A parliamentary standing committee on finance chaired by Yashwant Sinha has recommended sweeping changes to the Companies Act of 1956. There’s little doubt that the over 50-year-old law needs to be overhauled, and that a few amendments will not be sufficient to make the country’s company law up-to-date. Also, thanks to the Satyam fraud, it’s not surprising that policymakers have recommended tighter regulations.
Even so, the committee has gone overboard with some of its proposals. Take, for instance, the proposal to restrict the tenure of independent directors to six consecutive years. A newly inducted independent director typically takes some time before understanding the functioning of a company and it would be injudicious to make companies start hunting for a replacement in just a few years’ time. In any case, no developed markets have restrictions on the tenure of independent directors.
A major problem with having such restrictive regulations in the Companies Act is that revoking them would involve a long process. If the amendments are passed as law, changes and modifications to these regulations would need the approval of Parliament. It’s bad enough that policymakers want to get into micro-management of companies; what’s worse is that some of these proposed policies will be passed as law.
Another example of the committee going overboard is the stipulation that audit firms should be rotated every five years. In developed markets, the problem of auditor independence is addressed by mandating a rotation of audit partners in a firm. The parliamentary committee has extended this to restrictions on the tenure of audit firms themselves. Given the paucity of large audit firms, adhering to this regulation would cause practical problems for large companies. Besides, transitioning work from one audit firm to another would have its own set of problems and costs.
The committee has also recommended that companies would be only able to have one level of subsidiary companies. In other words, a subsidiary company cannot have further subsidiaries. While the intent is to prevent money laundering, such a regulation will work against companies’ flexibility in financing acquisitions. For instance, when Tata Steel Ltd acquired Corus Plc., it did so through a subsidiary to ring-fence the parent company. Thus Corus is a subsidiary of a subsidiary of Tata Steel, a structure that will be disallowed if the recommendations are made law.
Not all the proposals are bad, but those that are should be nipped in the bud before they make life unnecessarily difficult for companies.
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