Why is it easier for a firm to export instead of setting up a wholly owned foreign subsidiary?

What Is a Wholly Owned Subsidiary?

A wholly owned subsidiary is a company whose common stock is 100% owned by another company. A company can become a wholly owned subsidiary through an acquisition by a parent company. A majority-owned subsidiary is a company whose common stock is 51% to 99% owned by a parent company.

When lower costs and risks are desirable—or when it is not possible to obtain complete or majority control—the parent company might introduce an affiliate, associate, or associate company in which it would own a minority stake.

Key Takeaways

• A wholly owned subsidiary is a company whose common stock is 100% owned by a parent company.
• Wholly owned subsidiaries allow the parent company to diversify, manage, and possibly reduce its risk.
• Unlike other subsidiaries, a wholly-owned subsidiary has no obligations to minority shareholders.
• In general, wholly owned subsidiaries retain legal control over operations, products, and processes.
• The financial results of a wholly owned subsidiary are reported on the parent company's consolidated financial statement.

Wholly Owned Subsidiary

Understanding a Wholly Owned Subsidiary

Having a wholly owned subsidiary may help the parent company maintain operations in diverse geographic areas and markets or separate industries. These factors help hedge against changes in the market or geopolitical and trade practices, as well as declines in industry sectors.

Because the parent company owns all the shares of a wholly owned subsidiary, there are no minority shareholders. The subsidiary operates with the permission of the parent company, which may or may not have direct input into the subsidiary’s operations and management. This may make it an unconsolidated subsidiary.

Despite being owned by another entity, a wholly owned subsidiary may maintain its own management structure, clients, and corporate culture. When a company is acquired, its employees may worry about layoffs or restructuring.

Although subsidiaries are separate entities, they may share some executives or board members with their parent company.

Accounting for a Wholly Owned Subsidiary

From an accounting standpoint, a wholly owned subsidiary is still a separate company, so it keeps its own financial records and bank accounts tracking its assets and liabilities. Any transactions between the parent company and the subsidiary must be recorded.

Both Generally Accepted Accounting Principles (GAAP) and the International Financial Reporting Standards (IFRS) require companies to report the financial data of their subsidiaries if the parent company is public. This information can be found in the parent company's consolidated financial statement.

Advantages and Disadvantages of a Wholly Owned Subsidiary

Although a parent company has operational and strategic control over its wholly owned subsidiaries, the overall control is typically less for an acquired subsidiary with a strong operating history overseas. When a company hires its own staff to manage the subsidiary, forming common operating procedures is much less complicated than when taking over a company with established leadership.

In addition, the parent company may apply its own data access and security directives for the subsidiary as a method of lessening the risk of losing intellectual property to other companies. Similarly, using similar financial systems, sharing administrative services, and creating similar marketing programs help reduce costs for both companies, and a parent company directs how its wholly-owned subsidiary’s assets are invested.

However, acquiring a wholly owned subsidiary may result in the parent company paying a high price for its assets, especially if other companies are bidding on the same business. In addition, establishing relationships with vendors and local clients often takes time, which may hinder company operations; cultural differences may become an issue when hiring staff for an overseas subsidiary.

The parent company also assumes all the risk of owning a subsidiary, and that risk may increase when local laws differ significantly from the laws in the parent company's country.

Tax Advantages of Wholly Owned Subsidiaries

There are tax advantages for wholly owned subsidiaries that may be lost if the parent company simply absorbs the assets of an acquired company. When a parent company acquires a subsidiary by buying up that company's stock, the acquisition is considered a qualified stock purchase for tax purposes. Moreover, any losses by a subsidiary can be used to offset the profits of the parent company, resulting in a lower tax liability.

Sometimes, a subsidiary can do things that the parent company cannot. For example, a non-profit entity can create a for-profit subsidiary, in order to raise revenue. While the subsidiary would be subject to federal income taxes, the parent company would remain exempt.

Pros and Cons of Wholly Owned Subsidiaries

Pros

• Tax-exempt organizations can have for-profit subsidiaries

• Parent companies can use losses from one subsidiary to offset profits from another.

• The parent company inherits the acquired company's clients and good-will, which would be hard to recreate from scratch.

Cons

• Running a subsidiary can be difficult if the acquired company has a different management culture.

• Acquiring another company can be expensive, especially if other companies are also seeking to acquire them.

• Risks may be higher if the subsidiary is located in a different jurisdiction than the parent company.

Examples of Wholly Owned Subsidiaries

A popular example of a wholly owned subsidiary system is Volkswagen AG, which wholly owns Volkswagen Group of America, Inc. and its distinguished brands: Audi, Bentley, Bugatti, Lamborghini (wholly owned by Audi AG), and Volkswagen.

In addition, Marvel Entertainment and Lucasfilm are wholly owned subsidiaries of The Walt Disney Company. Coffee giant Starbucks Japan is a wholly owned subsidiary of Starbucks Corp.

What Is the Difference Between a Subsidiary and a Wholly Owned Subsidiary?

A subsidiary is any company whose stock is more than 50% owned by a parent company or holding company, giving that parent company a controlling interest in the subsidiary's profits and decisions. However, the management still has financial obligations to the minority shareholders. A wholly-owned subsidiary is 100% owned by the parent company, with no minority shareholders.

What Is the Difference Between a Holding Company and a Parent Company?

A holding company is a company that only exists to hold a controlling stock in other entities, while a parent company has its own operations. For example, Berkshire Hathaway is a well-known holding company whose main business is acquiring shares of other companies. Pepsi is a parent company that operates several subsidiaries, in addition to its core business as a soft drink manufacturer.

How Are Wholly Owned Subsidiaries Accounted for?

Wholly-owned subsidiaries maintain separate accounts from their parent companies, but their finances are usually reported together. If a public company has wholly-owned subsidiaries, the financial data for those subsidiaries are reported alongside those of the parent on the company's consolidated balance sheets.

What Are the Tax Benefits of a Subsidiary?

A company with multiple subsidiaries can use the losses of one subsidiary to offset the profits of another, thereby reducing the overall tax bill. Moreover, non-profit entities can establish for-profit subsidiaries without endangering their tax-exempt status.

What is one disadvantage of wholly owned subsidiaries as a mode of entry into foreign markets?

Which of the following is a disadvantage that a firm faces when forming a strategic alliance?