Who Really Governs the Subsidiary? Corporate Governance in a Group of Companies
A group of companies is often managed as a single economic enterprise. There may be a common brand, a Group Chief Executive Officer, shared policies, centralised finance and human resource functions, and an overall strategy determined at group level. The parent or holding company may also appoint some or all of the directors serving on the boards of its subsidiaries.
From a commercial perspective, this arrangement makes sense. From a corporate governance perspective, however, it can create an important question:
If the Group appoints the subsidiary’s board, to whom is that board ultimately accountable—the Group or the subsidiary?
The answer is more nuanced than it may initially appear.
The Group May Own the Company, but the Board Governs It
A fundamental principle of company law is that a company has a legal personality separate from its shareholders. This remains the case even where a subsidiary is wholly owned by another company.
The parent company may therefore own 100% of the shares in a subsidiary, but the assets, liabilities, contracts and business of the subsidiary remain those of the subsidiary itself.
This distinction is equally important when considering corporate governance.
A shareholder exercises its rights principally through the mechanisms available to shareholders. Depending on the company’s articles and applicable law, these may include appointing and removing directors, approving reserved matters and exercising voting rights at general meetings.
The board, on the other hand, is responsible for the governance and oversight of the company.
The fact that a parent company appointed a director does not ordinarily transform that director into an agent or representative of the parent company in the boardroom. Once appointed, the director assumes duties attached to the office of director and must exercise those duties accordingly.
This distinction is sometimes lost within corporate groups.
The Problem of the “Group Board”
A common governance difficulty arises where the parent company regards subsidiary boards as extensions of the Group’s management structure.
The practical arrangement may look something like this:
The Group appoints the subsidiary directors. The Group CEO or executive management determines what the subsidiary should do. Instructions are communicated to the subsidiary, and its board is expected to approve or implement them.
Board meetings then risk becoming exercises in formalising decisions that have already been made elsewhere.
This creates what may be described as a rubber-stamp board.
There is nothing inherently wrong with a parent company developing a group-wide strategy or expecting subsidiaries to operate consistently with that strategy. Indeed, effective group governance often requires significant coordination and oversight.
The governance problem arises when coordination becomes substitution—that is, when the parent or Group management effectively substitutes itself for the subsidiary’s board.
A properly constituted board should not exist merely to validate decisions already taken by the shareholder.
Appointment Does Not Mean Allegiance
Perhaps the most important principle for directors appointed by a parent company is this:
The person who appoints you is not necessarily the person whose interests you are required to serve as a director.
A director may have been nominated by the Group, may simultaneously hold an executive position within the parent company and may even sit on several boards within the Group.
Nevertheless, when participating in the affairs of a particular subsidiary, that director must recognise the separate responsibilities attaching to that office.
This becomes particularly important where the interests of the Group and the interests of the subsidiary do not perfectly align.
Consider, for example, a proposal that a profitable subsidiary:
- guarantees the borrowing of another Group company;
- transfers an asset to another Group entity on favourable terms;
- advances funds to the parent company;
- assumes liabilities for another subsidiary;
- enters into a related-party transaction;
- abandons a profitable opportunity in favour of another Group company; or
- incurs expenditure primarily for the benefit of the wider Group.
The fact that the transaction benefits the Group does not, by itself, answer whether the subsidiary should undertake it.
Its board must properly consider the transaction from the perspective of the subsidiary and satisfy itself that approving it is consistent with its duties and applicable law.
Group Strategy Is Not the Same as Group Instruction
A well-governed corporate group should distinguish between strategic direction and operational interference.
The parent company, as shareholder, is entitled to establish the broad commercial direction of the Group. It may determine matters such as the industries in which the Group operates, capital allocation priorities, risk appetite, branding strategy and expected financial performance.
The Group may also legitimately establish group-wide governance frameworks dealing with matters such as risk management, anti-bribery, data protection, financial controls, procurement, cybersecurity and reporting.
However, there should remain clarity as to which decisions belong to:
the shareholder;
the Group or parent board;
the subsidiary board; and
the subsidiary’s management.
Without this distinction, authority becomes blurred.
A Group CEO may begin exercising powers belonging to a subsidiary CEO. The parent board may begin making decisions belonging to the subsidiary board. Conversely, a subsidiary board may unnecessarily interfere with matters properly delegated to management.
Good corporate governance requires these lines of authority to be understood and respected.
The Subsidiary Board Must Be a Real Board
If a Group has decided that a subsidiary requires a board, that board should be permitted to perform the functions of a board.
This means, among other things, that directors should receive sufficient information, have an opportunity to interrogate management proposals, consider risks and alternatives, declare conflicts of interest where appropriate and make decisions through properly constituted meetings or resolutions.
Directors should not be discouraged from questioning a Group proposal simply because it originated from the shareholder or Group CEO.
Equally, disagreement by a subsidiary board should not automatically be regarded as insubordination.
The purpose of a board is not simply to agree. Its value lies partly in providing oversight, challenge and independent judgment.
If directors are expected to approve every Group instruction without meaningful consideration, the Group should question whether it has created a functioning governance structure or merely the appearance of one.
How Should a Group Exercise Control Properly?
Recognising the independence of subsidiary boards does not mean that a parent company must surrender control over its subsidiaries.
The objective is structured control rather than informal control.
