Market Governance, Power Rebalancing, and Signaling: The Three Functions of China’s Corporate Governance Law

Scholars have long posited that law’s primary role in corporate governance is to protect investors’ rights, arguing that robust legal safeguards reduce agency costs, foster dispersed ownership, and drive broader market growth. Yet, China presents a special case that challenges traditional law and economics theories. Despite historically lacking robust external governance mechanisms and formal investor protections, China has cultivated the world’s second-largest stock market.

Recent law and political economy scholarship, notably by Tamar Groswald Ozery, offers an instructive alternative, arguing that legal institutions in China serve a twofold function: promoting market growth while embedding state priorities and reconfiguring economic authority within the Party-state system. However, this framework remains incomplete. 

As argued in my working paper, to fully resolve the puzzling developments in China’s regulatory landscape, we must recognize a third, analytically distinct, function of legal institutions: signaling. Through legal reforms, corporate governance structures, and disclosure regimes, the Party-state simultaneously facilitates market development, embeds political priorities, and strategically signals regulatory sophistication to both domestic and international audiences.

The Signaling Function in Action

Signaling refers to a process in which better-informed signal senders convey information about unobservable qualities to less-informed receivers. In China’s corporate governance, legal reforms are used to convey credible information to foreign investors about the state’s commitment to institutional modernization and alignment with global norms. Through signaling, China projects an image as a promoter of responsible corporate governance to global investors, even as underlying political economy movesgradually. Incorporating this third function helps reconcile why recent reforms simultaneously strengthen market-oriented mechanisms such as independent directors and institutional investor stewardship, while deepening Party-state involvement through instruments like golden shares.

Embedding State Authority: The Rise of Golden Shares

A prime example of the Party-state embedding its authority within private corporate structures is the strategic use of ‘golden shares,’ or special management shares. Recently, state-affiliated funds have acquired minor equity stakes (approximately 1%) in leading technology and media firms, such as Tencent and various Alibaba subsidiaries.

Despite their modest financial footprint, these stakes grant government-appointed representatives board seats or veto power over key corporate decisions. From a political economy perspective, golden shares allow the state to embed its regulatory agenda directly into corporate decision-making without enacting new laws or resorting to formal nationalization. While the US government has rarely employed comparable arrangements, its retention of special rights in the Nippon Steel–US Steel acquisition on national security grounds illustrates a limited parallel. By contrast, China has institutionalized golden shares as a mechanism of direct state intervention.

Signaling and Divergence: The 2023 Company Law and ESG

The 2023 revision of China’s Company Law illustrates how the state creates leeway to extend its influence while signaling international alignment. The revision and its implementing rules introduce US-influenced provisions, such as replacing the supervisory board with an audit committee composed primarily of independent directors for listed companies by 2026.

More significantly, Article 20 of the revised law requires companies to consider stakeholder interests and encourages environmental, social, and governance (ESG) disclosure. Since 2024, Chinese authorities have been building a tiered, comprehensive ESG disclosure regime. Regulators explicitly designed this framework to align closely with international standards, with basic standards drawing heavily on the International Sustainability Standards Board (ISSB).

This state-led corporate governance push stands in stark contrast to the United States. In the US, ESG initiatives face severe political headwinds, with states enacting anti-ESG legislation that penalizes proxy advisors for utilizing nonfinancial factors, and large asset managers like BlackRock and Vanguard drastically retreating from supporting environmental and social shareholder proposals.

China’s aggressive pursuit of ESG disclosure functions primarily as a signaling tool. Domestically, it embeds corporate behaviour within state policy objectives, such as ecological governance. Globally, adopting internationally recognizable standards signals regulatory modernization, allowing China to attract capital inflows and assert leadership in shaping global corporate governance norms while US actors retreat.

Revamping Traditional Governance Mechanisms

The coexistence of market governance, political embedding, and signaling is equally apparent in China’s recent efforts to overhaul traditional corporate governance actors.

• Institutional Investors: In May 2025, new rules adopted by Asset Management Association of China (AMAC) mandated that fund managers holding 5% or more of a listed company’s free float shares actively exercise voting rights on key corporate matters, such as executive compensation and material transactions. These rules mimic Western models encourage active stewardship and private ordering, particularly through proxy voting. However, structural constraints persist, since many institutional investors are affiliated with state-owned enterprises, which entangles them with the Party-state and limits their independence. These capacity limitations increase reliance on proxy advisory recommendations, such as those provided by ZD Proxy in China. At the same time, the proxy advisory industry in China remains underdeveloped compared to the United States.  In contrast, proxy advisors in the United States are increasingly facing political and regulatory pressure at both the federal and state levels with respect to incorporating ESG considerations into their recommendations, such as Texas S.B. 2337 and Indiana H.B. 1273.
• Independent Directors:Prompted by the Kangmei case, which imposed devastating personal liability on independent directors, regulators issued new measures in 2023, which guarantee independent directors adequate resources, staffing, and information rights. However, while introducing discretionary administrative exculpation, the rules offer no protection against civil liability, and directors remain reliant on controlling shareholders for nomination.
• Gatekeeper Enforcement: Regulators are also signaling a stricter approach to external monitoring, highlighted by a record RMB 441 million fine and suspension imposed on PwC’s China affiliate for certifying false financial disclosures by the Evergrande Group.

Conclusion

Recent developments in China’s corporate governance do not represent a linear shift toward Western convergence, nor are they a simple reassertion of state control. Although the US and China exhibit some surface-level convergence in formal institutions, their underlying governance logics remain fundamentally distinct.

In the US, political constraints increasingly operate by shaping the incentives of market actors, as reflected in efforts to regulate ESG initiatives and proxy advisory firms. In China, legal institutions are deployed as a hybrid structure. Selective institutional borrowing is integrated into a system where market mechanisms, direct state authority, and strategic signaling mutually reinforce one another. To sustain economic growth and attract capital, China will likely continue adopting internationally recognizable practices. However, formal convergence will not produce functional convergence. Law in China will continue to serve as a strategic device for shaping expectations in a global marketplace while maintaining the Party-state’s ultimate economic authority.

Read the author’s working paper here.

Chen Wang is a Research Fellow at the Centre for Research on Digital Economy and Legal Innovation, University of International Business and Economics, and holds a JSD from UC Berkeley School of Law.