Determining the scope of consolidation is one of the most important aspects in preparing consolidated financial statements. At the same time, in order to understand which companies will be consolidated, it is necessary to find out which of them the parent company has control over. This article is devoted to determining the presence or absence of control.
The presence or absence of control of a parent company over a subsidiary is governed by IFRS 10 “Consolidated Financial Statements” (hereinafter referred to as IFRS 10).
According to this standard, an investor (parent) has control over an investee (subsidiary) only if the investor:
- has authority over the investee;
- is exposed to, or has the right to receive, risks associated with variable returns from its involvement with the investee;
- has the opportunity to use its powers in relation to the investee in order to influence the amount of its income.
Note that in the standard the word “income” (in the original returns - return) means not only income, but also expenses, and any profits and losses that the activity of the investee may bring to the investor. That is, the “return” can be in any form: both income and expense, and loss, and profit.
We also note that IFRS 10 uses the terms "investor" and "investee" until the investor's control over the investee is demonstrated. If the investor has control over the investee, then the investor is the parent company and the investee is the subsidiary.
Criterion "Authority"
Authority is the existing rights of an investor to direct the relevant activities of the investee.
An investor can obtain power over an investee in various ways, for example, by purchasing a share in it or entering into an agreement to manage it, etc. But not all types of powers may be sufficient to recognize the investor as controlling.
If an investor has an interest of more than 50 percent (more than half of the voting rights) in the investee, then, absent other circumstances, it is considered to have sufficient power. In this case, the other two control criteria are fulfilled automatically. It is such an investor who should consolidate the investment object.
However, there may be a variety of circumstances that could result in other investors also having power over a particular investee or in an investor holding more than 50 percent of the investment not meeting the other two control criteria. In this case, you need to analyze and determine:
- whose powers are more significant;
- whether investors meet other control criteria;
- Which investor is more exposed to risks associated with the return on investment.
Then, based on the totality of all the circumstances, a decision must be made as to which investor controls the investee. The controlling investor must consolidate the investee as a subsidiary.
First of all, let's define the term “meaningful activity”.
Significant activities are those activities of the investee that have a significant effect on the income (return) from the investee.
Of two investors who have power over an investee, the one that controls the most significant activities will have greater power.
Two investors create an investment for the purpose of developing and selling a drug.
One investor is responsible for developing the drug and obtaining appropriate regulatory approval. This responsibility includes the ability to make unilateral decisions regarding product development and regulatory approval.
Once the drug has been approved by the regulator, another investor begins producing and selling it. This investor can unilaterally make all decisions regarding the production and sale of the drug.
If all of the identified activities (development and regulatory approval, and manufacturing and marketing of the drug product) are relevant activities, then each investor must determine whether it has the ability to direct the activities that have the most significant impact on the return on investment of the investee.
Consequently, each investor must consider which type of activity is most significant to him and has the most significant impact on the return of the investee. Whoever controls the most significant activities has the greatest authority over that investee.
IFRS 10 does not specify which investors control the most significant activities, but it does identify issues that investors should consider when deciding which activities are most significant:
- the purpose and structure of the investment object;
- factors that determine the rate of return, revenue and value of the investment object,
- as well as the cost of the drug;
- the impact on the income (return) of the investee as a result of the exercise of the authority of each investor to make decisions regarding the factors listed above;
- investors' exposure to the risk of changes in income (return);
- uncertainty regarding obtaining regulatory approval and the efforts required to obtain such approval (given the investor's successful track record of developing drug products and obtaining appropriate regulatory approval);
- which investor exercises control over the drug after successful completion of the development phase.
It is possible to determine which investor’s activities are more significant only by analyzing all the above questions.
Authority is determined by and results from existing rights to direct the relevant activities. Let's consider the term "existing rights."
Existing rights are rights that provide the investor with the present ability to direct the relevant activities.
Examples of rights could be:
- voting rights (shares, shares) in the investment object;
- the right to appoint, reassign or remove key management personnel of the investee who can influence the relevant activities;
- the right to appoint or remove another entity that manages the relevant activities;
- the right to give instructions to the investee regarding the entry into any transactions or to veto any changes to any transactions in the interests of the investor;
- other rights (for example, decision-making rights specified in a management agreement) that provide their holder with the ability to direct the relevant activities.
An investor who holds more than half of the voting rights of an investee will, absent other circumstances, be considered to have power over it. However, this condition is not met if:
- the relevant activities are not managed through the vote of the holder of a controlling interest in voting rights;
- or a majority of the members of the governing body of the relevant activities are not appointed by a vote of the holder of a controlling interest in voting rights.
Example
Company A owns 100% of the shares in company B. At the same time, bankruptcy management has been introduced in company B, as a result of which its activities are managed not by company A, but by a bankruptcy trustee. Despite its 100% share, Company A has no power in Company B and should not consolidate it. Her rights cannot be recognized as existing.
Rights must be real to be empowering. Real rights is another important term used in IFRS 10. A right is real if the subject of the right (the investor) has the practical ability to exercise such a right, that is, has the right to currently exercise its rights.
