Certain Words Can Be Very Specific, Or Not

November 5, 2013       Thomas McLaughlin      

There are a few words that leave little ambiguity. Ouch is such a word. Another of those words is “subsidiary” as it is used to describe a type of corporate structure. Here the word “subsidiary” seems to embody a subordinate position.

The phrase “take-over” is sometimes associated with the concept of a subsidiary. This offers a kind of double condemnation. In a freedom-loving culture, being a “subsidiary” of any kind reeks of lost privilege and status.

It’s more complicated than it seems. Subsidiary as the word is used here means a corporation that holds a certain position and is in a defined relationship with at least one other corporation. Some of that relationship is legally defined and even legally required. But a lot of it is left to the judgment of the corporations and their respective managers. This is why digging into the actual terms and requirements of subsidiary relationships may produce some surprising, even counter-intuitive results.

Although it might seem otherwise, the subsidiary structure is more about accountability and protection than it is about power. In a corporate sense, power often refers to the ability of a person such as a CEO or a department head to compel certain behavior on the part of those who report to that person. This is the classic power imbalance that is usually muted but unmistakably underlies classic relationships in a corporation: the boss is in charge.

In a parent/subsidiary model the word “parent” refers to the corporate entity that is in charge of the subsidiaries. It might also be called a holding company or a management company. There is a power imbalance between the two entities, but it is nothing like that between boss and employee. In fact, for those employed in a subsidiary it is not unusual for the parent company to seem more like it’s located somewhere else on a cloud (and not the computer kind). The parent is a recognizable organization but employees of each corporation may well regard each other as though they are simply citizens of moderately allied countries.

The reason for this apparent estrangement is that it is a by-product of a major advantage of subsidiaries — they represent boundaries. This is one of the most compelling reasons for subsidiaries, because corporate boundaries represent a kind of firewall between the parent corporation and outsiders who might be intent on suing a subsidiary. Rarely does an aggrieved outside party succeed in attacking the parent company by first trying to go through a subsidiary. Lawyers refer to this as piercing the corporate veil and it is rarely accomplished because each corporation is expected to stand on its own in all legal proceedings.

This isn’t a corporate version of dodgeball. Different types of services have different risk patterns, and there could be dramatically negative economic consequences of treating all services in a parent-subsidiary environment alike. For example, major hospitals that co-exist in a complicated multi-corporate structure will virtually always run nursing homes or home care services as subsidiaries. This is because a successful lawsuit against a hospital could potentially bankrupt a nursing home if it were part of the same subsidiary.

Boards of directors represent a good example of subsidiary corporations’ roles in ensuring accountability. Not only will a smart parent company taking on a new subsidiary be open to the latter’s board continuing, they might insist on it. Apart from the fact that the parent company board might have to begin a crash course in running the new subsidiary, dismissing the board would destroy all institutional knowledge at a governance level.