Subsidiary Company: Definition, Examples, Pros & Cons

What Is a Subsidiary?

In the corporate world, a subsidiary is a company that belongs to another company, which is usually referred to as the parent company or holding company. The parent holds a controlling interest in the subsidiary company, meaning it owns or controls more than half of its stock. In cases where a subsidiary is 100% owned by another company, the subsidiary is referred to as a wholly owned subsidiary.

How Subsidiaries Work

Subsidiaries are separate and distinct legal entities from their parent companies, which is reflected in the independence of their liabilities, taxation, and governance. If a parent company owns a subsidiary in a foreign land, the subsidiary must follow the laws of the country where it is incorporated and operates.

However, given their controlling interest, parent companies often have considerable influence over their subsidiaries. They—along with other subsidiary shareholders, if any—vote to elect a subsidiary company's board of directors, and there may often be a board-member overlap between a subsidiary and its parent company.

Subsidiary Financials

A subsidiary usually prepares independent financial statements. Typically, these are sent to the parent, which will aggregate them—as it does financials from all of its operations—and carry them on its consolidated financial statements. In contrast, an associate company's financials are not combined with the parent's. Instead, the parent registers the value of its stake in the associate as an asset on its balance sheet.

Accounting standards generally require that public companies consolidate all majority-owned subsidiaries. Consolidation is viewed as a more meaningful method of accounting than providing separate financials for a parent company and each of its subsidiaries.

An unconsolidated subsidiary is a subsidiary with financials that are not included in its parent company's statements. Ownership of unconsolidated subsidiaries is typically treated as an equity investment and denoted as an asset on the parent company's balance sheet. For regulatory reasons, unconsolidated subsidiaries are generally those in which a parent company does not have a significant stake.

Subsidiary Pros and Cons

Buying an interest in a subsidiary usually requires a smaller investment on the part of the parent company than a merger would. Also unlike a merger, shareholder approval is not required to purchase or sell a subsidiary.

A parent company buys or establishes a subsidiary to obtain specific synergies, such as a more diversified product line or assets in the form of earnings, equipment, or property. Subsidiaries can be the experimental ground for different organizational structures, manufacturing techniques, and types of products.

In addition, subsidiaries can contain and limit problems for a parent company to some extent, with the subsidiary serving as a kind of liability shield in the event of lawsuits. Entertainment companies often set up individual movies or TV shows as separate subsidiaries for this reason.

However, subsidiaries also have a few drawbacks. Aggregating and consolidating a subsidiary's financials can make the parent company's accounting more complicated.

Since subsidiaries must remain independent to some degree, transactions with the parent may have to be "at arm's length," and the parent might not have all of the control it wishes. And while a subsidiary can help shield the parent company from certain legal problems, the parent may still be liable for criminal actions or corporate malfeasance by the subsidiary. Finally, it may have to guarantee the subsidiary's loans, leaving it exposed to financial losses.

Real World Examples of Subsidiaries 

Public companies are required by the SEC to disclose significant subsidiaries. Warren Buffett's Berkshire Hathaway Inc., for example, has a long and diverse list of subsidiary companies, including International Dairy Queen, Clayton Homes, Business Wire, GEICO, and Helzberg Diamonds.

Berkshire Hathaway's acquisition of many diverse businesses follows Buffett's oft-discussed strategy of buying undervalued assets and holding onto them. In return, acquired subsidiaries can often continue to operate independently while gaining access to broader financial resources. 

Like Berkshire Hathaway, Alphabet Inc. has many subsidiaries, the best known of which is Google. These separate business entities all perform unique operations intended to add value to Alphabet through diversification, revenue, earnings, and research and development (R&D).

For example, Sidewalk Labs seeks to modernize public transit in the United States. The company has developed a public transportation management system that aggregates millions of data points from smartphones, cars, and Wi-Fi hotspots to analyze and predict where traffic and commuters are most congregated. The system can redirect public transportation resources, such as buses, to these congested areas to keep the public transit system moving efficiently.

The Bottom Line

A subsidiary is a company that is completely or partially owned by another company. Acquiring and establishing subsidiaries is fairly common among publicly traded companies, especially in industries like tech and real estate. The advantages of these business structures include tax benefits, reduced risk, increased efficiencies, and diversification. Drawbacks include limited control and greater bureaucracy and legal costs.