Determining whether rights are substantive requires a judgment taking into account all the facts and circumstances. Here is a list of barriers (economic or other nature) that may prevent an investor from exercising his rights and thereby lead to the fact that the rights will not be real:
- financial sanctions and incentives;
- an exercise or conversion price that creates a financial barrier preventing the investor from exercising his rights;
- conditions that make the exercise of the right unlikely (for example, conditions that strictly limit the timing of execution);
- the absence in the constituent documents of the investee or the absence in applicable laws or regulations of a clear, reasonable mechanism that would allow the investor to exercise its rights;
- the inability of the investor to obtain the information necessary to exercise his rights;
- operational barriers or incentives (for example, lack of other managers willing or able to provide specialized services);
- requirements of laws or regulatory authorities (for example, if the foreign investor is prohibited from exercising his rights).
If there are any factors that prevent an investor from exercising his rights, he should analyze how significant such restrictions are and whether they can lead to a decision of lack of authority.
Example
Company A acquired a 95% share in company B from company C. A 5% share remained with company C. The activities of company B are specific; there are no such activities in company A. Currently, Company A does not have managers capable of managing the activities of Company B, so Company B is managed by a CEO appointed previously (prior to the purchase) by Company C. The board of directors consists of four board members (two from A and two from C) and a chairman appointed company A. Decisions of the board of directors on almost all issues are made by a simple majority.
Does Company A have authority to direct the significant activities of Company B, and should Company A consolidate Company B?
1. Let’s compare the powers of company A and company C.
The powers of company A are determined by its 95% share, which implies an absolute majority of votes at the shareholders meeting. Company A has an advantage on the board of directors. At the same time, company A has a factor limiting its rights - the current lack of necessary management personnel.
The powers of Company C are determined by 5% of voting rights, which does not give it any advantages at the meeting of shareholders and a majority on the board of directors. The CEO has been appointed by Company C and currently manages operations.
Due to the lack of qualifications of the members of the board of directors from company A, the general director of company B may not act in the interests of company A. But no matter what specific activity company B is engaged in, company A, if necessary, can find a specialist with the necessary qualifications or obtain the necessary advice on such activities from third party consultants. Because of its majority on the board of directors, Company A can remove the CEO of Company B if it believes that he is not acting in the best interests of Company A. Thus, the limiting factor is not critical.
2. Analysis of other control criteria.
Company A is exposed to variable returns from its investee (Company B) through its 95% stake. If Company B goes bankrupt, Company A will lose its investment. In addition, Company A will not receive the return it expected when purchasing Company B. Thus, Company A is significantly exposed to the risk of variable returns. While company C risks only a 5% share, which is incomparably less.
Company A has the ability to use its power over Company B to influence its returns through voting at a shareholders meeting, as well as through participation on the board of directors. The shareholders and director of Company A make right or wrong decisions and thereby lead Company B's business to either success or failure and, therefore, to the receipt or non-receipt of income from it. Thus, the ability of company A to use its powers to influence the return from company B is realized. Company C also has the opportunity to influence with its powers the return from company B - through participation in the board of directors and the general director.
Based on the combination of factors, we can draw the following conclusion. Company A has more power in relation to company B and is significantly more exposed to the risk of variable returns than company C. With approximately equal opportunity to influence with its powers the return from company B (third criterion), powers and exposure to the risk of variable returns (first and second criteria) Company A has more, so Company A should be recognized as the controlling party and consolidate Company B.
Another important concept in IFRS 10 is protection rights. Protection rights do not give the investor control. These are rights that give the investor the ability to protect his interests, but do not give him power over the investee.
Example
Company A has a 70% share in company B, and company C has a 30% share in company B. According to the charter of company B, company C can block with its share the decision to change the activities of company B, liquidate company B, or issue shares of company B ( leading to dilution of the share of company C), the issue of bonds exceeding the value of the assets of company B, etc.
Company C's rights are protective rights; they give it the ability to protect its interests, but do not give it control. If Company C has no other rights, Company A has control over the activities of Company B.
Powers without a controlling interest
In practice, situations often arise when an investor does not have a controlling, but quite significant share in the investee (for example, more than 40%, but less than the controlling stake). IFRS 10 states that in such cases the investor should consider its rights and the rights of others, as well as its exposure to variable returns and the ability of its power to influence the variable returns of the investee (other control criteria).
An investor may have power even if it does not hold a controlling interest in the investee, for example, as a result of:
- agreements between the investor and other voting rights holders;
- rights provided for in other agreements;
- investor voting rights;
- potential voting rights;
- combinations of situations specified in paragraphs (a)-(d).
Example from IFRS 10
The investor acquires 48% of the voting rights of the investee. The holders of the remaining voting rights are thousands of shareholders, none of whom have more than 1% of the voting rights. However, none of the shareholders has any agreement to consult with any of the other shareholders or make collective decisions.
Assessing how much voting rights to acquire based on the relative size of other shareholdings, the investor concluded that a 48% ownership stake would be sufficient to give him control. In this case, based on the absolute size of its holding and the relative size of other holdings, the investor concluded that it had a sufficiently dominant interest to satisfy the power test without the need to consider other evidence of power.
Indeed, the investor has a fairly large share and there are no other parties who can control the investee. Therefore, the investor can recognize himself as a controlling party, since the control criteria are met:
- presence of authority: 48% give the investor enough authority to make decisions (the remaining small investors will not be able to cooperate to oppose his decisions);
- exposure to variable returns from the investee: the investor is exposed to the risk of variable returns because it owns a large enough stake that it could suffer a loss if the investee suffers a loss or goes bankrupt, or receive income (for example, in the form of dividends) if the investee is profitable;
- influence of power on the variable return of the investee: an investor can use his power to influence the variable return of the investee, since, by making decisions at the shareholders' meeting, he leads the investee's activities to success or failure (profits or losses).
