Holding Company (Business) - Explained
What is a Holding Company?
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Table of ContentsHolding Company (Business) DefinitionA Little More on What is a Holding CompanyAcademic Research
What is a Holding Company?
A holding company is a company that has a controlling interest in another company. In simpler terms, a holding company is a parent company that owns enough outstanding stock in another company to exercise complete control over its policies and management decisions. The company that the holding company controls is called its subsidiary. If a holding company owns a 100% stake in a subsidiary, that subsidiary is called a wholly owned subsidiary. Holding companies as well as their subsidiaries can be corporations, limited liability partnerships or limited liability companies.
How Does a Holding Company Work?
A holding company's primary objective is to control another business. However, a holding company may also be formed for owning real estate, stocks and bonds, and intellectual property such as patents and trademarks. Another reason why holding companies choose to invest heavily in subsidiaries is to shield themselves from losses and other liabilities associated with direct ownership. For example, a holding company is not liable to pay remuneration to investors if one of its subsidiaries goes bankrupt. Successful corporations usually distribute their assets, including intellectual properties among their subsidiaries. This not only minimizes their liabilities but also provides tax benefits in cases where subsidiaries are situated in lower tax zones. A holding company may also help individual investors secure their personal assets by placing their asset investments with a subsidiary, so that during an event of bankruptcy, the investors personal assets are safe from potential compensation claims. The management of a holding company is expected to oversee the functioning of its subsidiaries. However, it is usually neither possible nor advisable for a holding company to micro-manage its subsidiaries. This job is best left to the management of the individual subsidiaries, although the holding company still reserves complete authority to appoint or dismiss managers of its subsidiaries. Being associated with a major corporation has its share of benefits for the subsidiaries as well. In the event that a subsidiary needs to take a loan, its parent company can streamline the lending process by providing a downstream guarantee to the lenders on behalf of the subsidiary. Such a downstream guarantee makes it possible for a subsidiary to acquire loans of substantially higher value and at more lucrative rates of interest than would have conceivable without a guarantee. Below are a few examples of holding companies along with their subsidiaries: Berkshire Hathaway with holdings in GEICO, Dairy Queen, Long & Foster, Coca Cola, American Express, besides several other wholly owned subsidiaries, and majority as well as minority holdings Tata Sons Limited, that has holdings in Tata Steel, Tata Motors, Tata Power and other Tata Group companies Loews Corporation with majority holdings in CNA Financial Corporation, Loews Hotels, Consolidated Container Company and several other subsidiaries.
Academic Research on Holding Companies
- Bankholding companymergers with nonbank financial firms: Effects on the risk of failure, Boyd, J. H., Graham, S. L., & Hewitt, R. S. (1993). Journal of Banking & Finance,17(1), 43-63. This paper examines the debate over the possible effects of of expanded nonbanking powers on BHC risk if they were permitted to enter nonbanking activities. test this issue empirically by simulating mergers between BHCs and firms in non-banking financial industries, calculating risk measures for the hypothetical merged firms, and comparing their risk characteristics with those of actual unmerged BHCs.
- Risk, regulation, and bankholding companyexpansion into nonbanking, Boyd, J. H., & Graham, S. L. (1986).Quarterly Review, (Spr), 2-17. This paper explores the debate between individuals that the venturing of banks into non business activities might or might not reduce total risk. This paper explains the reasoning behind these two views and then test to see which one best describes the behavior of U.S. bank holding companies since 1970. The authors suggest that left to their own devices, bank holding companies will expand into new lines of business to increase their risk, but that regulation can control this risk-taking.
- Relationship between bankholding companyrisk and nonbank activity, Brewer III, E. (1989).Journal of Economics and Business,41(4), 337-353. This article, using stock market data, examines the proposition that diversification into non-bank activities decreases bank holding company risk. In contrast to previous studies, we find that expansion into nonbank activities during the 19781986 period substantially decreased bank holding companies' risk. This suggests that limiting further expansion of nonbank activities of bank holding companies would reduce their ability to engage in risk reducing diversification.
- Board structure, banking firm performance and the bankholding companyorganizational form, Adams, R. B., & Mehran, H. (2003). InFederal Reserve Bank of Chicago Proceedings(No. 866). This paper examines the relation between board structure (size and composition) and firm performance using a sample of banking firms during 1959-1999. The paper finds that banking firms with larger boards do not underperform their peers in terms of Tobin's Q. It also argues that M&A activity and features of the bank holding company organizational form may make a larger board more desirable for these firms and document that board size is significantly related to characteristics of our sample firms' structures.
- The effect of interstate banking on large bankholding companyprofitability and risk, Rivard, R. J., & Thomas, C. R. (1997). Journal of Economics and Business,49(1), 61-76. This paper finds empirical evidence that interstate bank holding companies did experience a significantly higher level of profitability than strictly intrastate banking organizations during the 19881991 time period, using data from the early stage of widespread interstate banking. The effect of nonbank diversification on bankholding companyrisk, Templeton, W. K., & Severiens, J. T. (1992).Quarterly Journal of Business and Economics, 3-17. This paper examines the effect of activity diversification on bank holding company (BHC) risk. The paper explores the historical background of the BHC, presentation of the research design and test results, predictions of the modern portfolio theory, and provides implications of the study regarding the effect of nonbank diversification on BHC risk.
- Derivatives, portfolio composition, and bankholding companyinterest rate risk exposure, Hirtle, B. J. (1997). Journal of Financial Services Research,12(2-3), 243-266. This article examines the role played by derivatives in determining the interest rate sensitivity of bank holding companies' (BHCs) common stock, controlling for the influence of on-balance sheet activities and other bank-specific characteristics. The analysis suggests that derivatives have played a significant role in shaping banks' interest rate risk exposures in recent years.
- Bankholding companyacquisitions, stockholder returns, and regulatory uncertainty, Desai, A. S., & Stover, R. D. (1985). Journal of Financial Research,8(2), 145-156. This paper examines the returns accruing to the bank holding company (BHC) stockholders when an acquisition is initiated by the BHC.
- Market perception of efficiency in bankholding companymergers: the roles of the DEA and SFA models in capturing merger potential, Kohers, T., Huang, M. H., & Kohers, N. (2000). Review of Financial Economics,9(2), 101-120. Using the Stochastic Frontier Approach (SFA) and Data Envelope Analysis (DEA), this study examines the influence of bank efficiencies on the market assessment of bank holding company (BHC) mergers.
- The Effect of Credit Risk on Bank and BankHolding CompanyBond Yields: Evidence from the PostFDICIA Period, Jagtiani, J., Kaufman, G., & Lemieux, C. (2002).Journal of Financial Research,25(4), 559-575. In this article, the authors examine whether the federal safety net is viewed by the market as being extended beyond de jure deposits to other bank debt and even the debt of bank holding companies (BHCs). The paper extends previous research by focusing on the postFDICIA period and by examining the riskreturn relation of bonds issued directly by banks, not BHCs.
- Bankholding companycapital targets in the early 1990s: The regulators versus the markets, Wall, L. D., & Peterson, D. R. (1995).Journal of Banking & Finance,19(3-4), 563-574. This paper explores several studies which suggest that the credit crunch was due in large part to banks' needs to raise their capital ratios. This study develops a model to test the relative impact of the regulators and the financial markets on bank holding companies' (BHCs) capital ratios. The results suggest that most BHCs were relatively satisfied with their capital ratios in 1989.
- Historical patterns and recent changes in the relationship between bankholding companysize and risk, Demsetz, R., & Strahan, P. (1995).