Abstract
The conversion of China’s planned economy to a socialist market economy cleared the way for the emergence of enterprises in the sense of the Coasean theory of the firm. A centralized decision-maker coordinates the allocation of resources and the firm’s activities. He is vested with authority and responsible to the firm’s owners. The tension between authority and responsibility is balanced by the business judgment rule, a concept first established by U.S. Delaware courts. China has no statutory business judgment rule, and neither the English-speaking scholars nor the Chinese courts have yet established a uniform understanding of it. This paper proposes that China’s Company Law for joint stock limited companies has all the prerequisites needed for an adoption of the business judgment rule: It not only separates ownership and management but also grants a certain amount of authority to the companies’ directors and supervisors, who are required to perform their duties in due care, under good faith and in a loyal manner. This paper, after having assessed the feasibility of a legal transplant of the business judgment rule, thus argues that China’s Company Law should recognize the value of authority granted to the board of directors and the board of supervisors and implement a due process based ex post review of business decisions.

I. Introduction

In December 1978, the Third Plenary Session of the 11th Central Committee of the Communist Party of China heralded a big change by deciding to open up the People’s Republic of China (“China”). In 2018, China was the world’s second largest economy measured by gross domestic product at current U.S. dollars. On the way, China abandoned planned economy and turned towards market driven economy, labelled as “socialist economic system” or “socialist market economy” (see art. 6, para. 1 and art. 15, para. 1 Constitution). Hence, market mechanisms (the price mechanism in particular) became more and more important for the allocation and coordination of labor, capital and resources.

The term “market” describes a concept where goods and services are exchanged on the basis of individual transactions or, put differently, on the basis of contractual relationships. As Ronald H. Coase elucidated in his distinguished article The Nature of the Firm, the application of the price mechanism entails costs. Firms are established because they can reduce production costs by integrating certain transactions. According to Stephen M. Bainbridge, the decisive element of the Coasean model of the firm is the centralized decision-making. The decision-maker is vested with authority, directs the utilization of inputs and thereby reduces the (coordination) costs inherent in team production. The reason why the coordination of team activities requires authority lies in the fact that team members do not have identical interests and/or identical information. Authority thus increases the efficiency of group coordination (i.e., decision-making) and information processing. A centralized decision-maker with unlimited authority, however, is not responsible to anyone; there is no need for the centralized decision-maker to consider the interests of any other member. This calls for corrective measures, i.e., for a system which holds decision-makers responsible (or accountable) for their actions. Authority and responsibility are thus antithetical; an increase in authority implies a decrease in responsibility. Maximum responsibility leads to a shift of the decision-making power from the centralized decision-maker to the ones to whom he is responsible. Maximum responsibility therefore deprives the firm of its original purpose, i.e., the reduction of production costs through an efficient decision-making process. Consequently, the right balance between authority and responsibility has to be found.

In many jurisdictions, a corporation’s supreme authority is typically vested in the board of directors or an equivalent centralized corporate authority. It is the corporate law’s task to provide a framework for an efficient decision-making system. For this purpose, the U.S. corporate law developed the so-called business judgment rule which balances authority and responsibility. The business judgment rule is based on the economic theory of efficiency, as will be discussed later on, and has become a widely recognized legal institution implemented by numerous jurisdictions.

China’s economic transformation cleared the way for the emergence of enterprises in the sense of the Coasean theory of the firm. In order to be competitive, especially in today’s integrated world economy, Chinese firms need to incorporate a decision-making process whose efficiency at least matches its foreign counterparts. The question thus arises whether such a system is in process and how China’s Company Law balances authority and responsibility. This paper focuses on the statutory business judgment rule yet unknown to the Company Law. Scholars suggest that the business judgment rule is neither recognized by the Chinese courts, nor is the Company Law ready for a legal transplant of the business judgment rule.

However, while the business judgment rule has not gone unnoticed among scholars of Chinese Company Law, no in-depth review seems to have been conducted on the subject so far. It is therefore the purpose of this paper to establish a thorough understanding of the relevant aspects of the Company Law relating to the business judgment rule and to analyze what role the business judgment rule already plays in practice as far as joint stock limited companies (“Stock Companies”; art. 76 et seqq. Company Law) are concerned. In fact, this paper suggests that the business judgment rule fits well into the Chinese Company Law’s DNA and, contrary to the aforementioned scholarly opinions, has already received some judicial recognition. Codifying the business judgment rule would not only help establish a uniform understanding of the rule but also enhance the statutory corporate governance framework of Stock Companies. The analysis focuses exclusively on the Stock Company with its typically broad owner base where the need for protecting the centralized decision-maker’s discretionary powers is especially high. Due to the confines of this paper, the discourse concentrates uniquely on members of the Stock Company’s board of directors and board of supervisors without taking into account the role of officers or managers (cf. art. 113, para. 1 and art. 216, no. 1 Company Law).

As the business judgment rule arbitrates the tensions between authority and responsibility, Part II discusses the economic aspects of centralized decision-making. It not only highlights the importance of protecting the centralized decision-maker’s discretionary powers but also offers a unique explanation in this regard. Part III presents the “ideal model” of the business judgment rule developed by the case law of the U.S. state of Delaware. Part IV sheds light on the organizational structure of Stock Companies under the Company Law, the allocation of the decision-making power and the duties of the directors and supervisors. Part V introduces the legal framework for the review of business decisions and argues that the business judgment rule has already been recognized by Chinese courts. The question whether it is feasible to introduce a statutory business judgment rule into the Company Law is subject to the discourse under Part VI. The discussion looks at two foreign jurisdictions having transplanted the business judgment rule and analyzes four main aspects which might speak against the introduction of a statutory business judgment rule into the Company Law. Finally, Part VII concludes the analysis.