBOC has no legislative power to create

such liability on its own.

D. CSRC Initiatives

The CSRC has also been interested for some time in substantive
regulation of corporate governance and considered such matters within its
jurisdiction. To that end, it has issued (or proposed to issue) a number of
regulations relating to corporate governance in listed companies (the only
companies that are under its jurisdiction), and in these regulations has
addressed the issue of independent directors.

1. CSRC Guidelines for the Articles of Association

of Listed Companies

The CSRC made its first major foray into corporate governance
regulation several years ago, on December 16, 1997,215 with the
promulgation of its "Guidelines for the Articles of Association of Listed
Companies" (Shangshi Gongsi Zhangcheng Zhiyin) (1997 Guidelines).
According to the notice accompanying the 1997 Guidelines, listed
companies were required to adopt their provisions (with minor changes in
wording allowed) unless permitted to do otherwise by the CSRC. The
CSRC further announced that it would enforce this requirement by refusing
to accept submissions and filings from companies whose articles of
association contained unauthorized deviations from the 1997 Guidelines.
The 1997 Guidelines say little about independent directors. They
provide only that the company may establish independent directors in
accordance with its "actual needs," and provide that certain persons may
not act as independent directors: (1) shareholders or those employed by
shareholding entities; 2 6 (2) "internal personnel" of the company (such as
the manager or an employee); and (3) persons with a "relationship of
interest" (liyi guanxi) with affiliates or management of the company.217

215
On August 27, 1994, the State Council's Securities Commission (Zhengquan
Weiyuanhui), the former parent organization of the CSRC, issued (jointly with the State
Commission on Reform of the Economic System) the Mandatory Articles of Association for
Companies Listing Overseas (Mandatory Articles). These have nothing to say, however, about
independent directors.
2 6
' The Chinese text is ambiguous here. It may mean "those employed by shareholders
or shareholding entities." The meaning suggested above is more probable, given the CSRC's later
view expressed in Section 3(2) of the Independent Director Opinion, which prohibits anyone
holding over 1% of the company's shares from qualifying as an independent director.
2
'See China Securities Regulatory Commission, Shangshi GongsiZhangchengZhiyin
[Guidelines for the Articles ofAssociation of Listed Companies] art. 112, issued Dec. 16, 1997.
 DELAWARE JOURNAL OF CORPORATE LAW [Vol. 31

The provisions of the 1997 Guidelines relating to independent

directors must be considered weak. They do not, for example, say what the
point of having such independent directors might be, although the
prohibition on shareholding suggests the focus is on abusive practices by
dominant shareholders. They do not set forth any special powers for
independent directors, such as the sole power to approve certain
transactions. Key terms such as "affiliate" (guanlianren) and "relationship
of interest" (liyi guanxi) are undefined.2 1

2. CSRC/SETC Opinion on Further Promoting the Standard Operation

and Deeper Reform of Companies Listed Overseas

On March 29, 1999, the CSRC and the SETC jointly issued the
Opinion on Further Promoting the Standard Operation and Deeper Reform
of Companies Listed Overseas (Overseas Company Reform Opinion or
OCRO), the mandatory status of which is not clear. The document is
labeled "Opinion," which normally indicates that it is not of an absolutely
binding character. Nevertheless, it is clearly intended to have some effect.
The OCRO addresses the issue of independent directors in
surprisingly strong terms. "Outside directors" (waibu dongshi) (not
defined) must constitute at least half of the board of directors, and at least
two members of the board must be independent directors (defined to mean
independent of the shareholders of the company and not holding any
position within the company).2" 9 The OCRO provide that any transaction
between the company and an affiliate of the company (gongsi de guanlian

2
'Although the latter problem has been rectified in the Independent Director Opinion,
the term "affiliate" remains undefined in the Independent Director Opinion as well.
2
"See China Securities Regulatory Commission, State Economic and Trade
Commission, Guanyu Jinyibu Cujin JingwaiShangshiGongsi Guifan Yunzuo he Shenhua Gaige
de Yijian [Opinion on Further Promoting the Standard Operation and Deeper Reform of
Companies Listed Overseas], art. 6, issued Mar. 29, 1999. Interestingly, exactly the same
language is used in article 1(7) of a later SETC document, where it is provided that companies
"may" institute independent directors. State Economic and Trade Commission, Guoyou
Dazhongxing Qiye JianliXiandai Qiye Zhidu he JiaqiangGuanliJiben Guifan (Shi Xing) [Basic
Standardsfor Establishing a Modem Enterprise System and Strengthening Management in
Medium- andLarge-Sized State-Owned Enterprises(for TrialImplementation)], issued Sept. 28,
2000.
2006] CHINESE CORPORATE GOVERNANCE

jiaoyi) must be approved by the independent directors 220 before it is

effective.22 1
A spot-check of a few Chinese companies listed overseas is useful
for understanding the scope of what the CSRC will insist on. The articles
of association of China Telecom Corporation Limited (CTCL) provide for
two independent directors, but say nothing about outside directors
constituting half the board.222 While the OCRO require independent
director approval of all transactions with affiliates, CTCL's articles require
223
such approval only of board resolutions pertaining to such transactions,
and the articles do not require board approval of all such transactions. The
articles of association of neither China Petroleum and Chemical
Corporation 224 nor China UnicoM 225 call for independent directors to
constitute at least half the board.

3. CSRC Draft Rules for Companies Seeking Listing

on a Secondary Board

On August 23, 2000, the People'sDaily reported on a draft set of

rules for companies seeking listing on a proposed secondary board.226
These rules stated that fully two thirds of directors in such companies had
to be independent, and defined independent directors as directors other than
those who (1) were shareholders; (2) were directly related, or collaterally
related within three generations, to company directors, supervisors

22
°The OCRO do not specify whether such approval must come from at least one, a
majority, a supermajority, or all of the independent directors. The articles of association of one
company subject to the OCRO, China Telecom Corporation Limited, specify approval by all
independent directors. See CHINA TELECOM CORP. LTD., ARTICLES OF ASSOCIATION art. 96
(June 20, 2003), availableat http://www.sec. gov/Archivesledgar/data/1 191255/00010214080
3008986/dex2.txt.
221
1t is not clear if the OCRO really mean that the transaction will be a legal nullity
absent such approval. Such a rule is rare in Chinese law, and it is not clear if the CSRC and the
SETC have the legislative authority to override the standard rules of contract and civil law. One
could imagine a rule stating that the directors could be sued by shareholders for transactions with
affiliates unaccompanied by independent director approval, but that is not this rule.
222
See CHINA TELECOM CORP. LTD., ARTICLES OF ASSOCIATION, supra note 220, art.
94.
223
See id. art. 96.
224
CHINA PETROLEUM AND CHEMICAL CORPORATION, ARTICLES OF ASSOCIATION arts.
96-98, in Form 20-F (as filed with the SEC on June 22, 2004), available at http://secfilings.
nyse.com/files.php?symbol=SNP&fg=24.
22
CHINA UNICOM, LTD., ARTICLES OFASSOCIATION arts. 86-88, in Form 20-F (as filed
with the SEC on June 24, 2004), available at http://secfilings.nyse.com/
files.php?symbol=CHU&fg=24.
226
See Wu Li, Erban Shichang Choujian Dongtai [Trends in the Establishment of the
SecondaryBoard Market], RENMIN RIBAO [PEOPLE'S DAILY], Aug. 23, 2000, at 3.
 DELAWARE JOURNAL OF CORPORATE LAW (Vol. 31

(fianshi),or officers; (3) were directors, supervisors, or officers of affiliated

enterprises (guanxi qiye), a term that was not defined; or (4) were any
person that was manipulable by the company.
The draft rules do not appear to contemplate any special function
for independent directors other than to attend board meetings and vote as
directors. They do not spell out any transactions that need approval from
some number of independent directors.
It is not clear how the proposed rules are to be enforced. Most
likely, the CSRC will require compliance in order to be listed on the
secondary board, and non-compliance will result in de-listing. A secondary
board was established in Shenzhen on May 17, 2004,227 but to the author's
knowledge the draft rules have not been finalized and applied. Thus, the
applicable rules are those of the 228
Independent Director Opinion and the
various rules that implement it.

4. CSRC Guidelines for Internal Controls for Securities Companies

On January 31, 2001, the CSRC issued rules governing the internal
structure of securities companies, which are entities specifically subject to
regulation by the CSRC. These rules, the Internal Controls Guidelines,
mentioned only the need to "bring into full play the monitoring function of
229
independent directors.

5. CSRC Guidelines for Internal Controls

for Fund Management Companies

On December 19, 2002, the CSRC issued rules governing the

internal structure of fund management companies (Fund Managers Internal
Controls Opinion), which, like securities companies, are subject to its
jurisdiction. These rules, like the Internal Controls Guidelines applicable

22 7
See Nanfang Wang [Southern Net], Shenzhen ZhengquanJiaoyisuoSheli Zhongxiao
Qiye Bankuai [Shenzhen Stock Exchange Establishes Secondary Board], May 18, 2004, at
http://www.southcn.com/tech/special/fxtz/ftxw/200405180004.htm.
22 8
This is specifically stated in Shenzhen Stock Exchange, Zhongxiao Qiye Gupiao
Faxing Shangshi Zhinan [Stock Issuance and Listing Guide for Small and Medium-Sized
Enterprises], issued May 18, 2004, at 35 (citing the Independent Director Opinion and China
Securities Regulatory Commission [CSRC], Guanyu Jinyibu Guifan Gupiao Shouci Faxing
Shangshi Youguan Gongzuo de Tongzhi [Notice on FurtherRegulating Work Related to Initial
Issuances of Stock], issued Sept. 19, 2003).
229
See China Securities Regulatory Commission, Zhengquan Gongsi Neibu Kongzhi
Zhiyin [Guidelinesfor InternalControlsfor Securities Companies] art. 15, issued Jan. 31,2001.
2006] CHINESE CORPORATE GOVERNANCE

to securities companies, mention merely the need to "bring into full play the
function of independent directors, 230 but have no specific requirements.

6. CSRC Measures on the Administration

of Securities Companies

On June 20, 2001, the CSRC issued a draft for comment of its
proposed Measures on the Administration of Securities Companies
(Securities Companies Draft Measures), followed by the release on
December 28, 2001 of the final version (Securities Companies Measures).
Apparently, the comments convinced the CSRC that the draft version was
unreasonably strict. The final version of the rules contains an explicit
requirement that independent directors constitute not less than one
quarter2 31 of the board of directors in the following circumstances: (1) the
chairman of the board and the chief executive officer are the same person;
(2) internal directors constitute at least one fifth of the board;23 2 or (3) the
department in charge of the company, its shareholders' general meeting, or
the CSRC deems it necessary.23 3
While the draft measures contained detailed rules on who could
qualify as an independent director,234 the final version is much simpler: an

23
°See China Securities Regulatory Commission, Zhengquan TouziJijin Guanli Gongsi
Neibu Kongzhi Zhidao Yijian [Guidance Opinion on Implementing Internal Controls in
Securities Fund Investment Management Companies] art. 11, issued Dec. 19, 2002, effective
Jan. 1, 2003.
23 1
The Securities Companies Draft Measures put the proportion at one third. See China
Securities Regulatory Commission, Zhengquan Gongsi Guanli Banfa (Zhengqiu Yijian Gao)
[Measureson the Administration ofSecurities Companies (Draftfor Comment)], issued June 20,
2001 [hereinafter Securities Companies Draft Measures].
232
The Chinese text is ambiguous; it may mean "more than one fifth," but probably not.
233
The Securities Companies Draft Measures had two additional circumstances: "the
company has been sanctioned for unlawful activity or certain extraordinary situations have
occurred; [or] the reputation of the company is seriously deficient such that the interests of clients
and shareholders are affected." Securities Companies Draft Measures, supra note 231, at 88.
234A person must meet the following standards to qualify as an independent director
under the Securities Companies Draft Measures: (1) he (or she) meets the conditions stipulated
in the Company Law; (2) he is not an employee of an entity that holds shares in the company; (3)
he is not currently, nor in the last three years has been, employed by the company; (4) he has no
relationship of interest (liyi guanxi) with other company directors, supervisors (jianshi), or senior
officers, or persons who are responsible for finances or auditing in the company; (5) he is not
employed within any organization that has a major relationship of interest with the company; (6)
he has at least five years of experience in finance, law, or accounting, and has sufficient time and
energy to perform the duties of a director; and (7) he meets other conditions stipulated by the
CSRC. See Securities Companies Draft Measures, supra note 231, at 88.
The "conditions stipulated in the Company Law" means the disqualified persons
defined in 1993 Company Law, supra note 17, arts. 57,58, and Company Law, supra note 17, art.
147. They include persons subjected to punishment for certain property crimes or to deprivation
 DELAWARE JOURNAL OF CORPORATE LAW [Vol. 31

independent director is someone who holds no position in the company

other than director, and who has no relationship with the company or its
majority shareholder that would compromise his independence.235
Similarly, while the draft version gave independent directors a defined role
to play in approving specific transactions such as loan guarantees or
related-party transactions,23 6 the final version took this role away.