Please note that the example shows a share of 48%. Most likely, with a smaller share, for example 30%, the fulfillment of the criteria under points a) and b) would be doubtful.
Criterion "Exposure to the risk of changes in income (return) from the investment object or rights to receive such income (return)"
Variable income (return) is income that is not fixed and may vary depending on the performance of the investee. It can be only positive, only negative, or both positive and negative.
Examples of variable income (return):
- dividends, distributions of other economic benefits from the investee (for example, interest on debt securities issued by the investee);
- changes in the value of the investment made by the investor in the investee;
- remuneration for servicing the assets or liabilities of the investee;
- fees and risk of loss from credit support or providing a liquidity share of the residual value of the investee's assets and liabilities upon its liquidation, income tax benefits and access to future liquidity from the investor's participation in the investee;
- income that is not available to other equity holders (for example, an investor may use its assets in combination with those of an investee: combining operating functions to achieve economies of scale, reduce costs, source suppliers for scarce goods, gain access to proprietary knowledge, or impose restrictions on some transactions or assets to increase the value of the investor's other assets).
Thus, variable income (return) is almost any variable return from the investment object that the investor receives in connection with his investment.
Criterion "The ability to use one's powers in relation to the investee in order to influence variable returns"
If an investor has power and holds a significant interest in the investee, then, absent other circumstances, it is considered that it can use its power to influence the variable returns of the investee.
IFRS 10 places great emphasis on situations in which an investor transfers its authority to manage an investee to another party and that party becomes the 'decision maker'. The standard defines under what circumstances a decision maker is an agent and under what circumstances a decision maker is a principal.
In this case, the agent is the decision maker who manages the investee for the benefit of the principal. The agent uses the received powers in order to obtain variable returns from the investee not so much in his own favor as in favor of the principal, therefore the agent does not control the investee and does not consolidate it (that is, for the agent the considered sign of control is not satisfied).
IFRS 10 states that if an investor transfers control rights over an investee to a third party, it must determine whether it is a principal. On the other hand, the decision maker to whom the investor has delegated management authority must also determine whether he is a principal or an agent.
When a decision maker determines whether it is an agent, it should consider the relationship between itself, the investee it manages, and the other parties (the investor) involved in the investee, in all aspects of that relationship, and in particular the following factors:
- the limits of its decision-making powers regarding the investment object;
- rights of other parties (investor rights);
- the remuneration to which it is entitled under the remuneration agreement(s);
- exposure to changes in income from other interests in an investee that it holds.
Depending on the specific facts and circumstances, different weights are given to each of the above factors.
The limits of authority of the decision maker must be analyzed based on the management contract based on the following factors.
- Right of removal. If, according to the management agreement, any party has the unconditional right (without specifying a reason) to remove the decision maker from management, then the latter is an agent. If such an unconditional right of withdrawal is held by the investor who has transferred the rights to manage the investee to the decision maker, then the investor will be the principal (controls) and the decision maker will be the agent (does not control).
- The amount of remuneration of the decision maker. If the remuneration is market, this indicates that the decision maker is engaged as an agent and any other similarly qualified person would be able to provide the same services to manage the investee. Market remuneration exposes the decision maker to too little risk of variable returns from the investee. The more non-market remuneration a decision maker receives, the more responsibility it has for managing an investee, and the greater the volatility of remuneration, the greater its exposure to variable returns from the investee and the closer the decision maker is to the position of a principal.
- Whether the decision maker has other interests in the investee (other than management fees). Such an interest could be the decision maker's share in the investee, the provision of guarantees regarding the performance of the investee, etc.
The more interests a decision maker has in an investee, the greater his exposure to variable returns from the investee and the closer he is to the position of a principal.
Example
Scenario 1
Company A has a 100% stake in company B (investee). Company A transferred the management rights of company B to management company C under a management agreement. According to the agreement, company A has the right to unconditionally and without specifying reasons to remove company C from management.
By virtue of the right of unconditional estoppel, Company A is the principal and consolidates Company B.
Scenario 2
Company A has a 90% stake in company B (investee). Company A transferred the management rights of company B to management company C under a management agreement. According to the agreement, Company A has the right to remove Company C from management only if Company C violates the management agreement. The management company's remuneration is market-based. The management company has no other interests in company B.
In this scenario, Company A's right to remove the management company is considered a defensive right, since it can only be exercised in the event of a breach of contract. The right of defense is not taken into account when deciding the issue of control.
Since the management company's remuneration is market-based, it is exposed to the risk of variable returns from the investee to a much lesser extent than Company A. Therefore, Company C manages Company B more in the interests of Company A than in its own. Company A is the principal, and Company C is the principal. agent.
Example
The fund management company holds the investment in the form of a 20% share of the fund and is responsible for financing the fund's losses up to that share. Other investors can remove the management company by a simple majority vote, but only for violating the terms of the contract. The management company receives market remuneration for management services.
In this case, the right of other investors to remove the management company is regarded as the right to protect interests, since it can only be exercised in case of violation of the terms of the contract.
Although the management company receives a market fee that is commensurate with the services rendered, its investment, coupled with its fees, may result in exposure to changes in the fund's performance that are significant enough to indicate that the management company is a principal.
