With the guidance of a framework of new institutional economics, the theoretical modelling establishes the necessary and sufficient conditions for institutional change to occur in authoritarian regimes: first, external shocks must be strong, much stronger than in a democratic regime; second, the shocks must be of such a kind that gives rise to factional competition within the ruling group. It predicts that involvement by the ruled group brings about more extensive institutional change than that merely driven by the ruling group. The theory is then applied to explain rural China's market transition. As institutional change defines payoff structure, the extent of this change is approximated by the income advantage of cadre households relative to noncadre households. Econometric tests based on a Chinese rural household panel data of 21 years confirm the theoretical prediction.