of political rights within the preceding five years, persons who have been responsible for the
bankruptcy or business license revocation of an enterprise within the preceding five years, persons
with overdue personal indebtedness in a "relatively large" amount, and (in the 1993 Company Law
only) government officials. The last disqualification was quite unrealistic and not even desirable
in the case of wholly state-owned limited liability companies-surely it makes sense for the
government agency that owns the company to have its officials on the board, supervising
management. Otherwise the board will be dominated by management. See Jiang, supra note 89.
This provision was not in any case observed universally. See, e.g., HUANG XUEHAI & WANG
SHAOCHUN, QIYE FA GONGSI FA ANLI JINGXUAN JINGXI [SELECTED CASES AND ANALYSES IN
ENTERPRISE LAW AND COMPANY LAW] 32 (Falii Chubanshe 1998) (reporting a case in which all
four directors of a wholly state-owned limited liability company were government officials and
none was an employee, contrary in each case to what is called for by the Company Law). Article
58 of the 1993 Company Law equally prohibited government officials from serving as supervisors
(jianshi),and yet a subsequent State Council regulation made it clear that the State Council would
appoint government officials to serve as supervisors in wholly state-owned enterprises governed
by the Company Law. See State Council, Guoyou Qiye JianshiHui Zanxing Tiaoli [Temporary
Regulations on the Boardof Supervisors of State-Owned Enterprises]art. 14, effective Mar. 15,
2000. That the enterprises covered by these regulations include wholly state-owned limited
liability companies under the Company Law, as well as traditional state-owned enterprises, is
clear from an initial list of companies to which the supervisors were dispatched. See Guowuyuan
Paichu Jianshi Hui De 67-Jia Guoyou Zhongdian Daxing Qiye, SHEN SHI XINXI [SHENZHEN
MARKET INFORMATION], Aug. 18, 2000, available at http://www.chinainfobank.com.
The prohibition on government officials serving on boards was removed from the
Company Law in the 2005 revision, but remains on the books in other regulations. See, e.g., State
Council, Guojia Gongwuyuan Zanxing Tiaoli [ProvisionalRegulations on State Officials], art.
49, issued Aug. 14, 1993 (prohibiting state officials from holding positions in enterprises or for-
profit organizations).
235
See China Securities Regulatory Commission, Zhengquan Gongsi Guanli Banfa
[Measures on the Administration of Securities Companies] art. 27, issued Dec. 28, 2001,
effective Mar. 1, 2002.
236
The draft measures provided that the following matters required approval by a
majority of the independent directors: (1) matters relating to audits, (2) transactions with affiliates,
loan guarantees, and the granting of a security interest when borrowing, (3) the hiring and firing
of senior officers, (4) salaries and other emoluments for directors and senior officers, (5) the
engagement or replacement of the company's accounting firm, (6) other matters stipulated in the
company's articles of association, and (7) other matters stipulated by the CSRC. The Chinese term
I have translated as "majority," banshu yishang, could be read to include 50%, but in my judgment
probably does not mean that here. Securities Companies Draft Measures, supra note 231, at 88.
2006] CHINESE CORPORATE GOVERNANCE

7. CSRC Corporate Governance Principles

On September 11, 2001 (after the release of the Independent

Director Opinion discussed below),237 the CSRC released for comment a
draft of its Principles of Corporate Governance for Chinese Listed
Companies (Zhongguo Shangshi Gongsi Zhili Zhunze) (Draft Corporate
Governance Principles). This draft was followed by the release on
January 7, 2002 of the final version (Corporate Governance Principles).
According to contemporary commentary, these Principles are based on the
OECD Principles of Corporate Governance, as modified by appropriate
principles drawn from specific foreign jurisdictions and China's own
particular situation."' As is often the case with CSRC documents, there is
some purposeful ambiguity about the degree to which its implementation
is mandatory. 23 9 Listed companies are to disclose the extent to which their
rules of governance do not conform to the Principles, and the CSRC
presumably will bring various kinds of pressure to bear on companies that
do not amend their articles of association in conformity with the Principles.
The Corporate Governance Principles require companies to
"establish an independent director system in accordance with relevant
rules., 240 This is a weakening of the rule in the draft version, which
required at least half of the directors to be independent when the chairman
of the board of directors is also the chief executive officer.24 ! Other
provisions make it clear by implication that at least some independent

237
See infra Part IV.E.
23 8
5ee Shan Yuqing, Youguan Zhuanjia Zhichu Shangshi Gongsi Zhili Jiegou de
Quexian Shi Zhongguo Ziben Shichang Fazhan Mianlin de Juda Tiaozhan [Relevant Experts
Point Out that Shortcomings in the Governance Structure of Listed Companies Are a Great
Challenge Facing the Development of Capital Markets in China], ZHONGGUO JINGJI SHIBAO
[CHINA ECONOMIC TIMEs], July 9, 2001; Tang, supra note 177.
239
Tang writes that the Corporate Governance Principles are unlike the OECD
Principles of Corporate Governance on which they are modeled precisely in that they are intended
to be mandatory, but questions whether the CSRC has the tools to enforce compliance. He also
raises the broader issue of whether the CSRC has the legal authority under Article 167 of the
Securities Law (now Article 179 following the October 2005 amendment) even to regulate at all
in this area. See Tang, supra note 177. Zhang and Xiang view the Corporate Governance
Principles as being "for guidance only" and not technically legally binding. Indeed, they go so
far as to argue that because the Company Law gives shareholders the right to elect whomever they
please as directors, the CSRC has no right to require them to elect independent directors. See
Zhang & Xiang, supra note 178, at 54. This view is interesting theoretically, but any Chinese
governmental authority called upon to decide whether the CSRC has such authority is likely to
back the CSRC.
2
'oCorporate Governance Principles, supra note 163, art. 49.
241
See China Securities Regulatory Commission, Shangshi Gongsi Zhili Zhunze
(Zhengqiu Yijian Gao) [Principles of Corporate Governance for Listed Companies (Comment
Solicitation Draft)], issued Sept. 11, 2001, art. 32.
 DELAWARE JOURNAL OF CORPORATE LAW [Vol. 31

directors are required. For example, company boards are required to

establish certain committees; among them, independent directors must sit
on the auditing committee (shenji weiyuanhui) and the compensation and
assessment committee (xinchou yu kaohe weiyuanhui). Independent
directors must constitute a majority within the compensation and
assessment committee, the chair of which must also be an independent
director. At least one member of the auditing committee must be an
independent director who is an accountant.242
Although the Corporate Governance Principles contain many duties
for independent directors, they do not list any special powers for them as
a collective body. To be sure, their presence is required on two
committees, but in no case is an independent director's vote counted any
differently from the vote of a non-independent director. There are no
situations (such as, for example, conflicting interest transactions) in which
the approval of a majority of independent directors is required.243
The Principles seem to adopt the position that independent
directors should be independent of everyone. An independent director is
defined-not very rigorously-as a person who is independent of the
company and of its major shareholders. The independent director may not
have any position in the company other than director. 2 " Moreover, the
Principles state that "[t]he independent director should exercise his
functions independently, and not be influenced by the company's major
shareholders, its de facto controlling parties, or other units (danwei) or
individuals who have a relationship of interest in the company" (i.e.,
245
stakeholders in general).

E. The CSRC Guidance Opinion on the Establishment

of an Independent DirectorSystem in Listed Companies

On August 16, 2001, the CSRC issued its "Guidance Opinion on

the Establishment of an Independent Director System in Listed Companies"
(Independent Director Opinion). The Opinion covers Chinese companies
listed in China; it does not cover Chinese companies listed overseas. It
constitutes the most comprehensive measure taken to date by the CSR-or
indeed, by any Chinese governmental authority-to regulate internal
corporate governance through the institution of the independent director.

2 42
See CorporateGovernance Principles,supra note 163, art. 52.
243
See, by way of comparison, the discussion of the role of disinterested director voting
in Delaware law in supra Part Il.B.3.
2
"See CorporateGovernance Principles,supra note 163, art. 49.
245
1d. art. 50.
20061 CHINESE CORPORATE GOVERNANCE

In analyzing the Independent Director Opinion, considerable

insight can be gained by comparing the final version with an earlier draft
released by the CSRC in May 2001 (Draft Independent Director Opinion)
in order to solicit comments.

1. Basic Requirement of Independent Directors

The basic rule of the Independent Director Opinion is set forth in

Sec. 1(3): listed companies are to revise their articles of association to
provide for independent directors. At least one of these should be an
accounting professional. Listed companies were required to have at least
two independent directors by June 30, 2002, and such directors were to
constitute at least one third of the board by June 30, 2003.24

2. Whose Interests Are the Independent Directors to Serve?

The independent directors are said to owe a duty of good faith

(chengxin) and diligence (qinmian) to the company and to the entire body
of shareholders, but the Opinion singles out for special attention the
interests of small and medium shareholders, and states that the independent
directors are not to be influenced by major shareholders, controlling
persons, or others who have a relationship of interest with the company.247
To the extent that the drafters have considered the question at all, the
Opinion seems to come down clearly in favor of viewing the independent
director as independent from everyone with a significant interest in the
company, and as the protector of small shareholders against both
management and dominant shareholders.

3. Qualifications of Independent Directors

Unlike, for example, the corporate law and jurisprudence of most

states in the United States (but like various U.S. federal statutes and
regulations), the Opinion defines "independence" in a single way, instead
of taking a purposive transaction-by-transaction approach.
The Opinion takes a positive approach and a negative approach to
the qualifications of independent directors. On the positive side, an
independent director must (1) be qualified to serve as a director pursuant
to the Company Law and other regulations; (2) possess the independence

2
"The Company Law provides that JSCs should have five to thirteen directors.
247
See Independent DirectorOpinion, supra note 11, § 1(2).
 DELAWARE JOURNAL OF CORPORATE LAW [Vol. 31

required by the Opinion itself;248 (3) possess basic knowledge relevant to

the operations of the listed company, and be familiar with relevant laws and
administrative rules and regulations; (4) possess at least five years' work
experience in law, economics, or other fields necessary for the proper
exercise of his functions as independent director; and (5) possess other
qualifications stipulated in the company's articles of association.249 In a
later press release, the CSRC stated that independent directors must also
undergo a training course organized by the CSRC in conjunction with
Tsinghua University.250
On the negative side, the following persons may not serve as
independent directors: (1) a person who holds a position in the listed
company or its subordinate affiliates as well as the direct relatives of, and
those with important social connections 25 ' to, the former; (2) a person, or
the direct relative of a person, who directly or indirectly holds at least 1%252
of the company's stock or is among the top ten shareholders of the
company; 253 (3) a person, or the direct relative of a person, who is
employed by an entity that directly or indirectly holds at least 5%254 of the
company's stock or is among the top five non-natural person shareholders
of the company; (4) a person about whom any of the above conditions have
been met within the last year; (5) a person who supplies accounting, legal,
consulting, or other similar services to the company or its subordinate
affiliates; (6) any other person specified in the company's articles of
association; and (7) any other person specified by the CSRC.
Although the Opinion forbids independent directors from having
relationships with affiliates (guanlianren) of the company,255 it does not

