Navigating corporate governance of group structures

By ABDUL JABBAR BIN KARAM DIN

The Business Times, 10 November 2023

 

IN RECENT years, the adoption of group structures has become increasingly common worldwide as companies seek to optimise their business operations and facilitate growth. However, the governance landscape becomes notably complex when it comes to group structures, where multiple entities are interconnected through ownership and control.

What are some of the challenges and strategies involved in navigating corporate governance within group structures?

Understanding group structures

A group structure is formed when a company (the parent company) holds an interest in one or more companies – in the form of subsidiaries or associated companies (the group companies).

Group structures can offer advantages, including efficient decision-making and pooling of resources. From a legal perspective, group structures offer risk mitigation – each entity within the group has limited liability, safeguarding its assets from insolvency and other claims of creditors of the other group companies.

From a tax perspective, a group structure may provide tax advantages, such as tax exemptions and group relief. Additionally, group structures may be necessary to comply with specific laws or industry regulations, such as the separation of financial and non-financial businesses in the banking sector.

Control within a group structure

A group structure can often be complex, involving operations in different industries and countries with different laws and regulations. However, a failure at a downstream group company operating in a faraway jurisdiction can cause reputational and financial harm to the entire group. As such, parent companies should implement effective group corporate governance strategies.

Parent companies may seek to control or influence their group companies in several ways, such as by implementing group-wide policies and procedures. These policies typically include obtaining approvals for significant transactions or expenditures and the appointment of key personnel.

Where the group company has a substantive operating business, a parent company may seek to second personnel from the parent to executive positions within the group company and appoint directors to the board of the group company.

Common issues faced by parent companies

Several challenges arise in the corporate governance of group structures.

First, the parent company’s board of directors must decide on the extent of control and influence it wishes to exercise over its group companies. Not all group companies need to be controlled in the same way or to the same degree.

Usually, the more significant the financial contributions of the group company to the group, the greater the oversight that the parent may wish to exercise over its operations. Certain group companies that perform critical services may also need to be controlled more tightly, while others may be given greater autonomy. It would be challenging to have uniform corporate governance policies across the group for companies listed on a stock exchange or operating in a regulated environment, such as banking and insurance.

Second, operating in different jurisdictions introduces complexities due to varying legal and regulatory requirements. The laws of some countries may hold parent companies and their directors liable for the actions of a subsidiary. In addition, intra-group transactions may attract tax implications as they may shift income away from one group company to another in a different tax jurisdiction.

Third, a delicate balance must be struck when it comes to appointing nominee directors by the parent company. Nominee directors of group companies should be aware of their multiple and, sometimes, conflicting duties. On the one hand, they owe the principal fiduciary duties to the group company on which board they sit. On the other hand, they owe duties as employees to their employer (if they have been seconded by the parent company to the board of the group company) pursuant to their employment contracts.

Executives of parent companies that are not on the boards of group companies should not exert so much influence and control over a group company that they run the risk of being deemed by a court to be a shadow director of the group company, and hence subject to any liabilities facing directors of the group company.

Best practices on group governance

Generally, parent companies should assume responsibility for corporate governance across the group by approving and implementing a group governance framework. The implementation and adoption of policies, processes or procedures of the parent company should be considered and approved by the board of each group company as a separate legal entity.

To ensure group-wide coordination and consistency, and clear responsibilities and accountabilities, a group governance framework should address key issues. These include the tone for leadership and culture of the group, board and group governance, board composition (both at parent and group company level), group strategic objectives, priorities and principles, internal control and oversight of group entities. Group-wide matters such as reporting procedures, risk management, disclosure of information, intra-group transactions and compliance should also be clearly set out.

The directors of parent companies should recognise and respect that the group company boards need to exercise an appropriate degree of independence and act in the best interests of the group company. Unless required by law, no instructions of a prescriptive nature should be issued by parent company boards to avoid putting group company directors in a difficult position.

This is the first of a two-part series on the governance of group structures, associate companies, subsidiaries and joint ventures.

The writer is a member of the Professional Development Committee of the Singapore Institute of Directors.