In the corporate world, a subsidiary is a company owned or controlled by another company, known as the parent or holding company. A parent company holds a controlling interest in its subsidiary, often owning more than half of its stock. When a subsidiary is completely owned by another company, it is termed a ‘wholly owned subsidiary.’
Key Takeaways
- Controlling Interest: A subsidiary is more than 50% owned by a parent company or holding company.
- Separate Entities: Subsidiaries maintain independence in terms of liabilities, taxation, and governance.
- Strategic Benefits: Companies establish subsidiaries to gain specific synergies, secure tax advantages, and limit potential losses.
- Autonomy: Shareholder approval isn’t necessary to form or sell a subsidiary.
- Financial Reporting: A subsidiary’s financials appear on the parent’s consolidated financial statements.
The Mechanics of Subsidiaries
Subsidiaries operate as distinct legal entities separate from their parent companies. This independence influences their liabilities, taxation practices, and overall governance. If a subsidiary is situated in a different country, it must comply with local laws and regulations.
However, parent companies typically exert significant influence over their subsidiaries due to their controlling interest. They, along with any other shareholders, elect the subsidiary’s board of directors. Often, board members may overlap between a parent and its subsidiary.
To classify as a subsidiary, at least 50% of the company’s equity must be controlled by another entity. If an entity holds less than this amount, it is considered an associate or affiliate company.
Financial Practices within Subsidiaries
Typically, a subsidiary prepares its financial statements independently, which are then integrated into the parent company’s consolidated financial statements. For associate companies, only the value of the stake is recorded as an asset on the parent company’s balance sheet.
Accounting standards generally dictate that public companies include all majority-owned subsidiaries in their consolidated financials. This consolidation is often viewed as a more accurate reflection of the company’s financial position compared to separate accounts for each entity.
An unconsolidated subsidiary’s financials are not included with those of the parent company. Usually, this applies where the parent doesn’t have significant influence or for regulatory reasons. The SEC mandates that, except in rare cases like bankruptcy, majority-owned subsidiaries should be consolidated.
Pros and Cons of Subsidiaries
Purchasing stakes in a subsidiary generally requires less investment than a merger. Additionally, shareholder approval is not necessary for acquiring or selling a subsidiary.
A parent company may establish a subsidiary for a range of synergies such as a diversified product and asset portfolio. Subsidiaries can experiment with new business models, potentially shielding the parent company from significant risk.
However, managing subsidiaries has drawbacks too. Consolidating financials can complicate accounting, and transactions must be at arm’s length. While subsidiaries can shield parents from legal problems, the latter may still be held accountable for certain actions and may need to guarantee the subsidiary’s loans.
Pros:
- Contained/limited losses
- Potential tax advantages
- Easier to establish and sell
- Synergy with other corporate divisions and subsidiaries
Cons:
- Extra legal and accounting work
- Greater bureaucracy
- Complex financial statements
- Liability for subsidiary’s actions and debts
Real World Examples of Subsidiaries
Public companies, as required by the SEC, disclose significant subsidiaries. Berkshire Hathaway, led by Warren Buffett, manages a diverse list of subsidiaries including companies like GEICO and International Dairy Queen. Buffett’s strategy focuses on acquiring undervalued assets, allowing these subsidiaries to operate independently yet benefiting from extensive financial resources.
Similarly, Alphabet Inc., best known for owning Google, houses numerous subsidiaries focusing on different technological and innovative aspects. For instance, Sidewalk Labs aims to enhance public transit systems by leveraging data analytics.
FAQs: Practical Insights
Is a Subsidiary Its Own Company?
Yes, a subsidiary operates as a distinct and independent entity from its parent company. Nonetheless, the parent company, as the majority owner, has significant influence over its operations and might bear responsibilities for certain liabilities.
Does a Subsidiary Have Its Own CEO?
Yes, as a separate entity, a subsidiary typically has its own management team and CEO. However, the parent company plays a substantial role in selecting top management and director positions.
What Are Sister Companies?
Sister companies are two or more subsidiaries majority-owned by the same parent company.
Conclusion
Subsidiaries are either partially or wholly owned by another company called the parent or holding company. This common corporate structure offers strategic benefits including tax advantages, risk mitigation, improved efficiencies, and diversification. However, these benefits are balanced by increased complexity in financials and hazards associated with the subsidiary’s actions. Ultimately, subsidiaries serve as pivotal elements in the strategic expansion and stability of parent companies.
Related Terms: Wholly Owned Subsidiary, Holding Company, Parent Company, Consolidated Financial Statements, Associate Company.
References
- Financial Accounting Standards Board. “Summary of Statement No. 94”.
- Securities and Exchange Commission. “Final Rule: Financial Statements and Periodic Reports for Related Issuers and Guarantors”.
- Berkshire Hathaway. “Subsidiaries”.
- Sidewalk Labs. “About Us”.