24
One might well wonder where, if not in the positive requirements, such independence
was defined. First, Section 1(2) states that independent directors "are not to be influenced by
major shareholders, controlling persons, or others who have a relationship of interest with the
company." Second, the negative requirements of Section 3 specify further elements of the
definition. Independent DirectorOpinion, supra note 11, §§ 1(2), 3.
24 9
See id. § 2.
'5°See Zheng Jian Hui: Jiaqiang Peixun Duli Dongshi Houbei Rencai [CSRC:
Strengthen Trainingof a Reserve of QualifiedCandidatesfor Independent Director],Shanghai
Zhengquan Bao Wangluo Ban [Shanghai Securities News, Web Edition], Oct. 8,2001, available
at http://finance.sina.com.cn/y/20011008/113694.html.
25"'Direct relatives" are defined as a "spouse, mother, father, son, daughter, etc."
Independent DirectorOpinion, supra note 11, § 2. It is not clear to me what the "etc." is intended
to cover. "Important social connections" are defined as "brother, sister, father-in-law, mother-in-
law, son-in-law, daughter-in-law, spouse of a brother or sister, brother or sister of a spouse, etc."
Id. Again, it is not clear how far the "etc." is intended to reach.
2
1 The Chinese here is ambiguous; it could be "over 1%." Id.
3
2 "Natural person shareholders" may be meant here. Id.
.. 'TheChinese here is ambiguous; it could be "over 5%." Id.
255See Independent DirectorOpinion, supra note 11, § 5(l)(i).
20061 CHINESE CORPORATE GOVERNANCE

define the term. The prohibition on relationships with affiliates appeared

much earlier, in the 1997 Guidelines,256 but the term was also not defined
there. Does it mean only the company's affiliated enterprises, or is it meant
to include any natural person with a connection to the company? If it
means the latter, the definition is extremely sweeping and may cover far
more persons than is necessary for its purpose.
The Draft Independent Director Opinion stipulated that
independent directors should spend at least fifteen days per year on the
business of the company, but this was changed in the final Independent
Director Opinion to a prohibition "in principle" on persons serving as
independent director of more than five listed companies. 7 While the
former rule seems unenforceable in practice, the latter rule serves little
purpose, since it says nothing about what else the independent director
might be doing with his or her time. In practice, independent directors
seem to spend much less time on company business, while at the same time
not being excessively distracted by other directorships. According to a
2001 study by the Shenzhen Stock Exchange, eight independent directors
from its sample served on five boards, 95 served on two boards only, and
212 served on a single board. 258 A more recent study found roughly similar
numbers: 63% of the independent directors surveyed served on only a
single board. 259 The same study found that independent directors typically
spend nowhere near fifteen days per year on the business of the company;
they spend five to nine days attending board meetings and one to five days
working at the company offices on other matters. 2 °

4. Special Powers

The Independent Director Opinion seems to give special powers to

independent directors by requiring that they constitute at least halfP6 1 of the

26
1 See ShangshiGongsiZhangchengZhiyin [Guidelinesforthe Articles ofAssociation
of Listed Companies], supra note 217, art. 112.
257
See Independent DirectorOpinion, supra note 11, § 1(2).
258
See Quanjing Wangluo [Panorama Net], Du Dong Duiwu Jisu Kuorong [Ranks of
Independent Directors Quickly Enlarged], Mar. 22, 2003, at http://www.p5w.netp5w/home/
dissertation/company/200303220172.html. These numbers are, of course, incomplete in not
including figures for three boards, four boards, and more than five boards, and we do not know
if they come from a random sample. As with many of the figures cited in this paper, they were
probably not obtained through a rigorous methodology and should be considered only very roughly
indicative of what is really going on.
25 9
See Jin Xin Securities, supra note 156.
26°See id.
26 1
Possibly "more than half." The Chinese term (erfen zhi yi yishang) is ambiguous.
Independent DirectorOpinion, supra note 11.
 DELAWARE JOURNAL OF CORPORATE LAW [Vol. 3 1

members of a board's audit, nomination, and compensation committees. On

the other hand, there is no requirement that these committees be
established, so a company could keep inside director control over such
matters by having them decided by the entire board.262
In addition, independent directors are to have the following powers:
(1) to pass on important transactions with affiliates, defined as transactions
with affiliates (guanlian ren) where the amount at stake is more than 3
million yuan or more than 5% of the net asset value of the company
according to its most recent audit report; (2) to recommend engagement or
dismissal of the company's accounting firn; (3) to recommend the holding
of interim shareholders' meetings; (4) to recommend the holding of board
meetings; (5) to hire outside auditors and consultants (at the company's
expense); and (6) to solicit proxies prior to a shareholders' meeting.
Some of these powers are quite ambiguous. For example, the
independent directors apparently do not have the power to actually call a
meeting of shareholders or the board; they have only the power to
recommend to the board that such a meeting be called. More importantly,
the Opinion does not actually confer these powers on independent
directors. It calls on companies to confer these powers, presumably
through provisions in their articles of incorporation or other internal rules.
A company that does not do so may encounter pressure from the CSRC to
make appropriate changes, but it would not be acting illegally in failing to
do so.
The powers listed above cannot be exercised by individual
independent directors; their exercise must receive the consent of a
majority26 3 of the independent directors as a body. This is an interesting
change from the Draft Independent Director Opinion, which required
unanimous approval. On the other hand, the Draft Independent Director
Opinion did not require independent director approval for important
transactions with affiliates, stipulating only that the independent directors
should express their independent views about such transactions and that
such views should be disclosed. The final Opinion is more ambiguous; it
may well be that the failure of independent directors to approve a
transaction with an affiliate, for example, needs merely to be disclosed, and
is not a bar to the transaction. 2 64 This appears to be the CSRC's usual

262
A survey of listed companies showed that as of mid-May 2003, about half had not
established any of the board committees on which independent directors have a special role under
the Independent Director Opinion. See Jin Xin Securities, supra note 156.
26 3
Possibly "at least half." The Chinese term (erfen zhi yi yishang) is ambiguous.
Independent Director Opinion, supra note 11.
264See id. § 5(3).
2006] CHINESE CORPORATE GOVERNANCE

approach to the role of independent directors and is reflected in other

CSRC rules and policy documents.265

5. Selection Process

The provisions of the Opinion relating to the selection of

independent directors reveal some of the conceptual weaknesses behind the
scheme. As noted earlier, the fundamental impetus behind the institution
of independent directors in China seems to be a desire to protect small
shareholders from exploitation by dominant shareholders and management.
Yet directors are elected by shareholders, and dominant shareholders, by
definition, dominate shareholder voting. Where management or dominant
shareholders desire independent directors to signal their integrity to
investors and thereby lower the firm's cost of capital, or where they desire
them because their approval of conflict-of-interest transactions can be a
shield against liability,266 there is no conceptual problem with having
management or the dominant shareholder nominate independent directors
the same way they nominate other directors. Chinese regulators are thus
faced with a dilemma: if simply any stockholder is allowed to nominate a
candidate for independent director, then a profusion of candidates could
give inordinate power to dominant shareholders by scattering the votes of
small shareholders. But if only major stockholders are allowed to nominate
candidates, then they are unlikely to nominate candidates who will see their
duty as owed to small shareholders.
In the Draft Independent Director Opinion, the CSRC took the
second option, stipulating that individuals or groups representing at least
5% of the shares could nominate independent director candidates ; 267 in the
final version, however, it lowered the threshold to 1%.268
It is not clear in the Opinion, or indeed in the Company Law, how
exactly such directors might be elected once nominated, assuming multiple
nominations. Presumably, any director must be elected to office by a vote
of the majority of shares at a shareholders' meeting; this is the way

26
See, e.g., China Securities Regulatory Commission, Guanyu Shangshi Gongsi
Shougou Guanli Banfa [Measures on the Administration of Acquisitions of Listed Companies]
arts. 15, 20, 31 & 32, issued Oct. 8, 2002, effective Dec. 1, 2002 (calling for disclosure of
independent directors' views on various aspects of proposed acquisitions).
2
"See infra discussion in the text accompanying notes 331-32.
267
See China Securities Regulatory Commission, Guanyu Zai Shangshi Gongsi Jianli
Duli Dongshi Zhidu de Zhidao Yijian (Zhenqiu Yijian Gao) [Guidance Opinion on the
Establishmentof an Independent DirectorSystem in Listed Companies (Comment Solicitation
Draft)] § 4, issued May 31, 2001 [hereinafter Draft Independent DirectorOpinion].
268 See Independent Director Opinion, supra note 11, § 4(1).
 DELAWARE JOURNAL OF CORPORATE LAW [Vol. 31

shareholder action is generally accomplished under the Company Law. Yet

it is far from clear how this requirement would play out in elections of
independent directors.

6. Tenure of Independent Directors

The provisions of the Opinion regarding tenure of directors

contained a potential conflict with the Company Law. Article 115 of the
1993 Company Law provided that a director could not be removed from
office "without reason' 2 69 before the expiration of his term (which could
not exceed three years). Although this sentence was removed in the
October 2005 revision to the Company Law, it is not clear that the rule
itself has for all practical purposes disappeared. Both the former and the
present Company Law also provide that the number of directors of a
company may not exceed nineteen. 270 The Opinion provides that if an
independent director ceases to meet the definition of "independent," the
company shall appoint additional independent directors if necessary to meet
the prescribed ratio.27 1 What happens, then, if a company has nineteen
directors, seven of whom qualify as "independent," thus meeting the
requirement of one third, but one of whom subsequently loses that status?
It cannot appoint an additional director, since that would exceed the limit
stipulated in the Company Law. Nor is it likely that it can dismiss the
newly-disqualified director, or indeed any other director, since the loss of
independent status probably does not count as the "cause" justifying

269
Just as removal "for cause" in American corporate law means removal for legitimate
cause, so presumably does "without reason" (wugu) mean without legitimate reason.
Unfortunately, legitimacy is not a self-defining term. We know, for example, that in American
corporate law a new controlling shareholder's desire to get rid of directors nominated by a
previous controlling shareholder is not deemed legitimate cause for their removal if cause is
required. See R. FRANKLIN BALOTTI & JESSE A. FINKELSTEIN, THE DELAWARE LAW OF
CORPORATIONS AND BUSINESS ORGANIZATIONS § § 4.4,4-12 (Prentice-Hall Law & Bus. 1999 &
Supp. 2004). But it is not obvious that every other legal system would or should reach the same
conclusion. For Chinese views on this subject, see infra note 272.
270
See 1993 Company Law, supranote 17, art. 112; Company Law, supra note 17, art.
109.
271
See Independent DirectorOpinion, supra note 11, § 1(4).
20061 CHINESE CORPORATE GOVERNANCE

removal.272 The Company Law forbids it from meeting the demands of the
Independent Director Opinion.
The Opinion further provides that an independent director's
resignation from the board, if it would result in the number of independent
directors falling below the required number, may not take effect until a
substitute independent director takes his place.273 It is far from clear that
the CSRC possesses the authority to regulate the effectiveness of a
director's resignation from the board, and it is equally unclear what the
practical effect of not allowing the resignation to be effective might be.
The director could simply stop attending meetings, which, indeed, under
Section 4(5) of the Opinion would be grounds for removal from the board.
And of course the director could take some step to disqualify himself as an
independent director, in which case he would become just an ordinary
director whose resignation would be effective when desired.

7. Enforcement

A key question that is often not clearly answered in the various

standards for corporate governance is how, if at all, they shall be enforced.
The Independent Director Opinion, by its very name-a "guidance
opinion"-suggests that it is not strictly mandatory, even though listed
companies are invited to implement it. There is nothing in the Opinion to
suggest what kind of sanctions might follow upon a company's failing to
implement its provisions. The Draft Independent Director Opinion
provided that if a company failed to implement the provisions "without a
proper reason," it would be publicly criticized by the CSRC and ordered to
implement the provisions within a specified time, and would be required to

272
Neither the Company Law nor any developed body ofjurisprudence in China defines
the meaning of "without reason." Various sources suggest the kinds of reasons that might justify
removal upon the vote of a majority of shares: violation of law or regulations, violation of the
company's articles of association, or demonstrated lack of diligence with resultant great harm to
the company. See, e.g., Gongsi Fa Xin Shi yu Li Jie [A New Interpretationof the Company Law
with Explanatory Cases]215-16 (eng Tao ed., Tongxin Chubanshe 2000) (discussing a litigated
case concerning improper discharge of director); Gongsi Fa Ji PeitaoGuiding Xin Shi Xin Jie [A
New Interpretationand Explanation of the Company Law and Associated Rules] 703 (Kong
Xiangjun et al. eds., rev. ed., Renmin Fayuan Chubanshe 1998). One case reportedly found that
shareholder dissatisfaction with a director's business acumen, absent a violation of law or the
company's articles of association, does not constitute adequate cause. See Yu SHENGYONG &
ZHou GANG, GONGSI FA SHIWU YU ANLI PINGXI [COMPANY LAW: PRACTICAL MATrERS AND
CASE ANALYSIS] 397-99 (Zhongguo Gong Shang Chubanshe 2002). Neither the sources that I
have seen nor the Independent Director Opinion itself suggests that failure to qualify as
"independent" constitutes a reason justifying being voted out of office by shareholders.
273
See Independent DirectorOpinion, supra note 11, § 4(6).
 DELAWARE JOURNAL OF CORPORATE LAW [Vol. 31

note the circumstances in its public disclosures.2 74 Even this rule did not
specify exactly how the CSRC would back up its order if it were disobeyed,
and in any case the rule disappeared from the final version. The only place
where disclosure appears to be used as an enforcement mechanism is in
Section 5(3), where a company is required to disclose any failure to grant
independent directors the powers listed in that section.275
It could be that the CSRC intends to use its powers over listed
company filings to enforce the Opinion: in other words, it would reject
filings from companies that did not implement the provisions of the
Opinion. This is precisely the threat it made in the 1997 Guidelines.276
Yet, given that the CSRC apparently knows of this enforcement mechanism
and is capable of explicitly invoking it, it is curious, and possibly
significant, that it did not do so in the Opinion. According to one CSRC
official with whom I spoke, the sanction of an official reprimand from the
CSRC-a possible alternative to the sanction of rejecting a filing-remains
powerful, because most company officers are still in effect civil service
bureaucrats working in state enterprises, and are therefore sensitive to
anything that might blot their record and affect their chances for promotion.
Ultimately, however, management that chooses not to install
independent directors may do so with impunity. As noted below, four
companies had still not installed independent directors as of the end of July
2004, with no apparent official consequences. The most well known of
those, Sichuan Changhong, was even specifically instructed in 2003 by the
2 77
regional office of the CSRC to come into compliance, but failed to do SO.
The Opinion requires companies to submit to the CSRC (as well as
to its local branch office and the exchange where the company is listed) a
list of proposed independent director nominees and their qualifications.
The CSRC is then to vet the nominees and indicate approval or disapproval
within fifteen days.278 Candidates disapproved by the CSRC may not be
independent directors, but may still be directors. The company's board of