Structured organizations
Prior to the entry into force of IFRS 10, special purpose entities (SPEs) were accounted for in accordance with SIC 12 Special Purpose Entity Consolidation. According to this clarification, they should have been consolidated if the nature of the relationship between the company and the PSN indicated that the latter was controlled by the group. Moreover, control could arise due to the predetermined nature of the activities of the PSN (operating in “autopilot” mode). In practice, SPEs have always been consolidated simply on the basis that they are such.
Following the entry into force of IFRS 10, the term 'SPE' was replaced by the term 'structured entity'. The procedure for making a decision on the inclusion or non-inclusion of a structured organization in the consolidated statements has become absolutely similar to the procedure established for any other subsidiary: for consolidation, three control criteria must be met. Therefore, structured entities are not discussed separately in IFRS 10 and the definition of a structured entity is included in IFRS 12 Disclosure of Interests in Other Entities.
The only thing that distinguishes the reflection and accounting of structured organizations in the consolidated statements from the reflection and accounting of other investment objects is the procedure for disclosing information about it. In relation to a structured entity, the risks associated with it are disclosed.
In conclusion, we provide a diagram for deciding whether or not the investor has control over the investment object. The first part is devoted to determining the presence of authority, and the second to determining the presence of other control criteria. This diagram can be used to analyze the consolidation perimeter for each subsidiary.
Scheme for deciding whether or not the Group has control over an investee
Part 1. Scheme for deciding on the availability of authority
Part 2. Scheme for making a decision on the presence of other control criteria
We thank the Department of Information and Public Relations of Rosenergoatom Concern for providing this material.
“If changes happen faster outside than inside, the end is near.” Jack Welch, General Electric
History of the formation of the management circuit and problems of managing subsidiaries
The history of the formation of the Concern’s management loop goes back more than 15 years. The structure of financial investments in the authorized capitals of the Concern's subsidiaries and affiliates was formed based on economic conditions, forms of ownership and existing heritage as a result of transformations of line ministries and departments at the time of privatization.
The Concern's management system included more than 100 subsidiaries and dependent companies. Territorial remoteness, the specific nature of its activities and the need to make independent decisions taking into account local conditions have always created difficulties for the Concern to effectively manage its subsidiaries and affiliates.
In 2011, a project of the Rosatom State Corporation was launched to optimize the ownership structure by getting rid of non-core assets, forming a balanced portfolio of financial investments that ensures the production of the Concern’s main product - electricity and power, the main production business processes - technical support, repair and operation of nuclear power plants, commissioning works, as well as auxiliary business processes - fulfillment of social obligations to the staff of nuclear power plants located mainly in single-industry towns.
Currently, the Concern’s management system includes 40 subsidiaries, dependent and supervised organizations, grouped into the Electric Power Division as an integrating system (Fig. 1).
Rice. 1. Management perimeter of the Electric Power Division in 2015
The total volume of services consumed by the Concern from subsidiaries in 2015 amounted to 30.3 billion rubles, and the revenue of organizations operating outside the division was almost 60 billion rubles. At the same time, the distribution of the number of people in the sales markets for services is the opposite: 20 out of 23 thousand people work in the field of services for nuclear power plants. This distribution of personnel has a key impact on the management model of subsidiaries, since it requires taking into account not only the economic aspect of the activities of subsidiaries and affiliates, but also the social one, which largely shapes the climate in the locations of nuclear power plants as city-forming enterprises (Fig. 2).
Rice. 2. Volume and types of services provided by the division’s subsidiaries
The final products of service subsidiaries are services and works, such as repair and maintenance of NPP equipment and systems, commissioning, scientific and technical support for NPP operation, as well as transport services, cleaning services, personnel outstaffing, IT infrastructure support, etc. All they are integral components of the cost (tariff) of electricity and power - the final product of the Concern and are closely integrated into the technological process of the nuclear power plant.
Service subsidiaries were created as a result of the outsourcing of auxiliary and maintenance functions from the generating business, while with obligations to maintain the social package for personnel at the nuclear plant level. At that time, there was a clear understanding that the Concern, through its wholly owned subsidiaries, would be able to flexibly manage the cost of services, the number and workload of withdrawn personnel, reduce the cost of technological raw materials and materials through the transfer of procurement functions to subsidiaries and affiliates, optimizing, first of all, its costs.
Despite the Unified Industry Procurement System (UIPS) and the presence of long-term contracts with a fixed price, as well as a system of price standardization through the establishment of planned economic indicators and lowering indices, the real cost of services of subsidiaries and affiliates is becoming more expensive every year. The key reason for this is the presence of boiler accounting and planning, the opaque cost structure of subsidiaries, as well as a non-working system of resource planning and issuing orders in volumetric terms by type of service; in other words, there is no link between the allocated funding limit and the volume of ordered services; the limits are formed on the basis of “what has been achieved.”
Financial, labor and material flows within the division are organized in such a way that, on the one hand, optimizing the Concern’s need for services for itself, as a key customer, leads to a reduction in the cost of its final product, and on the other hand, it slows down the growth of the scale of production of subsidiaries such as suppliers and bears the risk of undesirable social consequences.
