If recent moves in the world of Japanese corporate governance are anything to go by, the process and reasons behind subsidiary listings are in a state of flux. In that country’s market, companies that list on stock exchanges alongside their subsidiaries are coming under closer scrutiny by investors over continuing concerns about corporate governance.

Parent companies see subsidiary listings as a win-win, a way to maintain their influence over subsidiaries while generating profits from the sale of some of their shareholdings in the units. It can bring stability to a subsidiary as it retains the parental influence, which can help to attract talent. However, investors are questioning the independence of subsidiary listings – and the scrutiny and mistrust are not just found in Japan.

Why would a company consider listing a subsidiary?

Even with the lure of increased profits for the parent, subsidiaries will need to meet certain conditions before they can be considered for listing on most stock exchanges around the world. First and foremost, there must be a genuine economic reason for the subsidiary listing – the subsidiary must have its own economic activity or diversified assets, which will mean the subsidiary listing won’t amount to a double-listing of the same activity.

This “genuine economic reason” for subsidiary listings can sometimes lead to a larger company spinning off a division to set it up as a subsidiary instead. Companies spin off portions of their operations for many reasons. It could be that there is a profitable division that is not related to the company’s core competencies, so spinning off the division under separate ownership and management will help both new entities to focus on what they do best. It might also be that management feels the stock price understates the value of those divisions when they act together, and so the spinoff results in a subsidiary and a parent that can be valued separately and focus on their own growth trajectories.

It’s worth noting that subsidiaries can sometimes outperform their parents, and holding companies can end up being discounted if the market is hot. Not all subsidiaries of a holding company will fare equally well, and the poor performers can pull down the valuations of holding companies. Analysts tend to advise investors that, if it’s one of the subsidiaries they are most interested in, they should focus investment efforts on that, instead of exposing themselves to the full diversity of the portfolio by investing in the parent.

What is considered a conflict of interest in subsidiary listings?

Remember, there are two different ways to set up a subsidiary: An entity can either be a separate subsidiary or a wholly owned subsidiary. The latter is considered owned in its entirety by the parent company, and there are no minority shareholders, nor is stock traded publicly. It does, however, remain an independent legal body with its own framework and administration. This type of subsidiary cannot be listed on a stock exchange, and the parent company owns all of the common stock.

A regular subsidiary company, then, has more than 50 percent of its voting stock controlled by another company, and for reasons of liability, tax and regulation, the subsidiary and parent companies remain separate legal entities. The parent company tends to retain some of the voting stock in its subsidiary, and will maintain some level of control depending on how the entity is set up in the first place. It’s this type of entity that is eligible for subsidiary listings, if the parent so chooses.

With the parent still exerting some control, whether it’s in ownership or management, conflicts of interest can arise if the subsidiary lists on the same exchange as its parent. In Japan, investors are concerned that a subsidiary could be forced by its parent to do business on unfavorable terms, impairing the rights of minority shareholders.

Dual listings of parents and subsidiaries may also contravene the principle of fairness of shareholders’ rights, which is set out in the corporate governance guidelines of many stock exchanges. The exchange will carefully examine any listing applications to check whether there are mechanisms and operations in place to enable management independence from parent companies.

How can subsidiary listings be concluded in a compliant way?

A conflict of interest occurs when “an entity or individual becomes unreliable because of a clash between personal (or self-serving) interests and professional duties or responsibilities,” according to Investopedia. “Such a conflict occurs when a company or person has a vested interest, such as money, status, knowledge, relationships or reputation, which puts into question whether their actions, judgment, and/or decision-making can be unbiased.”

This means that, when addressing conflicts of interest in subsidiary listings, those in charge of governance and compliance for the parent organization must ensure there are legitimate and robust checks and balances in place across the whole subsidiary structure. The parent company must not exert undue control or influence over the subsidiary, and there should be clear and demonstrable processes for how the subsidiary maintains its independence and protects the rights of its shareholders. This could include not sharing directors between parent and subsidiary, and ensuring separate codes of conduct and governance are developed.

How can entity management software help to address conflicts of interest in subsidiary listings?

Conflicts of interest at board level are a significant ethics issue in governance, but when it starts to impact the wider stock markets, regulators will take a very close interest in how an entire group structure is run. That’s why it’s important for legal operations to scrutinize how the structure handles entity management on both a global and a local entity level, and ensure there is a single source of truth for all entity data.

Using entity management software can bring entity managers that single source of truth, creating a central repository where all entity information, documents and organizational charts are stored in a highly secure format. Entity management software helps organizations to manage the ongoing accuracy of the corporate record by using compliance calendars, reminders and workflows for better data. It helps to get the right information to the right people at the right time to manage compliance and help to highlight any potential conflicts of interest or other risks before they become an issue.

To help gain full transparency over a group’s operations, Diligent Entities integrates seamlessly with the board portal (Diligent Boards) and a secure file-sharing platform to create the Governance Cloud, an all-in-one governance ecosystem designed with the processes of boards, directors, executives, general counsels and corporate secretaries in mind. The Governance Cloud enables legal operations and compliance teams to run reports and to gain a 360-degree view of the group’s operations to help address conflicts of interest.

Get in touch and request a demo to see how Diligent’s suite of cloud-based governance and compliance software can help you to address conflicts of interest in subsidiary listings.