274
Draft Independent DirectorOpinion, supra note 267.
275Independent DirectorOpinion, supra note 11, § 5(3).
276
See Mandatory Articles of Association for Companies Listing Overseas, supra note
215.
277
For more details on Sichuan Changhong's circumstances and that of the other three
delinquent companies, see Changhong de Duli DongshiZai Nali?Zai Rongzi JianghuiShoudao
Yingxiang [Where Are Changhong'sIndependentDirectors?TheirSubsequent CapitalRaising
Will Be Affected], Guoii JINRONG BAO [INT'L FIN. NEWS], July 6, 2004, available at
http://finance.sina.com.cn/roll/20040706/0048851431 .shtm (describing the Independent Director
Opinion as a "soft constraint" (ruan yueshu)).
278
See Independent DirectorOpinion, supra note 11, § 4(3).
2006] CHINESE CORPORATE GOVERNANCE

directors must report the CSRC's disapproval to shareholders at the meeting

where the directors are to be elected.279
The timetable for approval, as well as the deadline for the
introduction of independent directors, was tight, but by and large seems to
have been met. The first study of board composition appears to have been
conducted in 1996 by the CSRC, which found that out of China's 530 listed
companies, 22.1% had all inside directors, and 78.2% had over half inside
directors.2 8' As of 2001, China's over 1200 listed companies were still a
long way from having the requisite number. The total number of
independent directors nationwide was quite small-a survey by the
Shanghai Securities Exchange showed that only 0.3% of directors surveyed
could be classified as "independent '' 28 1 (other sources suggest 0.99%282 and
2M
3%283) and another claimed that only 314 existed in the whole country.
Moreover, only a small number of listed companies-perhaps 40,285
perhaps 56,286 perhaps 204 287-had any directors at all that might qualify
as independent. Commentators at the time expressed doubts that

279Id. § 4(3).
28
See Li, supra note 151, at 39-40. Similar numbers for 1998 (20.4% and 78.2%
respectively) are reported in another source. See Lin Ling & Chang Cheng, Duli DongshiZhidu
Yanjiu [Research into the Independent Director System], ZHENGQUAN SHICHANG DAOBAO
[SECURITIES MARKET HERALD], Sept. 2000, at 16, 16. The exact similarity of both the sample
size (530 companies) and the figure for the percentage of boards with over half inside directors
(78.2%), however, coupled with the authors' failure to provide a source for their figures, leads me
to conclude that they are probably just repeating the 1996 numbers from the CSRC study.
2
SSee McGregor, supra note 158; NI JIANLIN, GONGSI ZHILI JIEGOU: FALU YU SHIIAN
[THE STRUCTURE OF CORPORATE GOVERNANCE: LAW AND PRACTICE] 117 (Falui Chubanshe
2001). This and other statistics here cannot be viewed as terribly reliable.
2 82
See Touzizhe Repan Duli Dongshi[Investors EagerlyLook Forwardto Independent
Directors], XINMIN WANBAO [NEW PEOPLE'S EVENING NEWS], June 23, 2001, available at
http://www.pcpa.com.cn/ch/communicatelltem-content.asp?id=266 (citing annual reports forthe
year 2000 as the source).
28
3See, for example, the figures cited in Xie Chaobin, Shangshi Gongsi Faren Zhili
Jiegou Yu Gudong Quanyi Baohu [The Corporate Governance Structure of Listed Companies and
the Protection of Shareholders' Rights] (Paper for 21 st Century Commercial Law Forum, Tsinghua
Univ., Beijing, Nov. 18, 2001).
2
4See Duli Dongshi yu Duli Jianshi [Independent Directors and Independent
Supervisors], GUANGMING RIBAO [ENLIGHTENMENT DAILY], Sept. 18, 2001. Citing annual
reports for the year 2000, another source puts the number at 103. See Touzizhe Repan Duli
Dongshi [Investors Eagerly Look Forwardto Independent Directors], supra note 282.
2
"S5ee Li Yining: Shangshi Gongsi Duli Dongshi Zhi Shang Nan Fahui Zuoyong [Li
Yining: It Is Still Difficult for the Listed Company Independent DirectorSystem to Play Its
ProperRole], supra note 150.
28
6See Touzizhe Repan DuliDongshi [Investors EagerlyLook Forwardto Independent
Directors],supra note 282.
287
See Duli Dongshi yu Duli Jianshi [Independent Directors and Independent
Supervisors], supra note 284; Xie, supra note 283.
 DELAWARE JOURNAL OF CORPORATE LAW (Vol. 3 1

companies governed by the Opinion could find qualified persons in the

time available.288
As of June 30, 2002, all 1187 listed companies were reported to
have met the deadline for having at least two independent directors on the
board: 80% had two such directors and the rest had more than two. 289 As
of mid-May 2003-about six weeks prior to the June 30 deadline for
having a one-third independent board-companies appeared close to
reaching the target number. The average number of directors was 9.95, and
the average number of independent directors was 3.07-less than one third
but not by much. Fully 62% of a sample of companies surveyed were
already at one third.29 ° Many of the remaining companies may well have
made up the difference by June 30, 2003, the last possible day, when 140
companies-a record number-scheduled shareholder meetings.29'
Nevertheless, some non-compliance seems to remain. By the end of July
2004, 1382 out of 1386 listed companies had independent directors on the
board (i.e., four companies still had no independent directors at all). There
were 4559 independent directors in total, yielding an average of just over
three per company. 29'
Most companies have met--or at least have so reported-the
requirement for having an independent director trained in accounting.
According to one report, 70% of all listed companies had put an accounting
specialist on the board by June 30, 2002. A later report states that as of
mid-May 2003, 84% (58 companies) of a sample of 69 listed companies
had such an independent director.
The CSRC can probably handle the workload in terms of
processing paper. Local offices, which will handle the approval process
and have fifteen days to vet nominees, probably have over 1200 staff

2
. ee, for example, the comments to this effect by Li Yining, the chief architect of the
Securities Law, in Li Yining: ShangshiGongsi Duli Dongshi Zhi Shang Nan Fahui Zuoyong [Li
Yining: It Is Still Difficult for the Listed Company Independent Director System to Play Its
ProperRole], supra note 150. See also NI, supra note 281, at 120-2 1.
289
See Du Dong Duiwu Jisu Kuorong [Ranks of Independent Directors Quickly
Enlarged], supra note 258.
2
9See Jin Xin Securities, supra note 156. The information contained in this report is
based on a survey of 69 listed companies. One cannot tell from the report whether the companies
were randomly selected, but Ijudge it unlikely. Among other things, all the companies may have
been from the Shanghai Stock Exchange.
29 1
See Bai Duo Jia Gongsi Tuji Xuan Dongshi[Over 100 Companies Select Directors
in Sudden Attack], ZHENGQUAN SHIBAO [SECURmES TIMES], July 2, 2003, available at
http://www.p5w.net/p5w/home/stimetoday/200307020234.html.
292
See Duli DongshiZhidu Wanshan Zhi Lu Reng Manchang [The Road to Perfecting
the Independent DirectorSystem Is Still Long], SHICHANG BAO [MARKET NEWS], Sept. 14,2004,
at 11, available at http://finance.sina.com.cn/roll/20040914/024010135.shtml.
2006] CHINESE CORPORATE GOVERNANCE

members who could perform reviews, or about one per listed company, on
average. 2 The real issue lies in whether, given the many and subtle ties
that may exist between nominees and company management, independence
can really be ascertained in the abstract on the basis of paper submissions
by management, and whether independence so ascertained is really very
meaningful.294

V. CAN INDEPENDENT DIRECTORS FUNCTION AS HOPED?

Despite the great effort being put into developing the institution of
independent directors, it is far from clear that it will function as expected.
This Part will first, briefly canvass empirical research in the United States
and in China, and then discuss specific institutional reasons why an
externally imposed requirement of independent directors may not make
much of a difference.

293
Personal communication, CSRC staff member, July 2003. These numbers are very
approximate, but useful for providing a rough idea of the CSRC's capacity. Interestingly, Section
4 of the Draft Independent Director Opinion provided for a different procedure that would have
meant less work for the CSRC. Independent directors once elected were to be reported to the
local branch of the CSRC, which would then indicate its approval or disapproval. Disapprovals
could be appealed to the CSRC itself. Thus, there was no need to waste time reviewing the
qualifications of nominees who were not elected. For the story of two independent director
nominees who were voted down by the same controlling shareholder that nominated them, see
Chen Daofu, Zhi Duli Dongshi Yu Hedi!? [What Is Being Done to Independent Directors?!],
JINGJI YUEBAO [EcON. MONTHLY], No. 8, Aug. 2003, available at http://www.em99.com/
zhengwen/yuekanliulan/2002/8mu.htm.
2
9'The Special Litigation Committee directors found insufficiently independent in In
re Oracle Corp. DerivativeLitig., 824 A.2d 917, 921 (Del. Ch. 2003), for example, would have
passed any existing objective test of independence, but because they and the defendant directors
shared ties with Stanford University, the Delaware Court of Chancery found "a social atmosphere
painted in too much vivid Stanford Cardinal red for the SLC members to have reasonably ignored
it[.]" id. at 947. Similarly, RICHARD C. BREEDEN, RESTORING TRUST: REPORT TO THE HON. JED
S. RAKOFF, THE UNITED STATES DISTRICT COURT FOR THE SOUTHERN DISTRICT OF NEW YORK,
ON CORPORATE GOVERNANCE FOR THE FUTURE OF MCI, INC. (2003), available at http://www.
thecorporatelibrary.com/spotlight/scandals/RestoringTrust _Final-WorldCom.pdf, notes that the
chairs of WorldCom's compensation committee and audit committee (like 80% of the board in the
Ebbers era) both satisfied contemporary definitions of "independence," and would probably have
satisfied the proposed NYSE and Nasdaq definitions. Nevertheless, they had both been involved
in business with CEO Bernard Ebbers for years, and "seemed to be more solicitous of Ebbers'
wishes than shareholder interests." Id. at 28 n.27, 30.
 DELAWARE JOURNAL OF CORPORATE LAW [Vol. 31

A. EmpiricalResearch

1. United States

Board independence is clearly no guarantee of corporate success.