The economic environment for the functioning of subsidiaries within the division has historically developed taking into account the following factors:
- subsidiaries are obliged to act within the framework of the same scenario conditions as the management company - growth in business scale, labor productivity, increase in profits;
- subsidiaries that provide maintenance services to nuclear power plants are almost 100% dependent on orders from nuclear power plants and manage an undiversified portfolio. Services are closely integrated into the technological process of generating electricity and power as the Concern’s final product;
- multidirectional interests of the management company and its subsidiaries, which is clearly expressed in the form of unbalanced goals and indicators (for example, service subsidiaries and affiliates are trying to increase revenue from sources in the Concern, but they are limited);
- functional “overregulation”, which does not allow subsidiaries and affiliates to independently make management decisions (overlapping areas of control);
- the rules and regulations of the Unified Industry Procurement Standard impose restrictions on the ability to manage the cost of services of subsidiaries and affiliates in order to optimize them;
- the presence of external significant participants in economic relations who also have the opportunity to influence the activities of the division’s subsidiaries - other shareholders, government bodies, suppliers and partners.
Thus, there is objectively an imbalance between the corporate interests of the management company and the interests of its subsidiaries, the purpose of which is to make a profit. “External challenge” for subsidiaries and affiliates: under given scenario conditions, increase operational efficiency and diversify the order portfolio (Fig. 3).
Rice. 3. Terms of interaction with subsidiaries
Corporate governance tools for subsidiaries
An effective model for managing subsidiaries should be based on at least two basic principles:
1) organizational and legal principle of management - “what the management company has the right to do,” “what it can demand,” “what it can achieve” from its subsidiaries in accordance with the law, primarily in the field of corporate law;
2) managerial (economic) principle of management - “what and how needs to be organized” by the management company in order to implement the necessary managerial impact on subsidiaries and affiliates, without resorting to a strict corporate principle. At the same time, corporate legislation in this case is an external limitation and determines the scenario conditions of interaction.
The Concern created the so-called “5 control system” (Fig. 4), operating on the basis of centralization of the management functions of subsidiaries and affiliates. Its essence is that, depending on the task at hand, either all key managers included in the system are involved in the process of making management decisions of the management company in relation to subsidiaries and affiliates, or partially, depending on the functional affiliation of the decision being made.
Rice. 4. System of 5 controls of subsidiaries
The system for making management decisions in relation to subsidiaries and affiliates is built on the principle of joint responsibility of key managers of the Concern as a management company, namely:
- production control - an institute of business supervisors has been created - bearers of basic production competence for the activities of the supervised subsidiary organization. The key task is to set production targets and determine development strategies, monitoring and preventing risks;
- budgetary control and plan-fact analysis of the current state - within the framework of the financial and economic block of the Concern, a structural unit has been created to manage the economy of subsidiaries and affiliates. Its key task is to monitor and analyze the financial and economic indicators of subsidiaries and affiliates, forecast and prepare analytical information for making management decisions, including in the field of investment management of subsidiaries and affiliates, participate in the development of decisions of the board of directors on asset management, profit distribution, and development strategies;
- functional control - monitoring and analysis of the dynamics of operating indicators of subsidiaries and affiliates in the following areas: personnel and social policy; procurement and compliance with the requirements of the unified industry procurement system; liquidity management and implementation of financial policies; management of investment projects and identification of sources of financing; implementation of a unified accounting policy and minimization of tax risks;
- corporate control - formation of corporate governance bodies of subsidiaries, management of share capital, implementation of dividend policy, formation of a regulatory framework for regulating interaction with subsidiaries and affiliates;
- internal control and audit - a system for managing the reliability of information provided to the Concern for compliance with legislation, internal corporate local regulations, auditing the implementation of management decisions, carrying out internal investigations.
Internal corporate mechanisms have been built with the help of which it is possible to ensure controllability and transparency of the Concern’s financial investments in the assets of subsidiaries, determine the possibility of obtaining reliable information about their value as businesses and make appropriate management decisions.
Economic management tools for subsidiaries
At the moment, economic management of the division's subsidiaries is carried out through the construction of a unified information space - a system of management accounting and reporting, based on regulations of the budget process, plan-fact analysis and forecasting within the framework of the methodology of the State Corporation Rosatom.
The unified management accounting and reporting system allows us to formulate scenario planning conditions based on the mutual interests of the Concern and its subsidiaries and affiliates, to determine target values of balanced financial and economic indicators, which would be impossible without prompt quarterly monitoring of the current state of the activities of subsidiaries and affiliates in key areas and performance indicators (Fig. 5).
Rice. 5. Objects of economic management of subsidiaries
The management reporting of subsidiaries, having passed through the examination according to the “5 control system”, is submitted for consideration to the Budget Committee, Investment Committee, Board of Directors (depending on competencies), as a result, the Concern, as a management company, makes appropriate corporate decisions. Decision-making gives grounds for subsidiaries to take legally significant actions, and for the management company (Concern) to monitor their implementation (in 2014, 229 decisions were made, in 2015 - 270, including those related to the payment of dividends). The dividend flow in 2015 increased almost 3 times compared to the previous year.
In addition to the system for analyzing financial and economic indicators, at the end of 2015, the financial and economic block of the Concern initiated the project “Implementation of a program to increase the operational efficiency of subsidiaries and affiliates for the period 2016-2018.” When implementing this project, the division's subsidiaries developed specific activities in key functional areas of activity (Fig. 6), determined the deadlines and those responsible for their implementation on the ground. A methodology for building programs and a package of reporting forms were also developed and “growth points” for subsidiaries and affiliates were identified in the following two areas:
1) due to external factors - reducing dependence on orders from the Concern and searching for new markets, expanding the scale of activity, diversifying the order portfolio (new products), new pricing policy;
2) due to internal factors - reduction in the unit cost of the final product, restructuring of business processes (including centralization of management functions).
