incentives that are created around governance by Boards.
Then there is the problem of the role of the subsidiary
board in governance and potential conflicts with the
holding company, and potential conflicts for “subsidiary
directors” if they are also employees elsewhere in
the group.
From time to time, issues of how to deal with conflicts
between the parent and the subsidiaries arise even where
the subsidiary is wholly owned. Examples of some specific
issues that we have seen include:
• New product launches: The “parent” wants to launch
a new product but a majority of the subsidiary board
believes this is costly and inappropriate
• Declaration of dividends: The “parent” wants maximum
dividends declared while the subsidiary board wants to
retain profits for investment in the company
• Regulatory issues: The “parent” wants to comply with
home country regulation or practice, but the subsidiary
believes that is inappropriate
• Minimum working age/time/pay: The “parent” wants to
follow home country or its view of global practice, but the
subsidiary believes that such action puts the subsidiary at
a disadvantage in the local market
• Factory closure: The “parent” wants to consolidate
manufacturing but the subsidiary finds it hard to justify
redundancies when manufacturing is moved offshore
Beyond the issues of how the parent should exercise
oversight of its group entities and how to resolve conflicts
between the parent company and these entities, there are
issues of how directors of group entities deal with role
conflicts and discharge their fiduciary responsibilities.
Most people who hold “director” titles are in fact
directors of subsidiaries and other group entities, and are
frequently also employees in these entities. Often, they
act as shareholder representative for another company
elsewhere in the organizational “chain”. These directors
constantly have to make decisions involving conflicts
between the interests of the parent and the group
entity. They also have to take into account the incentives
applicable to them as individuals.
Whilst the legal position is clear - that directors of a
subsidiary or joint venture or associated company must
act in the best interests of that entity - the practical reality
is far more complex, especially as these directors often
have line responsibilities or are directors of the parent
or other group entities. We have seen it get so difficult
that local employees of the “owner” refuse to serve on the
22
Hawkamah issue02 56pages.indd 22
subsidiary board. It does not help that most organizations
provide little training and have, frankly, little sympathy
for the predicament.
Closing thoughts
From a financial reporting standpoint, the impact of
group entities are accounted for through accounting
methods and procedures, such as consolidations; equity
accounting; disclosure of subsidiaries, joint ventures,
associates and special purpose entities; and related party
disclosures. Accounting has recognized the economic
substance of groups and moved away from the legal
demarcations that exist amongst different entities.
In contrast, corporate governance standards and
guidelines have evolved more along the “legal” than the
“economic substance” route. Rules, regulations and codes
for corporate governance largely ignore the governance
issues that entities within a group and directors serving
on boards of these entities face. The focus of most
governance literature and most director education is on
those who sit on the boards of listed companies.
We are not advocating that parent companies “microgovern” their subsidiaries. This is not only impractical
given the complexity of company groups, but may
undermine the separate legal entity status of subsidiaries
and the “ring-fencing” of risks in these subsidiaries, and in
some cases, violate local laws and regulations. However,
it is also inappropriate to let the subsidiaries completely
self-determine their corporate governance.
Some large company groups are realizing the importance
of subsidiary governance by putting in place a subsidiary
governance programme. The emerging literature and
our own experience suggest the following as being
key components of a robust subsidiary governance
programme:
• Overall corporate governance framework/policy: This
should deal with key issues such as board composition,
the role of the board and their responsibilities, conflicts
of interest, the process for appointment of directors and
officers, director training and directors’ remuneration.
• Board composition: Having the right people on
any board is critical. We have seen cases of unlisted
subsidiaries having non-executive independent directors
who are not employees of the organization, although this
is relatively rare. At the other extreme, it is common for
unlisted subsidiaries to have boards comprised entirely
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