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To maintain control of a subsidiary and at the same time allow the subsidiary to operate as an independent entity under the direction of its board of directors, a parent business enterprise should: (1) be the sole shareholder; (2) include voting control provisions in the subsidiary’s articles of incorporation along with provisions that prohibit amendment of the articles without the approval of the sole shareholder; (3) prepare comprehensive bylaws defining the designation and authority of officers, their term of office, their removal (for cause, or for any or no reason); (4) include in the bylaws the procedure whereby the parent elects and removes directors; and (5) prohibit bylaw amendments without the sole shareholder’s approval, etc.
The board of directors of the subsidiary are responsible to manage the business and affairs of the subsidiary.
These reasons often include, for example: (1) the parent company desires to engage in a new line of business activity unrelated to its current business; (2) the existing or projected revenues from the new line of business activity are substantial; (3) the business enterprise prefers not to expose its assets to the liabilities associated with the new business line; or (4) the new business activities may carry risks of liability unacceptable to the parent; (5) the parent is a public corporation and it desires to keep the subsidiary privately held; (6) the parent wants to posture the subsidiary for going public without affecting the parent’s shareholders; or (7) that the organization desires to reward certain employees with increasing compensation, etc.
It is common to use the term “parent/subsidiary” when describing the relationship between a business enterprise and its subsidiary. The term “parent/subsidiary” is not equivalent to the term “parent/child”. While the parent business enterprise may incorporate its subsidiary corporation, name its board of directors and officers, enunciate the subsidiary’s business purpose, adopt bylaw provisions preserving the parent’s control of its subsidiary, etc., it is important that the subsidiary be established and recognized by the parent, as well as third parties, as an independent corporation managed by a board of directors.
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And, this is the purpose of the parent’s control of its subsidiary: to hold it accountable for performance.
The parent corporation, by virtue of its voting control of the subsidiary, has the power to hold the subsidiary accountable for its performance.
Since the parent retains voting control, it has the authority to select the subsidiary’s directors.
This does not mean, however, that there is no communication between the subsidiary’s CEO and the parent.
After all, the parent owns the subsidiary and by virtue of its ownership or control is entitled to examine the subsidiary’s financial reports and business plan, and to otherwise hold the subsidiary and its management accountable for the performance expectations of the parent.