Rice. 6. Objects of economic management of subsidiaries
The overall estimated economic effect from the implementation of the planned activities is the growth of the total free adjusted cash flow (AFCF, selected by the integral criterion) of the division's subsidiaries and affiliates, which is estimated at at least 15% in 2018 compared to the actual 2015.
Monitoring of the implementation of the declared economic effects from the implementation of the program to increase the operational efficiency of subsidiaries and affiliates is carried out through statistical forms for reporting the implementation of activities as of the reporting date, clarifying the calculated effects, analyzing the impact on the current and forecast budgetary parameters of subsidiaries, and developing proposals for adjusting activities.
conclusions
Currently, the management system for the division's subsidiaries provides operational monitoring of key business processes within the organizations. Besides:
- the order of functional interaction is regulated;
- unified management reporting formats have been developed;
- the traditional functions of the budget committee of the management company have been transformed into a decision-making platform based on the “here and now” principle;
- the decision-making process on profit distribution has been transferred to technology (dividend policy is linked to the investment strategy, a system of control over sources of financing);
- control over the activities of subsidiaries has been brought to the level of the General Director of the Concern.
The management model of subsidiaries depends to a large extent on the assigned tasks of the management company, the production role of subsidiaries in the value chain of the holding’s final products and the interest of the management company to respect the community of mutual corporate and economic interests.
(Baranov K.)
(“Shareholder Bulletin”, 2012, N 12)
HOW TO BUILD CONTROL BEST
OVER THE ACTIVITIES OF SUBSIDIARIES AND DEPENDENT COMPANIES?
K. BARANOV
Baranov Kirill, expert of the magazine “Shareholder Bulletin”.
Methods used in the technology: organizing control over the actions of the management of a subsidiary/dependent organization; limiting the powers of the subsidiary's managers; creation of a contractual policy in a controlled structure; development of a scheme for the protection of intangible assets.
Participants in the process: general director of the parent company, head of the subsidiary, specialists in the management of subsidiaries and affiliates.
In accordance with Art. 6 of the Federal Law of December 26, 1995 N 208-FZ (as amended on July 28, 2012) “On Joint-Stock Companies” (hereinafter referred to as the JSC Law), a company is recognized as:
- a subsidiary, if another (main) business company, due to its predominant participation in its authorized capital, or in accordance with an agreement concluded between them, or otherwise has the opportunity to determine the decisions made by such company;
- dependent, if another (dominant) company has more than 20 percent of the voting shares of the first company.
What resources does the company have?
1. Staff.
2. Means of production and money.
3. Intangible assets (organizational, social information resources, including knowledge).
When talking about the management of subsidiaries and affiliates, we most often mean a complex system with various components: personnel, means of production and finance, and intangible assets. And in each specific case this list can be individual. The main thing is that the process of distribution of these resources is properly controlled. How is this control achieved?
Rule No. 1. Organize control over the actions of the management of the subsidiary/dependent company. This way you will avoid risks.
In accordance with Art. 48 of the Law on JSC, the parent company has the right to transfer the following issues to the competence of the board of directors of subsidiaries and affiliates:
— increasing the authorized capital of the company by increasing the par value of shares or by placing additional shares;
— formation of the executive body of the company, early termination of its powers.
As practice shows, strictly following the law in this case is risky. It is better if the parent company itself forms the governing bodies of its “daughter”. This will avoid the risk that most often arises during remote management - the creation by top managers of a competing business, the so-called clone company.
Rule No. 2. Limit the actions of the heads of subsidiaries and affiliates and record this in the company documents.
The competence of the board of directors includes:
1) determination of priority areas of the company’s activities;
2) convening annual and extraordinary general meetings of shareholders, except for cases when other bodies may initiate it;
3) approval of the agenda of the general meeting of shareholders;
4) determining the date for compiling a list of persons entitled to participate in the general meeting of shareholders, and other issues within the competence of the board of directors (supervisory board) of the company;
5) placement by the company of bonds and other issue-grade securities.
Please note that this list is not complete. The list of issues falling within the competence of the board of directors is not exhaustive; the legislator left the list of such issues open.
The loyalty of staff to management, of course, can ensure the effectiveness of control by the latter. But this approach is too risky. Relying on loyalty alone, it will be extremely difficult to extinguish an unexpected conflict between the managers of the subsidiary and parent companies. In order to minimize risks when interacting with a subsidiary, you should consider the issue of limiting the powers of its manager and, as a result, determine the grounds for holding liable. In those subsidiaries where the parent company has 100% participation in the authorized capital, control is usually exercised over the activities of a sole or collegial management body. How can I do that?
Firstly, by limiting the legal independence of the subsidiary's governing bodies.
Secondly, by specifying restrictions in the employment contract with the top manager of the subsidiary.
Thirdly, by exercising operational control over the activities of top managers of the subsidiary.
Let's analyze each of the methods in detail. Limitations on the legal independence of the executive body are permitted by the JSC Law. In accordance with Art. 69, the competence of the executive body includes all issues of managing the current activities of subsidiaries and affiliates. You can provide in the charter a procedure for preliminary approval of a transaction or decision-making. Use, for example, the following wording: “Without prior approval from the general meeting of shareholders, the general director has no right:
1. Conclude transactions directly or indirectly related to the alienation, acquisition or encumbrance of the company’s property, if the price of such a transaction or set of transactions is equal to or exceeds 1,000,000 rubles.
2. Conclude employment contracts and issue orders on hiring or dismissal from work in (or from) the position of: deputy general director, chief accountant, financial director, commercial director, production director, etc.”