As one commentator recently noted:

[B]oard independence has done little to prevent past

mismanagement and fraud. For example, thirty years ago
the SEC cast much of the blame for the collapse of the
Penn Central Company on the passive nonmanagement
directors. No corporate boards could be much more
independent than those of Amtrak, which have managed
that company into chronic failure and government
dependence. Enron had a fully functional audit committee
operating under the SEC's expanded rules on audit
committee disclosure.2 95

Anecdotal examples of failure do not, of course, prove the absence

of success. More to the point are the results of several studies of the effect
of independent directors on corporate performance in the United States: the
overall weight of their findings is that there is no solid evidence suggesting
they improve it.296 Some studies have even found a negative correlation

95
Larry E. Ribstein, Market vs. RegulatoryResponses to CorporateFraud:A Critique
of the Sarbanes-Oxley Act of 2002, 28 J. CORP. L. 1, 26 (2002) (footnotes omitted). It is
particularly noteworthy that Enron's audit committee "was headed by a widely respected
accounting professor.., and included another respected academic." Paul M. Healy & Krishna
G. Palepu, GovernanceandIntermediationProblemsin CapitalMarkets: Evidencefrom the Fall
of Enron 16 (Harvard NOM, Working Paper No. 02-27, 2002).
296
As this is not the place to review the literature comprehensively, see generally Dan
R. Dalton et al., Meta-Analytic Reviews of Board Composition, Leadership Structure, and
FinancialPerformance, 19 STRATEGIC MGMT. J. 269 (1998); Jill E. Fisch, The New Federal
Regulation of CorporateGovernance, 28 HARv. J.L. & PUB. POL'Y 39 (2004); Benjamin E.
Hermalin & Michael S. Weisbach, Boards of Directors as an Endogenously Determined
Institution:A Survey of the Economic Literature,FED. RES. BANKN.Y. ECON. POL'Y REv., Apr.
2003, at 7; Laura Lin, The Effectiveness of Outside Directorsas a Corporate Governance
Mechanism: Theories and Evidence, 90 Nw. U. L. REv. 898 (1996); Stephen M. Bainbridge, A
Critique of the NYSE's Director Independence Listing Standards (UCLA School of Law,
Research Paper No. 02-15, 2002), availableat http://www.ssrn.com/abstract_id=317121; and
Sanjai Bhagat & Bernard Black, The Non-CorrelationBetween BoardIndependence andLong-
Term Firm Performance, 27 J. CORP. L. 231 (2002) for reviews of other studies and meta-
analyses. One study suggesting that outside directors do add value is Kenneth A. Borokhovich
et al., Outside Directorsand CEO Selection, 31 J. FIN. & QUANTITATIVE ANALYSIs 337, 338
(1996), a study of CEO successions at 588 large public firms between 1970 and 1988. Dahya and
McConnell also found a positive stock price reaction to the increase in outside directors in British
20061 CHINESE CORPORATE GOVERNANCE

between board independence and corporate performance. 297 The most

recent comprehensive study is that of Bhagat and Black, who in a review
of other studies as well as with their own research find, among other things,
that:

there is no evidence that greater board independence leads to better

firm performance. Poor performance is correlated with subsequent
greater independence, but there is no evidence that this strategy
works to improve performance.29 8

having insiders on the board can add value.299

independent directors with significant stock positions may add

value, whereas others do not."°

A study by April Klein finds that the traditionally outsider-

dominated monitoring committees (audit, nomination, and compensation)
have little, if any, effect on firm performance, regardless of how they are
staffed.3"' Indeed, in direct contrast to conventional wisdom, Klein found
a positive correlation between firm performance and the presence of
insiders on board finance and investment committees.3 °2 Evans and Evans
found that the presence of independent directors on board or compensation

companies following the issuance of the Cadbury Report. See Dahya & McConnell, supra note
133, at 23-27. Note that these studies are not necessarily all about the same thing. Studies of
directors who meet a criterion of outsideness do not, strictly speaking, tell us about directors who
meet a criterion of independence, since the latter group excludes those (and those who represent
companies) doing extensive business with the company in question, whereas the former group
does not.
It is worth noting that the results of these studies have been reported in the Chinese
corporate governance literature. See, e.g., NI, supra note 281, at 115.
297
See Anup Agrawal & Charles R. Knoeber, Firm Performance and Mechanisms to
ControlAgency Problems Between Managers and Shareholders,31 J. FIN. & QUANTITATIVE
ANALYSIS 377, 394 (1996); Catherine M. Daily & Dan R. Dalton, Board ofDirectorsLeadership
and Structure: Control and Performance Implications, 17 ENTREPRENEURSHIP: THEORY AND
PRAC. 65, 75 (Spring 1993).
298
See Bhagat & Black, supra note 296, at 263.
2
9See id. This finding is also supported by Baysinger & Butler, supra note 147, at 578.
3
"See Bhagat & Black, supra note 296, at 265-67.
31
° See April Klein, Firm Performance and Board Committee Structure, 41 J.L. &
ECON. 275 (1998).
302
See id.
 DELAWARE JOURNAL OF CoRPoRATE LAW [Vol. 31

committees had no effect on CEO pay levels." 3

2. China

Intriguingly, researchers have also failed to find empirical support

in China for the effectiveness of independent directors in enhancing
corporate performance. Tian and Lau looked at the results for 1996 and
1997 of the 207 companies that went public on one of China's two
exchanges in 1996, and found no positive correlation between reported
performance and the proportion of independent directors on the board. 304
He and Wang studied the 56 listed companies that had independent
directors as of the end of 2000 and found that there was no obvious link to
the economic performance of the company or to dividends.3 5 Gao and Ma
examined all 1151 reporting companies on the two Chinese exchanges
(yielding an effective sample of 1018 companies), 83 of which had
appointed independent directors in the previous three years.30 6 They found
no support for the hypotheses that (a) there is a clear difference in
performance between companies with independent directors and those
without, or that (b) there is a positive correlation between percentage of
independent directors on the board and corporate performance. 30 7 Most
recently, Luo, Zhou, and Guo examined 81 listed companies that had had
independent directors since 2000 or before, and found that the
establishment of an independent director system was followed by a
subsequent decline in corporate performance as measured by earnings per

303
See Robert Evans & John Evans, The Influence of Non-Executive DirectorControl
andRewards on CEO Remuneration:AustralianEvidence (unpublished manuscript, EFMA 2002
London Meetings, Working Paper Series, Mar. 12, 2001), available at http://ssm.com/
abstract=263050. Interestingly, the authors did find a link between compensation structures for
non-executive directors (as they defined them) and CEO pay. Where such directors have equity
stakes, CEO pay tends to be lower. Where they do not, CEO pay tends to increase with director
pay.
3
"See Jenny J. Tian & Chung-Ming Lau, Board Composition, Leadership Structure
and Performance in Chinese ShareholdingCompanies, 18 ASIA PACIFIC J. OF MGMT. 245,256-
60(2001).
305
See He Wentao & Wang Jinquan, Woguo DuliDongshiZhidude Shizheng Fenxi [An
Empirical Analysis of China's Independent DirectorSystem], CAIMAO JINGJI [FIN., TRADE, &
ECON.], No. 9, 2002, at 61-64.
3
°6See Gao Minghua & Ma Shouli, Duli Dongshi Zhidu yu Gongsi Jixiao Guanxi de
Shizheng Fenxi [An EmpiricalAnalysis of the RelationshipBetween the Independent Director
System and Corporate Results], NANKAI JINGII YANJIU [NANKAI UNIVERSITY ECONOMIC
STUDIES], No. 2, 2002, at 64-68.
307
See id.
20061 CHINESE CORPORATE GOVERNANCE

share and return on equity.3 °8 They also found no relationship between the
proportion of independent directors on the board and corporate
performance. 3" Finally, Xiao found that while the degree of independence
of independent directors (measured by whether or not they were nominated
by the controlling shareholder) was significantly (although very modestly)
related to corporate performance, the proportion of independent directors
on the board was not.3t °
Doubtless all these studies are subject to measurement problems.
All one can really study is the relationship between the number of persons
who are labeled independent directors and reported corporate results, and
in each case what is reported may not reflect reality. It remains true,
nevertheless, that to date there does not appear to be any strong empirical
support for the view that independent directors in China enhance corporate
performance.

B. Why Don't Independent DirectorsSeem to Work?

The preceding section canvassed the lack of empirical evidence in

support of the usefulness of independent directors in the United States and
China. There are a number of factors, both measurable and unmeasurable,
that might be adduced to explain these results. This section explores those
factors.

1. Characteristics of Independent Directors

It has been argued that independent directors are reluctant to

oppose those who selected them because their fees are high.3 1' The
evidence on this point is mixed. One study reports annual director fees in

3 8
° See Luo Pinliang et al., Duli Dongshi Zhidu yu Gongsi Yeji de Xiangguanxing
Fenxi: Laizi Hushi A-Gu De Shizheng Yanjiu [An Analysis of the Relationship Between
IndependentDirectorsand CorporatePerformance:An EmpiricalStudy ofA-share Performance
in the ShanghaiStock Market], SHANGHAI GUANLI KEXUE [SHANGHAI MGMT.SCI.], No. 2,2004,
at 20-23. The study was based on reported results as of the companies' annual reports for 2002.
Needless to say, a sequence in time does not establish causation. Unfortunately, the authors do
not have a control group of companies that did not introduce independent directors, thus leaving
open the possibility that the performance of many companies may have suffered simply due to
economic conditions.
3 09
See id.
31
See Xiao Li, Duli Dongshi Zhidu yu Shangshi Gongsi Yeji: Laizi Zhongguo
Shangshi Gongsi de Zhengju [Independent Directors and Listed Company Performance:
Evidence from Listed Companies in China], NANJING SHENJI XUEYUAN XUEBAO [J. NANJING
AUDIT INST.], No. 2, 2004, at 21-23.
3
'See Han Zhiguo, Duli Dongshi Bu "Duli" [Independent Directors Are Not
"Independent"], FAZHAN [DEVELOPMENT], No. 8, 2002, at 40.
 DELAWARE JOURNAL OF CoRpoRATE LAW [Vol. 31

the range of 5000 to 12,000 yuan." 2 This is between US$600 and $1,500
at current exchange rates-in the range of a junior white-collar worker's
monthly salary. In view of other studies, however, this figure seems low.
A survey of 69 listed companies reports that over half paid between 20,000
and 40,000 yuan per year to independent directors, while another 31% paid
between 40,000 and 60,000 yuan. 13 A study conducted in 2001 by the
Shenzhen Stock Exchange reportedly found annual director fees in the
range of 20,000 to 50,000 yuan. 1 4 Another 2001 study of 130 listed
companies is reported to have found that 18 companies paid between
10,000 and 20,000 yuan, 26 paid between 20,000 and 30,000 yuan, 49 paid
between 30,000 and 40,000 yuan, 21 paid between 40,000 and 50,000 yuan,
and 16 paid more than 50,000 yuan.1 5
In the 56 companies with independent directors studied by He and
Wang, only 13 independent directors received fees (or at least were
reported to have received fees).31 6 The other 80 did not receive any
compensation from the company."a 7 A study of disclosure of independent
director compensation by 1116 listed companies found that 777 (70%) did
not disclose one way or the other, 137 (12%) reported that they
compensated directors, and 202 (18%) reported that their independent
directors received no compensation. Of the top twenty companies in terms
of compensation, the highest paid 265,000 yuan per year, while the lowest
paid 60,000 yuan. Fifteen of the top twenty paid between 60,000 and
80,000 yuan per year. Thus, this amount would seem to represent the
general maximum, aside from a few outliers. The bottom twenty reporting
companies all paid less than 10,000 yuan per year, but this number does not
include companies that paid nothing and companies that did not disclose." 8

3 12
See Wu et al., supra note 160.
3
'See Jin Xin Securities, supra note 156. For a caveat about the methodology of this
survey, see supra note 290.
3 14
See Du Dong Duiwu Jisu Kuorong [Ranks of Independent Directors Quickly
Enlarged], supra note 258.
3
'See Wu Libo, Jingjixuejia Wei Qiye Daiyan de Shishi Feifei [The Wrongs and
Rights of Economists Speaking On Behalf of Enterprises], LIAOWANG DONGFANG ZHOUKAN
[OUTLOOK ORIENTAL WEEKLY], No. 7, Feb. 9, 2004, available at http://news.sina.com.cn/c/
2004-02-09/10252808298.shtml.
a"6See He & Wang, supra note 305.
317
See id.
3
"See Duli Dongshi Nianxin Ji He? [What Is the Annual Salary of Independent
Directors?], GONGREN RIBAO [WORKERS' DAILY], Oct. 20, 2002.
20061 CHINESE CoRPoRATE GOVERNANCE

A later survey is that of Yue, 31 9 based on data as of July 30, 2002

from a random sample of 500 listed companies. He found that directors'
fees averaged 31,900 yuan per year, with a highest reported fee of 200,000
yuan and a lowest reported fee of 5000 yuan.
The most recent study is based on data from the annual reports for
2002 of 81 listed companies that had independent directors since at least
2000.320 The authors found that over half the companies paid less than
30,000 yuan annually to each independent director.
Perhaps more telling are the personal characteristics of independent
directors. Unlike independent directors in U.S. companies, who often, but
not always, share personal characteristics such as education and business
experience with inside directors, independent directors in China are
typically quite different from their fellow directors. In a survey of the
occupational background of independent directors, Shi found that almost
half were teachers in institutions of higher education or researchers in
scientific institutes (see Figure 1).321 A CSRC study in 2002 found a
similar number, with accountants, lawyers, and other intermediaries making
up another 30%. Only 10% were executives from other companies.322 Shi's
study found that some 22% were from the world of business, and another
15% were current or former government officials, whereas the CSRC study
found that 10% were company executives and only 5% were "other," a
residual category that included retired government officials (current
government officials are not supposed to be independent directors). A
more recent study based on a random sample of 500 listed companies found
that 45% of independent directors were university professors or researchers
from institutes, similar to the figure in previous studies. Other (presumably
industrial) companies were the source for 28% of the independent directors,
while lawyers, accountants, and other service industry professionals
accounted for 14%.323

9
) Yue Qingtang, Dui500 JiaShangshi Gongsi Duli DongshiNianlingZhuanye Deng
Goucheng de Shizheng Yanjiu [An EmpiricalStudy of the Age and OccupationalComposition
ofthe IndependentDirectors in 500 Listed Companies], JINGJUIE [ECON. WORLD], No. 2, 2004,
at 86-88.
32
1LUO et al., supra note 308. For a further breakdown, see infra Figure 4.
32
'See Shi Xinghui, 104 Wei Duli Dongshi Diaocha Fenxi-Tamen Shi Shei? [An
InvestigationandAnalysis of 104 Independent Directors:Who Are They?], ZHONGGUOQIYEJIA
[THE CHINESE ENTREPRENEUR], No. 7, 2001, at 17.
322
See Du Dong Duiwu Jisu Kuorong [Ranks of Independent Directors Quickly
Enlarged], supra note 258. A 2003 study put the number of professors at 39%; this is not
necessarily inconsistent with the other studies, since the category "professors" may have been
more narrowly defined than the category "professors and technical specialists." See Jin Xin
Securities, supra note 156.
32 3
See Yue, supra note 319.
 DELAWARE JOURNAL OF CORPORATE LAW [Vol. 31

Also striking were differences in educational background (see

Figures 2a, 2b, and 2c, from different studies with consistent results) 3 24 and
age (see Figure 3). In short, the numbers appear to bear out the common
stereotype of independent directors as perhaps well-meaning but ultimately
ineffectual academics and celebrities brought onto boards for their prestige
value and perhaps to satisfy the CSRC, but for little else.

