Formation of Holding Companies and Capital Allocation Within Them

Formation of Holding Companies and Capital Allocation Within Them

The earliest forms of corporate combination and synergy date back to 1833, when family companies were established to expand and strengthen commercial activities, coordinate production processes, and reduce overhead costs by eliminating or reducing fixed expenses. According to various sources, General Electric is regarded as a primary inspiration for the emergence of holding companies.

This company operated through approximately 170 subsidiary and affiliated entities, all managed by a central office and supervised by ten senior executives who reported directly to the chief executive officer.

Legal and Tax Challenges of Holding Companies

Types of Capital Allocation in Holding Companies

A holding company is an entity that owns preferred shares and common shares in multiple companies. Holders of preferred shares generally do not possess voting rights in the company. As a result, a holding company may assume decision-making authority over a subsidiary by acquiring a majority of its common shares.

The parent company typically appoints at least one member to each subsidiary’s board of directors, enabling it to participate formally in corporate governance and decision-making.

In addition to voting rights, the profits and losses of subsidiaries directly affect the financial position of the parent holding company.

Common shares are divided into registered shares and bearer shares. In legal terminology, bearer shares are considered negotiable instruments, meaning that possession of the share certificate establishes ownership.

The primary distinction between registered and bearer shares lies in whether the shareholder’s name is recorded on the share certificate.

Characteristics of Common Shares

Common shares possess several defining characteristics, including the following:

1. They represent a permanent source of financing and indicate ownership of the issuing company. These shares have no maturity date, and the issuing company is not obligated to repurchase them.
2. Holders of common shares bear the highest investment risk, as preferred shareholders have priority in the distribution of profits and in the repayment of capital.
3. The liability of common shareholders is limited to the amount of their investment. In the event of bankruptcy and liquidation, if the proceeds from the sale of company assets are insufficient to satisfy creditors, no further liability is imposed on common shareholders.
4. Because of the large number of shareholders in joint-stock companies, individual shareholders generally cannot directly influence company operations beyond exercising their voting rights.
5. Common shareholders have the right to elect members of the board of directors and to approve or reject the company’s management structure through their votes.
6. Common shareholders enjoy preemptive rights in the purchase of newly issued shares.
7. Common shareholders have the right to inspect the company’s records and to transfer their shares freely.

Non Common Shares

Non-common shares are divided into two categories:

• Founders’ Shares: These shares are designated by the status of their holders, and the initial holders must be among the company’s founders. In many holding company structures, founders’ shares exist alongside common shares. The primary advantage of founders’ shares lies in the special benefits granted to their holders in recognition of their contributions to the company’s establishment.
• Preferred Shares: Preferred shares grant special privileges to their holders that common shareholders do not have. These shares are typically issued when the cost of raising capital through common shares is relatively high.

Advantages of Preferred Shares

Pursuant to Article 42 of the Commercial Code, preferred shares offer the following advantages:

1. The initial holders of preferred shares may include the company’s founders.
2. Preferred shares confer an ownership interest in the company. Dividends on these shares are paid before dividends on common shares, thereby giving preferred shareholders priority. While dividend payments are not guaranteed, they are often predetermined and fixed.
3. In the event of liquidation or sale of company assets, preferred shareholders are entitled to receive their share of the assets after the settlement of company debts and before any distribution to common shareholders.
4. Preferred shares are considered hybrid securities because they combine characteristics of common shares and debt instruments.
5. They resemble common shares in that they have no maturity date and offer certain tax advantages, yet resemble debt instruments because they feature a fixed dividend.
6. Preferred shares are issued through public subscription and may be traded on the stock exchange.

Frequently Asked Questions About the Formation of Holding Companies and Capital Allocation