Please note that it is extremely important here to be precise in identifying the actions that limit the activities of top managers. Avoid vague wording and phrases that cause double interpretation.
The same restrictions should be recorded in the employment contract with the head of the subsidiary company. By the way, it would not be a bad idea to register the latter as a part-time employee of the parent company by concluding a part-time contract. Thus, if the director of a subsidiary abuses his powers, the parent company will be able to recover damages caused to the subsidiary. And even apply disciplinary sanctions against him.
Pay attention in advance to the contents of the documents that regulate the work of the general director, namely:
- employment contract;
- job description.
Such a scheme of working with the head of a subsidiary will keep him on his toes and limit his freedom of action. Feeling behind him not an abstract shareholder in the form of a huge, clumsy corporate structure, but a specific person (supervisor) giving him direct instructions, this will allow the director of the subsidiaries and affiliates to realize his position. The curator here can be the general director of the parent company. And you shouldn’t entrust this right to someone else.
In addition to restrictions, the job description should specify functions and structural subordination, as well as establish a provision on the mandatory implementation of orders of the immediate supervisor - the supervisor.
As a result, you should have a system that functions autonomously: the general director of the subsidiaries and affiliates makes decisions, promptly coordinating them with the curator. The parent company retains control over the resources of the subsidiary to the extent necessary and reflected in its charter.
Rule No. 3. Develop a contractual policy in your subsidiary that could become an effective tool for financial control.
What is important to know here? That the contractual policy of a subsidiary can prevent the withdrawal of finances through the unauthorized use of production equipment, its sale, pledge, etc., as well as the sale of products at inflated prices. We are talking about a certain document that determines the actions of employees of subsidiaries and affiliates when concluding contracts for their main economic activities. Please note that the policy, as a document regulating the internal procedures of the subsidiary, is approved by the parent company.
What might such a document include?
Firstly, the criteria for selecting counterparties.
Secondly, the procedure for identifying the counterparty.
The criteria for selecting a counterparty should contain not only information on how to sell the manufactured product (service) most profitably, but also how to establish requirements for the future party to the transaction.
Such criteria may include:
— how long ago the counterparty was registered as a legal entity, in other words, how many years it has been operating in the market;
— information about the personnel of management bodies;
— information about the origin of the counterparty’s capital (borrowed or owner’s funds).
The identification procedure regulates the actions to obtain information and documents from a potential counterparty. Usually these are documents confirming the powers of management bodies, charter, certificates, etc. Please note that they should be requested in the form of copies certified by the seal of the counterparty. In order to avoid the risks of providing false information by the top manager of the subsidiaries and affiliates, it would be good to oblige him to show these documents to the curator for their approval.
What is also important here is the content of the contract for the main business activity: the sale of goods or the provision of services. To be on the safe side, develop a standard form of contracts. In addition, establish a rule under which the procedure for making changes to the form of the contract will be made with the prior consent of the main company.
Rule No. 4. Be sure to protect intangible assets. These include information and intellectual property. For example, a brand. To begin with, it would not hurt to study the law regarding the legal protection of such assets: Federal Law of July 27, 2006 N 152-FZ (as amended on July 25, 2011) “On Personal Data”, Federal Law of July 29, 2004 N 98-FZ ( as amended on July 11, 2011) “On trade secrets.” Again, refer to the norms of Part IV of the Civil Code of the Russian Federation, which, as we remember, regulates issues of intellectual property protection. It is advisable to assign intellectual property rights to the parent company. And organize the use of the trademark by the subsidiary on the basis of a license agreement. By the way, in accordance with paragraph 5 of Art. 1235 of the Civil Code, such an agreement may be free of charge. This means that the subsidiary will not incur additional costs for using the trademark.
Attention!
The parent company needs to determine what information has commercial value. This may result in the creation of an appropriate provision on trade secrets of a subsidiary. This document, by the way, is approved by the head structure. In addition, an agreement on non-disclosure of confidential information should be concluded with all employees of the subsidiary organization, which would include a list of information that constitutes a trade secret. Thus, in the event of a confirmed fact of disclosure of information to competitors, the subsidiary will be able to recover compensation for the damage caused from the employee. If the company’s structure is highly branched and there are many employees at different levels, it would be good to include in the regulations the conditions for providing them with access to certain information. For clarity, such information can be presented in the form of an appropriate matrix.
Alexander Molotnikov
Head of Corporate Governance Department
JSC FPK "Slavyanka", Vladimir
The operating efficiency of a subsidiary depends on many factors, including how the intra-company administrative vertical is structured.
As a rule, top managers of holding companies concentrate on solving global strategic tasks, forgetting that their successful implementation will ultimately depend entirely on the activities of specific subsidiaries. There are examples where brilliant strategic business decisions were either not implemented properly or remained unimplemented. That is why it is important to understand how exactly subsidiaries need to be managed.
Domestic holdings can use one of three models for managing the current activities of a subsidiary:
· sole executive body (director, general director);
· collegial executive body (board, directorate) and sole executive body (chairman of the board);
· management organization or manager - parent company or specialized company, third party.
CEO
The most common and frequently used management option is the use of a sole executive body. In this case, the person performing the functions of the general director alone solves all current problems facing the company, independently disposes of property, the value of which does not exceed 25% of the book value of the company’s assets, and determines the internal structure of the enterprise.