2. Institutional Factors

In a recent paper, Kanda and Milhaupt suggest a useful way of

thinking about legal transplants in terms of micro-fit (compatibility with the
existing legal infrastructure), macro-fit (compatibility with existing
political and economic institutions), the availability of substitutes for the
transplanted doctrine, and the motivations of those responsible for the
transplanting and those who might be in a position to make it an active
element of the host country's legal system.325 While independent directors
in China are less a legal transplant than an institutional transplant, the
above guidelines are nevertheless a useful way of ordering the discussion.

a. Motivations

The best place to start might be with the motivations of those

responsible for introducing the independent director system. From a
bureaucratic perspective, one can, of course, speculate that in imposing this
requirement, the CSRC was simply looking for another handle with which
to grasp the companies under its jurisdiction and thus increase its power
over them. It is just one more requirement with no private law
consequences32 6 that CSRC officials can choose to enforce strictly or not,
depending on the company's degree of cooperation on other fronts. If this
theory is correct, the requirement will be more a regulatory bargaining chip
than a categorical imperative.

32
tTwo studies show the percentage of independent directors with a master's degree or
higher to be respectively 49 (Figure 2a) and 60 (Figure 2b). Oddly, however, a news report dated
Aug. 18, 2002 (well after the data for the two studies was taken) states that in Shanghai listed
companies, where one would expect the educational level of independent directors to be high, over
one third (but presumably not close to or over one half) had a master's degree or above. See
Shanghai Shangshi Gongsi Quanbu Shishi Duli Dongshi Zhidu [Shanghai Listed Companies
Fully Implement Independent DirectorSystem], JIEFANG RIBAO [LIBERATION DAILY], Aug. 23,
2002, available at http://www.chinainfobank.com.
•"See Kanda & Milhaupt, supra note 13, at 9-10.
326
See infra Part V.B.2.b.
2006] CHINESE CORPORATE GOVERNANCE

It is also important not to overlook the possibility of mixed and

possibly contradictory motivations, perhaps driven, like the Sarbanes-Oxley
Act in some respects, by the desire simply to do something even if it is not
clear that the medicine will cure the disease.3 27 As shown in Section 4
above, regulations and policy documents calling for independent directors
were being issued long before the Independent Director Opinion. Thus,
looking at the CSRC's motivations is not enough. It seems that independent
directors as part of the solution to corporate ills were part of the zeitgeist
that had reached China by the late 1990s, and they were promoted,
apparently without much serious consideration, as a weapon against abuse
by dominant shareholders by precisely those same dominant shareholders
(for example, local governments 328).
In sum, although the motivation for adopting an independent
director system seems straightforward at first glance, upon closer
examination it is surprisingly amorphous and unclear. This lack of clarity
is likely to impair the successful transplantation of the institution.

b. Micro-Fit

The micro-fit of independent directors in China is poor. This is so

for two reasons. First, the micro-fit of the borrowed institution-
independent directors--even in the home country is not terribly good. The
U.S. legal system at the state level (usually the state of Delaware) is quite
at home with the notion of disinterested directors and has various
mechanisms in place, such as enforceable recusal requirements and
shareholder lawsuits, for making their presence meaningful. Independent
director requirements imposed by federal law and stock exchange listing
rules, however, are much harder to police, and are not backed up by a
plausible theory of motivation.32 9
Second, China's independent director system is not tied into any
system of incentives that would make it function as expected. Corporate
officers and fellow directors have few incentives to listen to independent
directors because independent directors have little in the way of veto power
over corporate actions. Independent directors may have the fear of liability

327
For this view of the Sarbanes-Oxley Act, see Roberta Romano, The Sarbanes-Oxley
Act and the Makingof Quack CorporateGovernance(New York University, Law and Economics
Research Paper No. 04-032; Yale Law and Economics Research Paper 297; Yale International
Center for Finance (ICF), Working Paper No. 04-37; European Corporate Governance Institute
(ECGI), Finance Working Paper No. 52/2004, 2004), available at http://ssrn.com/
abstract=596101.
328
See supra Part IV.B.
329
See supra note 119 and accompanying text.
 DELAWARE JOURNAL OF CORPORATE LAW [Vol. 31

as an incentive not to sign off on questionable deals, but inside directors

have the same incentive. Finally, those in control of the corporation have
little incentive to appoint truly independent directors because there is no
institution with the capacity to make the fine individualized determinations
of who is truly independent, and controlling parties would get no benefit
from having such truly independent directors. China does not now have the
kind of legal institutions that could make the independent director
requirement meaningful, and even if it did, the rules at present do not
contemplate a significant role for legal institutions. They contemplate a
role only for the CSRC.
In thinking about the kind of legal institutions that could make an
independent (or disinterested) director requirement meaningful, it is useful
to think about how such rules are made meaningful (or not) by legal
institutions in the United States. Let us imagine an American company, for
example, whose board of directors is dominated by management. Why
would management ever want to appoint independent directors? There are
a few answers, of course: it might be that this is a bonding device whereby
management signals to potential investors that it is willing to be monitored
effectively, and thereby reduces the firm's cost of capital, making it more
competitive with other firms and thus more likely to survive.33 °
Another answer, however, is that management engages independent
directors in order to protect itself from liability in shareholder suits. 331 A
company's management often does, and sometimes must (for example, in
the case of compensation), engage in transactions that either are or look
very much like self-dealing or in some other way implicate a conflict of
interest. In such cases the blessing of independent directors can be
invaluable. As noted above, corporate statutes in the United States do not
prohibit self-dealing transactions outright and do not even necessarily
require approval by independent directors. Instead, they provide a safe
harbor for transactions that are approved by directors who are disinterested
in the transaction in question. The good-faith use by management of
independent directors is recognized by courts and extremely valuable.332

3I'This is essentially the story told by law-and-economics scholars such as Easterbrook

and Fischel. See FRANK EASTERBROOK & DANIEL FISCHEL, THE ECONOMIC STRUCTURE OF
CORPORATE LAW (Harvard Univ. Press 1991).
33
This is the view of Miwa and Ramseyer, who label such suits "legalized extortion."
See Miwa & Ramseyer, supra note 98, at 8.
"32 Consider the recent admonition of the Chief Justice of the Delaware Supreme Court,
Norman Veasey:
I would urge boards of directors to demonstrate their independence, hold
executive sessions, and follow governance procedures sincerely and
effectively, not only as a guard against the intrusion of the federal
government but as a guard against anything that might happen to them in
2006] CHINESE CORPORATE GOVERNANCE

Consider also that, as I have argued above, the jurisprudence of

disinterested directors is far more developed than the jurisprudence of
independent directors. An important reason is that disinterested directors
are a concept in Delaware's corporate law, and Delaware has courts and a
responsive legislature that sees problems and responds to them. The NYSE
rules, by contrast, carry with them no system for spotting problems and
resolving disputes through a fair process resulting in written decisions. The
same applies to the rules of the SOA: they come from a source that cannot
be changed quickly.333 Furthermore, if Delaware wants disinterested
directors, it can give incentives to shareholders to sue if they do not get
them. But the exchanges have only the blunt tool of delisting for the
enforcement of their rules.
However Congress may have contemplated that the independent
director requirements of the SOA would be enforced-through SEC action,
through private litigation under the federal securities laws, or through some
other method-it is important to note the possible interplay of state law
with federal law here. Law firms are already warning their clients that
penalties in one forum can turn into penalties in another. For example, the
SOA mandates the stock exchanges to require corporations to adopt
internal governance rules on pain of delisting. A director might well not be
protected by the business judgment rule for actions she took that resulted
in delisting; she might be held to have a fiduciary duty to prevent such an
occurrence.334 As Chandler and Strine predict:

court from a properly presented complaint.

Peter Olson, What's Wrong with Executive Compensation?:A RoundtableModeratedby Charles
Elson, 18 HARv. Bus. REv., Jan. 2003, at 68, 76 (citing Norman Veasey). The wisdom of Chief
Justice Veasey's advice can be seen by looking at the fate of the management buyouts of
Macmillan, Inc. and RJR Nabisco, Inc. In the former case, management hand-picked the board
committee that was to negotiate the terms of the deal and in other ways exercised control over the
process; as a result, the board was found to have breached its fiduciary duties in accepting
management's bid even though it was nominally higher than a competing bid. See Mills
Acquisition Co. v. Macmillan, Inc., 559 A.2d 1261, 1281 (Del. 1988). In the latter case, by
contrast, the president and CEO of the company leading the buyout group had no role in the
selection of the board committee and the members of that committee had no direct or indirect
financial interest in the transaction. As a result, although the board rejected a nominally higher
bid, its decision was protected by the business judgment rule. See In re RJR Nabisco, Inc.
S'holders Litig., [ 1988-1989 Transfer Binder] Fed. Sec. L. Rep. (CCH) 94,194 (Del. Ch. 1989),
reprinted in 14 DEL. J. CoRp. L. 1132 (1989). For a detailed discussion of the two cases, see
Stephen M. Bainbridge, Independent Directorsand the AU CorporateGovernance Project, 61
GEO. WASH. L. REv. 1034, 1076-79 (1993). On the insulating effect of disinterested directors
generally, see CHANDLER & STRINE, supra note 98, at 35.
333
The arguments in this paragraph are made more fully in CHANDLER & STRINE, supra
note 98.
334See, e.g., Weil, Gotshal & Manges LLP,DirectorLiability Warningsfrom Delaware
(memorandum, Feb. 2003).
 DELAWARE JOURNAL OF CORPORATE LAW [Vol. 3 1

[I]t is unlikely that stockholder-plaintiffs will be content to

leave enforcement of the 2002 Reforms entirely to the
SEC and the Exchanges. Rather, if history is any guide,
the active corporate plaintiffs' bar will be creative and
aggressive in deploying the Reforms as a tool in
shareholder litigation under state law.335

In the United States, therefore, one can see that the requirements
of the SOA are already being viewed by judges, plaintiffs' lawyers, and
defendants' lawyers in terms of their liability implications in the hands of
different institutions. This makes it all the more important to note that
virtually none of these mechanisms is available in China, or if available,
contemplated by the Independent Director Opinion or other rules and policy
documents calling for independent directors.
Most importantly, the Opinion is a policy document to be
administered by the CSRC. It grants no private rights. It operates by
giving the CSRC leverage to require companies to revise their articles of
association to accommodate independent directors, and to put them on their
boards. The only body with the authority to judge whether companies have
met the requirements of the Opinion, and to make consequences follow
from their failure to do so, is the CSRC. As discussed above, even if the
CSRC has the manpower to ensure that independent directors meet its
standards at the time of appointment, it can hardly be expected to carry on
monitoring to ensure that they continue to meet the standards, much less to
investigate every transaction approved by the board to ensure that the
independent directors were also disinteresteddirectors.
Shareholders and courts cannot be expected to carry this burden
within China's legal system for several reasons. First, shareholders have no
right to sue if companies do not comply with the Opinion. The CSRC has
no legislative power to grant such rights, and even if it had such power, it
has not done so. Second, it is not clear that shareholders have a right to sue
if companies do comply with the Opinion by revising their charters and
appointing independent directors, but then fail to allow the independent
directors to play their contemplated role. All the Opinion seems to require
is that such failure be disclosed, and the CSRC is evidently not requiring
listed companies to commit to more than that in their charter revisions.336

