Beware of over-regulation

Regulation of unlisted firms must be rational, not reactive

This newspaper has reported that the Union Ministry of Corporate Affairs (MCA) is considering expanding regulatory control over unlisted companies that are above various thresholds in terms of revenue. The apparent reasons for this move to further regulate large unlisted companies are varied. They include the possibility that some of these companies are large enough to have “systemic” implications. The proposed regulatory framework would require even unlisted companies to submit quarterly financial statements to the MCA, and may have followed some well-publicised failures of large unlisted companies that had been hailed in the press as “unicorns”. It is easy to see what the determinants of this push might be. India’s startup sector is growing fast and is a major contributor to the economy. Large foreign firms have also started trooping into the country in crucial sectors. There are naturally questions on how their behaviour will affect employees, consumers, and their trading counterparties.

However, policy should not be made on a knee-jerk basis. A rational accounting of the costs and benefits of additional regulation is needed. For example, what systemic risk occurs outside of the financial sector? Systemic risk emerges from firms that have an outsize influence on the economy, and the decline of which would set off a broader contagion. This is true in finance — but outside that field, it is harder to find examples. Research in 2020 by the Rand Corporation noted that some technology and telecommunications companies may have the backward and forward linkages that are associated with systemic risk. How many such companies are there among large unlisted firms in India? And would any such companies already be regulated elsewhere — for example by the telecom regulator? If so, is sweeping up all unlisted companies too blunt an instrument when it comes to systemic risk? These are basic questions that must be addressed clearly by the government before it moves further down this regulatory pathway. Other regulatory mechanisms should also be examined. For example, the US has determined that some large privately held companies may be mis-selling debt securities and so desired to expand its regulation of them under that one hea­ding. If a large educational tech unicorn, for example, is mis-selling its product then that requires a sectoral regulator with specific expertise — declaration of financial results to the government is hardly likely to protect consumers.

One major reason that many companies go private, or delist themselves, is precisely to avoid the various additional costs and revelations involved in the formal filing of accounts. Do startups, even those achieving scale, have more relaxed corporate governance? Yes, indeed they do — partly because they are particularly dynamic, and partly because they are not supposed to be the primary destination of the savings of regular investors. This flexibility provides many benefits to the broader economy that should not be minimised. There are also legitimate concerns in the government that some large unlisted companies are domestic arms of foreign companies and have an increasing stake in critical sectors like consumer electronics and ecommerce. Again, however, the case must be made that scrutiny of such companies is best done by the MCA, and that this is also the most cost-effective manner of regulation in such cases. There is no objection to a new regulatory framework for unlisted companies per se — but any expansion of the regulatory net must be proportional, targeted, and compliant with the government’s thrust on the ease of doing business.