Holding Companies 99
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A holding company is a corporation that is organized for the purpose of owning stock in other corporations. A company may become a holding company by acquiring enough voting stock in another company to exercise control of its operations, or by forming a new corporation and retaining all or part of the new corporation's stock. While owning more than 50 percent of the voting stock of another company ensures control, in many cases it is possible to exercise control of another company by owning as little as ten percent of its stock.

Holding companies and the companies they control have a parent-subsidiary relationship. When a holding company owns a controlling interest in another company, the holding company is called the parent company and the controlled company is called the subsidiary. If the parent owns all of the voting stock of another company, that company is said to be a wholly-owned subsidiary of the parent company.

Holding companies and their subsidiaries can establish pyramids, whereby one subsidiary owns a controlling interest in another company, thus becoming its parent company. While three to five levels are common in corporate pyramid structures, as many as 60 levels have been known to exist in practice. In the case of public utility holding companies, regulations of the Securities and Exchange Commission allow only two levels of holding companies in addition to the operating subsidiaries.

A holding company is said to be a "pure" holding company if it exists solely for the purpose of owning stock in other companies and does not engage in business operations separate from its subsidiaries. If the parent company also engages in its own business operations, then it is said to be a "mixed" holding company or a holding-operating company. Holding companies whose subsidiaries engage in unrelated lines of business are called conglomerates.

There are many advantages to establishing a holding company. From a financial point of view, it is usually possible to obtain control of another company with less investment than would be required in a merger or consolidation. A holding company only needs a controlling interest in the acquired company, not complete interest as in the case of a merger or consolidation. Consequently, it is possible to obtain control over large properties with less investment than would otherwise be required in a merger or consolidation.

Another advantage is that shares of stock in the subsidiary company are held as assets on the books of the parent company and can be used as collateral for additional debt financing. In addition, one company can acquire stock in another company without approval of its stockholders; mergers and consolidations typically require stockholder approval. Holding companies and their subsidiaries are considered separate legal entities, so that the assets of the parent company and the individual subsidiaries are protected against creditors' claims against one of the subsidiaries. However, holding companies and their subsidiaries may be considered a single economic entity, and consolidated financial statements are then prepared for the entire structure.

For tax purposes, the parent company must own at least 80 percent of the voting stock in another company in order to be able to file a consolidated tax return. The tax advantage here is that losses from one subsidiary can be used to offset profits from another subsidiary and reduce the overall taxable corporate income on the consolidated tax return. A significant disadvantage occurs when a company holds less than 80 percent of the subsidiary's voting stock; in that case separate tax returns must be filed for the parent and the subsidiary, and intercorporate dividends are subject to an additional tax.

From a management point of view, the parent-subsidiary relationship of holding companies and their subsidiaries allows for decentralized management. Each subsidiary retains its own management team, and the subsidiaries become responsible to the parent company on a profit and loss basis. Unprofitable subsidiaries can more easily be sold off than can divisions of a consolidated business. Subsidiaries retain their corporate identities, and the holding company benefits from any goodwill and recognition attached to the subsidiary's name. Parent companies may provide specialized staff services for the benefit of any of their subsidiaries.

Holding companies in certain industries are subject to special regulations. Public utility holding companies are subject to the Public Utility Holding Company Act of 1935 and must meet special SEC requirements. Railroad holding companies were regulated by the Interstate Commerce Commission (ICC) until that agency was abolished at the end of 1995, at which time they came under the regulation of the newly created Surface Transportation Board.

Bank holding companies are subject to regulation by the Board of Governors of the Federal Reserve System as well as to regulations issued by the Federal Deposit Insurance Corporation (FDIC), Office of Thrift Supervision (OTS), and Office of the Comptroller of the Currency (OCC). Through holding companies, national banks are allowed to conduct activities in subsidiaries that they may not conduct directly, such as securities underwriting and real estate development, under the OCC's operating subsidiary rule. The Federal Reserve Board, whose rules supersede those of other agencies with respect to bank regulation, restricts bank investments in subsidiaries to 20 percent of the parent company's capital, with no single subsidiary allowed to receive more than 10 percent of the capital.

In addition, the acquisition of new subsidiaries and the formation of new holding companies are subject to the pre-notification requirements of the Antitrust Improvement Act of 1976, which provides that the U.S. Department of Justice and the Federal Trade Commission (FTC) be notified in advance of all proposed mergers and acquisitions. Finally, corporations must specifically be granted the power to acquire stock in another corporation, through their corporate charter as well as through state laws of incorporation. The first state to grant corporations the power to acquire stock in other corporations was New Jersey in 1889.

Internationally, Japan passed a new law in 1997 that eliminated a 50-year ban on holding companies in that nation. The new law requires firms with assets of $30 billion or more to issue a report on the setting up of a holding company. It was expected that being allowed to set up holding companies would allow Japanese firms greater flexibility in terms of creating units or subsidiaries with different pay systems and labor forces than the parent company.

In 1995 China established new rules regarding foreign companies that set up holding companies as vehicles for investment in China. Under the new rules, such firms must have a total asset value of at least $400 million for one year prior to application or have already set up at least 10 foreign investment enterprises. Additional rules were issued to limit the scope of business for projects involving foreign holding companies.

[ David P. Bianco ]


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——. "U.S. Asks Japan about Holding Company Law," Journal of Commerce and Commercial, 28 February 1997.

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