3 35
CHANDLER & STRINE, supra note 98, at 44.
3 36
See, for example, the charter revisions of a Shenzhen listed company reported in
Guanyu Xiugai Gongsi Zhangcheng De Yian [Resolution on Amendment of the Company's
Articles of Association], ZHENGQUAN SHIBAo [SECuRITIES TIMES], July 29,2003, at 25, available
at http://www.p5w.net/p5w/home/stime/today/200307290030.html.
2006] CHINESE CORPORATE GOVERNANCE

Thus, even if charter violations gave rise to a cause of action in Chinese

courts, the failure to heed the views of independent directors will for many
companies probably not be a charter violation, provided the failure is
disclosed.
Not only do shareholders have no right to compel companies to
allow diligent independent directors to fulfill their role, but they also have
no real right to sanction independent directors who, whether negligently or
deliberately, fail to do so. The Independent Director Opinion states that
independent directors have a duty of good faith and diligence, but the
CSRC has no authority to establish civil law standards. Such standards
might operate to create liability if adopted in the company's charter, but so
far no such cases have been reported. Article 123 of the Company Law
provides the directors have a duty to carry out their duties "in good faith,"
but it is far from clear that this language creates a private right of action.337
Thus, the incentive for management and dominant shareholders to
install directors who will pass an individualized after-the-fact examination
of independence does not really exist in China. Chinese corporate law
contains no doctrine under which shareholders can sue management for
engaging in self-dealing transactions, and no doctrine under which
management could cite independent director approval in legitimation of
some action. Because shareholder suits are already extremely difficult in
China,338 Chinese courts and regulators have not developed a doctrine of
deference to board decisions, and thus have not developed any theory about
what kind of procedures are worthy of deference in particular cases. In this

337
For more on the enforcement of the duty of care of independent directors, see infra
Appendix 1.
338
The recent history of shareholder suits in China is complex. Originally disfavored
by courts, they were made even more difficult by a Supreme People's Court (SPC) notice of
September 21, 2001, ordering lower courts to cease accepting all shareholder suits under the
Securities Law bringing claims of fraud (including, apparently, false or misleading disclosures),
insider trading, or market manipulation. See Supreme People's Court, Guanyu She Zhengquan
Minshi PeichangAnjian Zan Bu Yu Shouli de Tongzhi [Notice on Temporarily Not Accepting
Securities Cases Involving Civil Suits for Damages], issued Sept. 21, 2001 [hereinafter 2001
Securities Litigation Notice]. In January 2002, however, the SPC issued another notice allowing
shareholders, under certain strictly limited conditions, to bring suits against listed companies and
others for false or misleading disclosures. See Supreme People's Court, Guanyu Shouli
Zhengquan Shichang Yin Xujia Chenshu Yinfa de Minshi Qinquan Jiufen Anjian Youguan Wenti
de Tongzhi [Notice on Issues Relating to the Acceptance of Civil Cases in Tort Arising out of
False Representations in Securities Markets], issued Jan. 15, 2002 [hereinafter 2002 Securities
Litigation Notice]. In January 2003, the SPC followed up with yet another notice elaborating on
the notice of the previous year. See Supreme People's Court, Guanyu ShenliZhengquan Shichang
Yin Xujia Chenshu Yinfa de Minshi Peichang Anjian de Ruogan Guiding [Several Provisions on
the Adjudication of Civil Suitsfor Damages Arising out ofFalse Representations in Securities
Markets], issued Jan. 9, 2003 [hereinafter 2003 Securities Litigation Notice]. The issuance of
notices (tongzhi) is an accepted form of rulemaking by the SPC.
 DELAWARE JOURNAL OF CORPORATE LAW [Vol. 31

case, therefore, there is no market pressure in the form of legal liability on

management and dominant shareholders to appoint independent directors.
While the absence of market pressure might be adduced in support of a
government-imposed requirement, by the same token it implies that
implementation of this requirement will be particularly difficult, since it
does not serve the purposes of those who are expected to carry it
out-management and dominant shareholders-and will require the
constant expenditure of resources by the CSRC to ensure that nominated
directors meet the requirements of independence and continue to meet them
over time.
This problem highlights yet another difference between the Chinese
model of independent directors-and indeed of corporate regulation in
general-and the U.S. model, particularly that of state corporate law.
Although Delaware statutory and case law gives an important role to
disinterested directors, the Delaware authorities need not spend a penny on
ascertaining whether any particular director is disinterested unless a
particular dispute arises. Thus, there is no need to spend resources on
companies where problems do not arise; the existence of a dispute signals
the existence of a problem (regardless of which party is ultimately
determined to be right). Moreover, when a dispute arises it is quite within
the province of courts to make careful and individualized determinations
of the disinterestedness of particular directors with respect to the
challenged conflict-of-interest transaction. While prevention is often
considered superior to after-the-fact remediation, the latter approach offers
some significant cost savings of its own.
The approach of the Independent Director Opinion is preventative,
not remedial. By requiring the presence on the board of certain directors
who meet a test of independence, it aims to keep problems from occurring
in the first place. But the problem with this approach is that it can be
terribly wasteful. The CSRC will invariably be examining the
qualifications of directors in many companies where problems will never
arise. And continued monitoring will be required to make sure that the
independent directors stay independent. This is because after-the-fact
remediation through litigation has been made so difficult. Yet it is hard to
imagine this avenue being opened up. The Chinese legal system in general
is wary of individualized rights-driven dispute resolution carried on through
courts. Even now, it remains impossible to seek civil damages for acts such
as market manipulation or insider trading, and damages for misleading
disclosures may be sought only where a government organ has already
made a formal finding of a violation.33 9

339
See 2003 Securities LitigationNotice, supra note 338.
2006] CHINESE CORPORATE GOVERNANCE

c. Macro-Fit

The macro-fit picture is bleak as well. As discussed above, Fama

and Jensen have hypothesized that independent directors will be motivated
to perform as expected by reputational incentives. Whatever the
plausibility of this hypothesis in the political economy of the United
States,3" Chinese commentators agree that the conditions for such
incentives, such as a market for directors, do not now exist in China.3 4'
More importantly, the dominance of state shareholding, coupled
with the priority placed on the interests of the state, means that China's
corporate governance regime can never wholeheartedly sanction a system
in which independent directors can obstruct the wishes of dominant
shareholders.342 Such a system might be possible were state-dominated
companies governed by a different regime from non-state-dominated
companies, but a key goal of enterprise reform in China has been to unify
the legal regime governing each type of company.343

d. Availability of Substitute Institutions

In the Kanda-Milhaupt framework, whether a transplanted legal

doctrine will be used or not depends in part on the ready availability of
substitutes. Applying this framework to the transplanted institution of
independent directors yields interesting insights. First, one must ask:
substitutes for what? Because the answer is "independent directors," one
must then identify thefunction of independent directors in order to be able
to identify substitute institutions.If that function is one of monitoring and
restraining dominant shareholders, the fact is that substitute institutions are
not strongly present. The board of supervisors is weak and dominated by
management. Shareholders, even if not suffering from collective action
problems, have few legal remedies. Neither the criminal law nor the
CSRC's powers are appropriate for the fine-tuned monitoring tasks that
independent directors are intended to undertake. The various markets often
relied upon by theorists to play disciplining functions, such as equity
markets, cannot be expected to play a strong role. In the classical story,
dominant shareholders who abuse their power will be punished in the

34°For skeptical comments, see Bebchuk et al., supra note 119, at 787-88.
341
See, e.g., Tian & Lau, supra note 304, at 259; Yan & Chen, supra note 12, at 26.
12In a non-random sample of companies, Tenev and Zhang found that 70% of directors
were appointed by holders of state shares or state-owned legal person shares. See TENEv &
ZHANG, supra note 80, at 83.
S 3See Clarke, supra note 18, at 495-96.
 DELAWARE JOURNAL OF CORPORATE LAW [Vol. 31

equity markets by being forced to pay a higher price for further capital from
skittish investors. In China, however, companies rely very little on the
equity market for financing. 3 " Moreover, given the prevalence of
controlling-shareholder abuse, it is quite possible that stock prices in
general already reflect a discount for expected abuse. If it is also costly for
investors to obtain information about which individual companies do not
suffer from such abuse, a dominant shareholder that refrained from abusing
its control would get no benefit from doing so.
From the lack of good substitutes it does not automatically follow,
however, that independent directors will play their expected role. There
must be a force pushing for that monitoring and restraining role to be
played, and independent directors have to be capable of playing it. For the
reasons discussed above, the institution of independent directors in China
as currently designed is not really capable of playing that role. Nor is a
force pushing for it apparent. The state in its capacity as dominant
shareholder does not want or need it; neither do non-state dominant
shareholders. There are no laws or practices such as Delaware's
jurisprudence of disinterested directors that make independent directors
desirable to those in control of a company's board composition. Small
investors might benefit, or at least think they benefit, but they do not
constitute a force. The only real force pushing strongly for independent
directors seems to be the CSRC, whose authority over internal corporate
governance matters has been questioned and which in any case has not
required companies to give independent directors real power.345

VI. CONCLUSION

It is difficult to imagine that the Independent Director Opinion will

have a great effect on the way listed companies are run. Whether it
represents a laudable, if flawed, effort to protect shareholders depends on
one's confidence in the possibility of market solutions to the problems it
addresses. One could propose a vision of corporate governance rules in
which their only function was to provide a set of default rules, which
participants in a corporation could alter if they chose in the corporation's
articles of association. The content of the initial rule-requiring or not
requiring independent directors-would matter only where the transaction

3
"See GREEN, supra note 20, at 8-9.
'As discussed above in notes 328-30 and accompanying text, the Independent Director
Opinion requires companies to insert in their charters a provision mandating disclosure of failure
to respect certain powers to independent directors, but does not require a provision mandating
actual respect of those powers.
2006] CHINESE CoRPoRATE GOVERNANCE

costs of bargaining were too high for the parties to negotiate around the
rule. Individual corporations would choose whatever rule made the most
economic sense for them; if they chose wrongly, the resulting relative
inefficiency would lead to their elimination in competition.
The Chinese government has never, however, had much faith in
market solutions. Its approach to corporate governance has been no
different. In the case of Chinese companies listed overseas, for example,
it has promulgated mandatory articles of association that must be adopted
by all companies, no matter what their business or other particular
circumstances. Now it is requiring independent directors without any real
evidence that the presence of such directors will have the intended effect.
Research on U.S. companies has failed to show that independent directors
have any effect upon any of several measures of corporate performance.
This may, of course, be due to particular features of the legal, economic,
and political environment for corporate governance in the United States
that are not present in China. Perhaps, for example, the problems that
could be solved by independent directors are already solved more
efficiently in the United States by such institutions as shareholder
derivative suits, the market for corporate control, or the managerial labor
market, none of which exist in a developed form in China. Nevertheless,
given the substantial cost to the CSRC of monitoring the implementation
of this regulation, there should be some reason other than intuition for
believing it will be effective.
There is a further potential downside to the implementation of the
Independent Director Opinion if it turns out to have any real effect. The
usual substitutes for shareholder monitoring as a means of disciplining
managers-shareholder litigation, the managerial labor market, the input
and product market, and the market for corporate control-do not, with the
exception of the input and product market, function at all well in China.
Regulatory authorities have limited resources, and civil litigation by
shareholders is tightly restricted. Because these methods of monitoring
management and making it accountable do not work well, the state should
not place constraints around the one mechanism that might work well: large
shareholding. It should not block concentration of shareholding or make
it difficult for large shareholders to exercise control over the company by
making the board too independent. At the same time, a better system for
preventing abuse of that control, including after-the-fact remedial litigation,
should be developed. In short, the state should pay more attention to the
formulation often repeated in the official media: consider China's particular
conditions, and develop a system of "corporate governance with Chinese
characteristics."
 DELAWARE JOURNAL OF CORPORATE LAW [Vol. 31

