Much of the discussion on corporate governance has weighed more heavily on public companies and their audit companies than on any other types of organizations. The ever-increasing complexity and regulatory expectations, along with globalization, are now shining a spotlight on corporate governance matters with their subsidiaries, as well as at the parent level. In-house counsel and, when necessary, external counsel need to consider carefully the advice that they give in light of current pressures.
Large complex organizations with vast subsidiary networks face a broad set of new and highly complex problems that they need to address in today’s marketplace. The lack of corporate leadership attention or ineffective oversight at the parent or subsidiary levels can create serious gaps in governance controls that may reflect poorly on the board, the executives and the company.
Governance Differences in Subsidiaries and Virtual Entities
Failures at the subsidiary level don’t often get much attention, and they certainly don’t get as much attention as a large corporation would get under the same circumstances. Even though subsidiary risks tend to be smaller and less significant, they still pose a fair amount of reputational and economic risk for public parent companies.
Another risk that large corporations have to address is the rapid rise of virtual entities that are necessary in some industries to accommodate new business in order for the company to thrive and sustain itself in today’s world. Guidance from regulators has been slower to realize than the actual pace of virtual entity business development. From an academic point of view, the jury is still out on the best practices for how to govern virtual entities.
Corporate Governance for Subsidiaries
While parent companies are inherently responsible for the oversight of the parent company and all its subsidiaries, it’s impractical at best to rely solely on the parent company to manage governance practices for themselves and every subsidiary.
To effectively manage corporate governance within the subsidiaries, parent companies need to ensure that they have extensive control mechanisms throughout the organization. It’s vital for parent companies to ensure downstream governance by setting up a system in which subsidiary boards have the same values, ethics, controls and processes as there are at the parent board level.
Parent boards of directors take the lead on deciding what board structures are right for subsidiaries so that they can provide an effective chain of oversight.
One-size-fits-all governance simply doesn’t work for companies with subsidiaries. Parent boards need to consider the many regulations that are imposed on organizations from different geographical areas in multiple jurisdictions. The growth of virtual entities that have risen up next to legal entities is another major factor in today’s business world.
Having multiple subsidiaries means that companies need financial institutions to provide them with innovative financing products. This need leads to the creation of a highly complex web of subsidiaries to deliver these products.
In addition, the rapid evolution of the marketplace is causing companies and other stakeholders to reconsider and reevaluate many industry terms and definitions. Today, we still have a broad definition of the word “subsidiary,” but that’s something that could change in the near future.
Getting Board Composition Right
Entities need to be concerned with making sure they have the right individuals on the parent board, as well as the right individuals on the subsidiary boards. Getting the right composition on all boards will take time and effort, and it can be a little tricky as well.
There is no need to put as many independent board directors on subsidiary boards and this would be too costly to be worthwhile anyway. Too much independence would also impair the parent board’s ability to control the strategic direction of the organization as a whole.
Boards of subsidiaries need to do more than merely project back the management of their operations. Subsidiaries need effective board oversight at their level. This is especially critical for regulated entities.
Some parent boards suggest it’s best to appoint a few outside board directors from the parent board to serve on subsidiary boards. Outside directors will ensure consistency in the strategic direction while providing the important connection between boards. To get some degree of independence, subsidiaries might look for talent among individuals who are outside of the management of the subsidiary or from unrelated businesses or from the head office. The benefit of appointing these types of individuals to the subsidiary boards is that they would be familiar with the strategic direction of the parent company and still be objective about the management of other parts of the business.
Parent boards also need to consider whether the board must be located within a particular jurisdiction and whether that jurisdiction requires an external board director.
The Role of the Board in Impacting Corporate Governance Focus Within Subsidiaries
Many of the roles for parent and subsidiary boards are identical, but effective oversight requires them to have some variance in their roles. It’s even more important for parent entities to delineate and document the lines between the role of the parent board and that of the subsidiary boards.
Some of the ways that entities can do this are to make use of tools like unanimous shareholder agreements and written delegations of authority to ensure that there are no gaps in oversight. Subsidiary boards should ensure that parent boards are reviewing things that they don’t have responsibility for as a matter of checks and balances. In addition, subsidiary boards should pay special attention to compliance matters for their own subsidiary.
Parent boards should own the responsibility for managing subsidiaries from creation to dissolution. It’s crucial for parent boards to keep track of their corporate structure, as well as the related compliance and other responsibilities, as they create or dissolve subsidiaries. Losing track of the corporate structure as a whole entity can be costly when it’s not being properly reviewed and managed appropriately. Also, good management helps to prevent unnecessary exposure to risk.
Diligent Entity Management
Regulators are increasingly demanding more information from corporations, and boards need to be able to produce documents and other information quickly and efficiently. The solution for this requires innovative solutions and a sophisticated technical solution like Diligent Entities.
Diligent Entities is a software solution that helps to give corporations oversight of the entire governance framework where entities can centralize, manage and structure their corporate record to improve entity governance, which will pave the way for better compliance, mitigating risks and improved decision-making through a fully integrated governance solution. This tool provides a modern way to ensure that the right people get the right information at the right time for a single source of truth.