Legal Deterrence: the foundation of corporate governance – evidence from China

To evaluate the Chinese government's recent market‐orientated efforts to promote good corporate governance, this paper conducts a re‐examination of the working mechanics for market competition and other market‐based governance mechanisms to ensure good corporate governance. The finding is that the utility of market mechanisms may have been exaggerated. Not only are they not effective in disciplining serious managerial misbehaviour that offers managers more gain than loss, even their limited value to discourage such misbehaviour as managerial shirking is conditioned on that the opportunities for illegitimate enrichment by managers are few. On the contrary, legal sanction is fundamental to good corporate governance, because it is the only feasible way to combat such serious misbehaviour and curb illegitimate enrichment. Current experience of corporate governance in China conforms to this finding and poor corporate governance in China is better explained by the lack of credible legal deterrence. This being the case, the top priority for China is to strengthen legal sanction in order to rein in the excessive misappropriation and flagrant fraud. Only once this has been done will the efforts to implement market‐orientated reforms bear any significant fruits.