Occupation of Directors

N Independent Directors [] Regular Directors

90

80

70

50

40

30
20

10

01
Higher education Go'ernmert Business Intemlediary Other
occupat Uon service
organizations

Figure 1: Occupation of Directors

Source: Shi, supra note 321
20061 CHINESE CORPORATE GOVERNANCE 219

Educational Level of Directors

0 Independent Directors 0 Regular Directors

50-
40 --
30 ---
Percentage

10--

Middle Juror College Masters PhD

school college
Education

Figure 2a: Educational Level of Directors

Source: Shi, supra note 321
 DELAWARE JOURNAL OF CORPORATE LAW [Vol. 31

Educational Level of Independent Directors

40

30

Percentage 20

10

0
Unknown Other College Masters PhD or above
Education

Figure 2b: Educational Level of Independent Directors

Source: Chen Zhengrong, Xianqi 500 Wei Duli Dongshi de Miansha
[Lifting the Veil on 500 Independent Directors],
FAZHAN [Development], No. 8, 2002, at 38-39
2006] CHINESE CoRPoRATE GOVERNANCE 221

Educational Level of Independent Directors

50
40
30
Percentage
20
10
10-

Junior college or College Masters PhD or above

below

Education

Figure 2c: Educational Level of Independent Directors

Source: Yue, supra note 319
 DELAWARE JOURNAL OF CORPORATE LAW [Vol. 31

Age Structure of Boards

[ Independent Directors 0 Regular Directors
45 -
40 -
35
30 -- 77
25 . .__
Percentage
20

15
10

20-29 30-39 40-49 50-59 60-69 70-

Age Range

Figure 3: Age Structure of Boards

Source: Shi, supra note 321
2006] CHINESE CORPORATE GOVERNANCE

Independent director annual

compensation
(in thousands of yuan)

25

20 _____

15 ---

10 - ___

0
C,0

Figure 4: Independent Director Annual Compensation

(in thousands of yuan)
Source: Luo et al., supra note 308
 DELAWARE JOURNAL OF CORPORATE LAW [Vol. 31

Appendix 1

Standardsof Liabilityfor Directors

Chinese law and regulatory practice remains unclear on the issue

of standards of liability for independent directors, and indeed for directors
in general. The recent case of Lu Jiahao, a retired language professor who,
despite no experience in business, was asked to serve as an independent
director, sheds some light. Lu served without compensation on the board
of Zhengzhou Baiwen Corporation, a company listed on the Shanghai Stock
Exchange that was involved in a false disclosure scandal, and was among
the directors fined 100,000 yuan by the CSRC for his involvement. 3" Lu's
defense was essentially that his position was purely honorary, and that he
had neither expected nor been expected to play any substantial role in
company management or oversight. The CSRC's position was essentially
that of the New Jersey Supreme Court in Francisv. United Jersey Bank:

Because directors are bound to exercise ordinary care, they

cannot set up as a defense lack of the knowledge needed to
exercise the requisite degree of care. If one "feels that he
has not had sufficient business experience to qualify him
to perform the duties of a director, he should either acquire
the knowledge by inquiry, or refuse to act."347'

It rejected the notion of an honorary director and in effect insisted that any
director who feels unable to perform the duties of the position should resign
and make way for someone who can.348
It is worth noting first of all that Lu was not sued by shareholders.
The action against him was purely governmental. Lu was fined by the
CSRC and appealed his fine within the administrative system. Failing
there, he brought suit in the Beijing Intermediate-Level People's Court as
allowed under the Administrative Litigation Law to have the CSRC's
administrative decision overturned. He lost in the first instance and
appealed to the Beijing Higher-Level People's Court, but lost again on
appeal.
The CSRC's authority to impose fines on violators of laws and
administrative regulations in the field of securities stems from a set of 1998

'See Wei, supra note 173; Wu, supra note 173.

"7 Francis v. United Jersey Bank, 432 A.2d 814, 822 (N.J. 1981) (citations omitted).
"aSee supra text accompanying note 347.
2006] CHINESE CORPORATE GOVERNANCE

State Council regulations.349 These rules give ministry-level status to the

CSRC and state that it is the body with authority over the regulation of
securities and futures. Section 2(11) of the rules gives the CSRC authority
to investigate and punish violations of laws and regulations relating to
securities and futures. Article 177 of the original Securities Law (in effect
from July 1, 1999) stated that a fine of 30,000 to 300,000 yuan could be
imposed on those directly responsible for disclosure violations. Although
it did not state which authority could impose the fine, it was well
understood that the CSRC was empowered to do so.
Lu's punishment was specifically grounded in a set of 1993
regulations, 350 Article 74 of which lists a number of offenses, including that
of making misleading disclosures in the course of stock issuance or trading.
It states that any unit or individual who commits one of these offenses may
be punished by a number of methods, including a fine. (It does not specify
directors, but does not exclude them.) The regulations also name the CSRC
as the body in charge of implementation. Although Article 77 gives a
private right of action for civil damages to anyone who is damaged by a
violation of (apparently) any provision of the regulations, this provision has
never to my knowledge been the basis of any such lawsuit.
It is not clear whether the CSRC applied a fault standard or a strict
35
liability standard. Neither the original CSRC decision (First Decision) '
nor the CSRC decision upon administrative appeal (Second Decision)3 52 go
into a great amount of detail on the relevant standard. The standard appears
to be one of liability for any director who does not register an objection to
the offending practices at a board meeting.
The First Decision recites the facts of the misleading disclosures
and simply states that Lu Jiahao was among those directly responsible. It
does not provide any explanation of the standard of responsibility applied

"9State
Council, Zhongguo Zhengquan Jiandu Guanli Weiyuanhui Zhineng Peizhi,
Neishe Jigou he Renyuan Bianzhi Guiding [Rules on the Allocation of Functions, Internal
Organization,and Staffing of the China Securities Regulatory and Supervision Commission],
issued Sept. 30, 1998.
35
State Council, Gupiao Faxing Yu Jiaoyi Guanli Zanxing Tiaoli [Provisional
Regulations on the Administrationof Stock Issuance and Trading], issued and effective Apr. 22,
1993.
351
China Securities Regulatory Commission, Guanyu Zhengzhou Baiwen Gufen
Youxian Gongsi (Jituan)ji Youguan Renyuan Weifan Zhengquan Fagui Xingwei de Chufa
Jueding [Decision on Punishment of Acts in Violation of Securities Laws and Regulations
Committed by Zhengzhou Baiwen (Group) Corp. and Relevant Individuals], Zheng Jian Fa Zi
(2001) No. 19, Sept. 27, 2001, available at http://www.chinainfobank.com.
352
China Securities Regulatory Commission, Xingzheng Fuyi Jueding Shu
[Administrative Appeal Decision], Zheng Jian Fu Jue Zi (2002) No. 2, Mar. 4, 2002, available
at http://www.chinainfobank.com.
 DELAWARE JOURNAL OF CORPORATE LAW (Vol. 31

to Lu, and does not explain why other persons who held board positions
prior to the company's listing were not punished.353
The Second Decision, dealing exclusively with Lu, is a little more
enlightening. It summarizes the First Decision as finding that violations
occurred, and that Lu Jiahao "as a director.., bears direct responsi-
bility." 354 The Second Decision does not, however, state that Lu's being a
director is all that is required. It first recites Lu's arguments: that an
independent directorship is an honorary position, that he received no
compensation, and that he had no duties at the company. Lu further argued
that he was absent at a board meeting at which listing materials were
discussed, and that he did not sign the listing application.
The Second Decision then rejects all these arguments. It notes that
Lu, who was appointed in 1995, 355 attended board meetings in the spring of
1996, 1997, 1998, and 1999 to approve the previous year's financial report,
and expressed no objection to the proceedings. His occasional absence
from board meetings could not be grounds for exculpation. The misleading
disclosure materials were discussed at board meetings, and therefore
directors should be responsible. The fact that Lu had no duties in the
company and received no compensation was irrelevant. Moreover, neither
the First Decision nor the Second Decision make anything of the fact that
Lu was an independent director. The First Decision never uses the term at
all, calling him simply a director. The Second Decision at one point calls
him an independent director, but the point is of no relevance to its
reasoning. To all appearances, therefore, the CSRC's position seems to be
that all directors, independent or not, should be subject to the same
standard.
Other sources make the CSRC's position a little clearer. At the
hearing of Lu's appeal to court of the Second Decision, the CSRC's
representative argued that the punishment was not based on whether or not
the director gained financially. A person about to become a director should
know what is expected and whether he or she is capable of doing the job.35 6

" That such persons exist is stated in Zhongguo Caikuai Wang [China Fin. & Acct.
Web], "HuapingDongshi"Lu JiahaoGai FuSha Zeren [WhatResponsibilityShould the "Flower
Vase Director" Lu Jiahao Bear], June 22, 2002, http://www.e521.comcjkx/redian/
0622074233.htm.
3
-41d. (emphasis added).
35
5Lu was appointed in January of 1995 as a "director from society" (shehui dongshi)
(i.e., outside director). See Yu Lingbo, Hanyuan de Du Dong he Neizhang 10 Wan Yuan Fadan
[The Independent DirectorWho Cries of Injustice and that 100,000 Yuan Fine], ZHENGQUAN
SHIBAO [SECURITIES TIMES], Dec. 29, 2002, available at http://www.p5w.net/p5w/home/
stime/week/200212270694.html. This term was later replaced by the term "independent director."
356
See "HuapingDongshi" Lu JiahaoGai Fu Sha Ziren [What Responsibility Should
the "FlowerVase Director"Lu JiahaoBear], supra note 353.
20061 CHINESE CORPORATE GOVERNANCE

Again, the CSRC did not propose a different standard for independent
directors. An unnamed CSRC official muddied the waters by arguing to
reporters that Lu was not in any case an independent director because he
held 10,000 shares of company stock,3" 7 but this was probably more of a
belt-and-suspenders argument than a considered position. At the times in
question, there was no settled and uniform definition of independent
director. Even if one were to apply the standards of the Independent
Director Opinion, Lu's 10,000 shares were far below the 1% disqualifying
ceiling of the Opinion.
A CSRC official (writing in an unofficial capacity) addressed
several of Lu's arguments in an article in the Procuratorate Daily in late
2002. 358 First, he repeated the CSRC's position that there was no basis in
law for distinguishing between independent directors and other directors
when assigning liability. Second, he noted that Lu's not signing the listing
application materials was not irrelevant, and was indeed the reason why he
had not been held criminally liable as had been the chairman of the board
and the CEO of the company. Third, he argued that Lu had not been held
liable for any board decisions taken at meetings at which he had not been
present or for documents that he had not signed.
Unfortunately, for procedural reasons the CSRC's position has
never had to face a proper challenge in adversarial proceedings. First, Lu
himself turned down the opportunity to make his case before the CSRC
when it was in the stage of deciding administrative punishments. The
company was at the time in question undergoing a restructuring involving
a third-party savior, and Lu stated later that he had received several
telephone calls from Zhengzhou city officials and others instructing him not
to rock the boat and to consider the interests of the company's 6.8 million
stockholders as well as its employees.3 5 9 These calls appear to have been
rather threatening; Lu told a reporter, "I received telephone calls from many
different circles. I can only tell you that much; I can't be more specific."3
Finally, no court has ever ruled on the merits of the CSRC's
position with respect to Lu Jiahao. The Beijing No. 1 Intermediate People's
Court rejected his initial suit to quash the Second Decision on the grounds

357
See id. Lu apparently had purchased his 10,000 shares in 1992, well before he
became a director. See Wei, supra note 173.
358
See Wu, supra note 173.
359
See "HuapingDongshi" Lu Jiahao Gai Fu Sha Ziren [What Responsibility Should
the "Flower Vase Director" Lu Jiahao Bear], supra note 353.
36
See Lu Jiahao Bai Su de Qishi-Dudong de Liangnan Xuanze [The Lessons of Lu
Jiahao's Loss in Court: The Dilemma Facing Independent Directors], Nov. 27, 2002, available
at http://economy.enorth.com.cn/system2002/11/27/000461375.shtml.
 DELAWARE JOURNAL OF CORPORATE LAW [Vol. 31

that the applicable time limit had expired,"' and that rejection was upheld
on appeal.362

361
See Lu JiahaoGao Zheng Jian Hui An Bei Bohui [Lu Jiahao'sSuit Against CSRC
Rejected], BEIJING WANBAO [BEIJING EVENING NEWS], Aug. 13, 2002, available at
http://www.chinainfobank.com.
362
See Lu JiahaoZhuanggaoZheng JianHuiAn Zao Beijing Shi Gaoyuan Zhongshen
Bohui [Lu Jiahao'sLawsuit Against CSRC Rejected by Beijing HigherLevel People's Court in
FinalJudgment], SHANGHAI ZHENGQUAN BAO [SHANGHAI SECURITIES NEWS], Nov. 18, 2002,
availableat http://www.chinainfobank.com.