A sound group governance framework should clearly identify how the parent company exercises its shareholder rights and how authority is allocated throughout the Group.
One useful mechanism is a Group Governance Framework or Subsidiary Governance Policy. This can establish the relationship between the parent and subsidiary boards and define the respective responsibilities of each.
The Group should also have a clear Delegation of Authority Matrix.
Certain significant matters may appropriately be designated as Reserved Matters, requiring shareholder or Group approval before a subsidiary may proceed. These might include major acquisitions and disposals, borrowing above specified thresholds, material capital expenditure, changes to the nature of the business, significant related-party transactions and other matters considered strategically important to the Group.
The important point is that these controls should be documented and transparent, rather than exercised through informal instructions from Group executives.
The subsidiary’s constitutional documents, board charter and delegations should also be consistent with the overall governance framework.
What Happens When the Group Disagrees With the Subsidiary Board?
This is where the distinction between governance and ownership becomes particularly important.
Suppose the parent company proposes a transaction and the subsidiary board, after considering the matter, concludes that it should not approve it.
The appropriate response is not simply to tell the directors:
“We appointed you, therefore you must approve it.”
The matter should instead be dealt with through the applicable governance mechanisms.
The shareholder may exercise whatever rights it lawfully possesses under the company’s constitutional documents and applicable company law. Depending on the circumstances, this may include exercising reserved-matter rights, voting at a general meeting, changing the composition of the board or reconsidering the governance arrangements.
What should generally be avoided is maintaining a board formally while expecting it to disregard its responsibilities whenever the shareholder wants a different outcome.
Beware of Conflicts Within the Group
Corporate groups also require careful management of conflicts of interest.
Directors who sit on several Group boards may receive information in one capacity that is relevant to another company. They may participate in transactions where two Group entities have different commercial interests.
Related-party transactions therefore require particular care.
The fact that two companies have the same ultimate shareholder does not necessarily mean that their interests are identical.
Boards should ensure that conflicts are properly disclosed and managed, appropriate approvals are obtained, and transactions between Group companies are entered into on defensible terms and properly documented.
This is particularly important where the subsidiary has minority shareholders, external creditors or other stakeholders whose interests may be affected.
The Parent Board Also Has a Governance Responsibility
Good subsidiary governance is not solely the responsibility of subsidiary directors.
The parent board should itself establish an appropriate governance architecture for the Group.
It should know which matters require central oversight and which should remain with subsidiary boards. It should receive appropriate information about subsidiary performance and risk without unnecessarily taking over the day-to-day governance of each entity.
The objective should be neither complete subsidiary autonomy nor excessive centralisation.
It should be accountable delegation.
The Group establishes the strategy and governance framework. The subsidiary board governs the subsidiary within that framework. Management operates the business within the authority delegated to it. Matters requiring shareholder approval are escalated through clearly defined channels.
Avoiding “Shadow Governance”
One of the greatest risks in poorly structured groups is the emergence of what may be called shadow governance.
The formal documents may show that the subsidiary has a board and a CEO. In reality, however, decisions may be made by individuals at Group level who hold no formal position in the subsidiary.
This creates a dangerous gap between who appears to have authority and who actually exercises it.
Good governance seeks to ensure that actual decision-making authority corresponds with documented authority.
If Group executives are intended to exercise particular powers over subsidiaries, those powers should be properly structured through delegations, reserved matters, shareholder rights, management agreements or other appropriate governance mechanisms.
Informal authority should not become a substitute for formal governance.
Practical Governance Structure for a Group of Companies
A well-governed group should therefore consider having:
- a Group Governance Framework or Subsidiary Governance Policy setting out the relationship between the parent and subsidiaries;
- properly constituted boards with clear terms of reference or board charters;
- a Delegation of Authority Matrix distinguishing shareholder, board and management authority;
- clearly defined Reserved Matters requiring Group or shareholder approval;
- procedures for managing conflicts of interest and related-party transactions;
- appropriate reporting arrangements between subsidiary management, subsidiary boards and the parent;
- clear procedures for the appointment, evaluation and removal of subsidiary directors; and
- proper documentation of intercompany transactions and decisions.
These mechanisms allow the parent company to maintain legitimate oversight without undermining the governance responsibilities of subsidiary boards.
Conclusion: Ownership Is Not the Same as Governance
A corporate group naturally requires coordination. A parent company that has invested capital in subsidiaries cannot reasonably be expected to have no influence over their strategic direction.
But influence, ownership and governance are different concepts.
The shareholder owns the shares.
The shareholder may appoint the directors.
The Group may establish the overall strategy and governance framework.
But once a subsidiary board has been constituted, it must be allowed to perform the role for which it exists.
A subsidiary board should therefore neither operate as though the parent company does not exist nor function merely as the administrative arm of Group management.
The better approach lies between those extremes: a clearly documented group governance framework in which the parent exercises legitimate shareholder oversight, subsidiary boards exercise genuine governance responsibility, and management operates within properly delegated authority.
Ultimately, the test of good group governance is not whether the parent company exercises control. Control is inherent in many corporate groups. The real question is how that control is exercised.
Where control is exercised transparently through shareholder rights, reserved matters, delegations and proper reporting structures, it can coexist with effective subsidiary governance.
Where it is exercised through informal instructions, predetermined board decisions and expectations of unquestioning compliance, the Group may have boards on paper without having effective boards in practice.