A subsidiary is an entity owned by another where the latter entity holds more than half (at least 51%) of the subsidiary’s issued equity. Subsidiaries are created for reasons ranging from the need to carry out business through another entity due to inability of the parent company to undertake the particular business or where the law so requires. Subsidiaries are also set up as vehicles for entering new markets, isolating or mitigating risk, diversification or in pursuit of globalization and expansion in the case of offshore subsidiaries. A subsidiary can also be established by the parent company to carry out businesses not allowed under its Memorandum of Association.
As subsidiaries are vehicles for achieving various business purposes by Parent companies, the latter often considers it imperative to put in place measures aimed at maintaining control of such subsidiaries either via the composition of the Board of Directors, maintaining substantial shareholding and controlling business operations. In exercising control, regard is not had to the wider governance implications for the subsidiary entity by the Parent company.
As separate a legal entity, a subsidiary company has a distinct legal persona. It is expected to have an independent Board and separate governance structures. Good corporate governance practices should not be sacrificed on the altar of “corporate control”. The Board of directors of the two entities should respect their distinct roles and responsibilities regardless of any relationship. The subsidiary Board should be granted requisite autonomy with respect to its oversight over the affairs of the entity. . Furthermore, the subsidiary entity would usually be operating in a foreign jurisdiction and thus would be required to comply with local regulations, which may be different from those applicable to the Parent entity.
Depending on the size and complexity of the subsidiary’s operations it is important that directors bring the right skills to the table to offer effective oversight. Directors on subsidiary Boards have the same fiduciary responsibilities as those of the Parent Board. The board must supervise management but not supplant it. It should review the strategic plans, assess the risks and controls, review internal control processes, etc. The board is responsible for the stewardship of the subsidiary and owes a duty to act in its best interest with due regard for the interests of the Parent, the ultimate shareholder.
There is also the requirement to observe the principle of arm’s length in the conduct of business between related parties with strict penal sanctions for infractions. To illustrate, in a situation where the parent company as substantial shareholder in the subsidiary owns the premises where the subsidiary operates, the transaction should pass the arm’s length test.
It is important to establish a group-wide corporate culture that forms the backbone of subsidiary governance. It makes sense to have a corporate culture in which governance and performance goals are given equal prominence. Every member of each subsidiary entity needs to know what the group’s guidelines on management, individual conduct and corporate social responsibility mean for them, and what they can do to help the efforts of the group as a whole.
Finally, it is important to ensure that a separate and independent Board oversees the subsidiary to guarantee effectiveness. It is also essential, in the light of the obligations of directors, their statutory duties and the implications thereof as well as the potential liability to parent companies that an appropriate subsidiary governance framework is in place as a tool in facilitating smooth business operations, risk management and ensuring compliance with legal obligations. The responsibility of monitoring compliance by the various subsidiaries within the group with defined corporate governance policies and processes at the group level as well as with specific local requirements should be that of a global Compliance Officer or the Group Company Secretary