After listing even a small part of the rights of the general director, his key role in the management of the company becomes obvious. Sooner or later, the parent company is faced with a difficult task: how, within the framework of the law, to limit or bring under control the activities of the executive body of the subsidiary, without having a negative impact on the management processes within the company?
In this situation, it is necessary to take into account that the main guarantee of normal working relations between the management of the holding and the general director of the subsidiary company is detailed regulation of their mutual rights and obligations, which should be enshrined in the charters of enterprises and in other internal documents, for example in the “Regulations on the General Director of the Company "(hereinafter referred to as the Regulations), as well as in the employment contract concluded with the General Director.
Of course, the Charters should not cover in great detail the activities of the executive body of a subsidiary. For example, in the Charter of a subsidiary it will be enough to list the issues within the scope of the director’s activities and determine the body responsible for his election and termination of powers (general meeting of shareholders or Board of Directors). More detailed regulation of activities should be contained in the Regulations, in which it is necessary to pay attention to certain points.
· The procedure for appointment and dismissal from a position. This section describes in detail the procedure for electing the general director: the requirements for applicants are established (education, professional and business qualities, experience in management positions), the procedure for nominating candidates and providing information about persons applying for this post is indicated. Particular attention must be paid to the election procedure itself: by what number of votes (simple or qualified majority) it is carried out.
In addition, we must not forget about such a specific procedure as the assumption of office by a newly elected general director and the transfer of affairs by his predecessor. The absence of a detailed mechanism for the transfer of cases in the “Regulations on the General Director” can lead to very sad consequences.
Example. The General Meeting of Shareholders decided to prematurely terminate the powers of the former general director, who was convicted of theft. Instead, a new leader was elected, who arrived at the enterprise the next day after the meeting, with the corresponding protocol in hand. However, his predecessor refused to allow the new general director to enter the plant and transfer affairs. These actions were motivated by the fact that he still continues to be the CEO, because. the new manager has not yet concluded an employment contract with the joint-stock company. And he turned out to be right, because in accordance with the Law “On Joint Stock Companies”, the agreement with the general director must be signed by the chairman of the Board of Directors or another authorized person. The situation was complicated by the fact that the Chairman of the Board of Directors was on a long business trip abroad, and it was not possible to assemble a quorum of the Board of Directors in the next few weeks. Ultimately, the employment contract was signed only two weeks after these events. At the same time, throughout the entire time, the former director, dishonestly disposing of the property of the enterprise, tried to extract the maximum of personal benefit.
This could have been avoided if the “Regulations on the General Director” had clearly stated that “the newly elected General Director takes office from the moment of his election by the general meeting of shareholders.”
The Regulations should describe the procedure for transferring affairs to the new director from his predecessor. The round seal of the company and its constituent documents must be handed over. In addition, to establish the real state of affairs at the enterprise, it is necessary to provide for an inventory of inventory items. After carrying out these procedures, the new and old general director must sign the act of acceptance and transfer of affairs.
Attention should also be paid to the grounds for dismissing the director from his position. This may be not only the grounds provided for by labor legislation, but also a number of others: damage to the business reputation of the company; establishment of commercial organizations that compete with the company, or participation in them during the period of performance of the duties of the general director; concealing one’s interest in making a transaction with the participation of the company, etc.
· Rights and responsibilities of the general director. When drawing up this section of the Regulations, it is necessary to regulate in as much detail as possible the procedure for the activities of the general director, and one should proceed from the principle: the more, the better. Particular attention is paid to mechanisms of control over the activities of the executive body. The holding company must clearly understand that stipulating in the Regulations the obligation of the general director to report to the parent company is illegal. Therefore, control over the activities of the director should be entrusted to the Board of Directors of the subsidiary, which, in turn, is formed from candidates supported by the parent company.
Practice shows that the main management goal of the position under consideration should be a rigid vertical: Board of Directors - General Director. This approach allows not only to promptly communicate the instructions of the parent company to the executive body, but also to exercise effective control over their implementation.
· Responsibility of the General Director. This section must also be present in the “Regulations on the General Director”. Here it is established that the director bears full responsibility for damage caused to the organization. In addition, it is advisable to indicate how the calculation of losses caused to the company will be made, as well as the procedure for their compensation.
We cannot ignore the issue of applying disciplinary sanctions to the general director, such as a reprimand or reprimand. If this point remains unresolved, there is a high likelihood of legal errors being made.
Example. The parent company decided to reprimand the director of its subsidiary, but the question immediately arose: who should apply this penalty to the director, since neither the Charter of the subsidiary nor the Regulations on the General Director addressed this problem. Ultimately, the parent company insisted that the reprimand be issued by the subsidiary’s deputy director for personnel management, which in itself contradicts relations within the company: a subordinate cannot punish a boss! To avoid such situations, the Regulations should indicate that disciplinary sanctions against the general director of the company are applied based on the decision of the Board of Directors by its chairman.
In addition to the Charter and Regulations, the activities of the General Director are regulated by an employment contract. At its core, the employment contract duplicates the content of the “Regulations on the General Director”, but it is characterized by the presence of a number of other conditions. In particular, this concerns the remuneration of the director. The employment contract must necessarily contain the amount and procedure for paying wages to the general director; in addition, it may indicate social guarantees, including the right to purchase a certain number of shares in the company on preferential terms (option), as well as the right to receive part the company's net profit.
The employment contract also contains the grounds for the dismissal of the general director from his position. It should be taken into account that if the director is forced to resign early, then in the absence of guilty actions on his part, he is paid compensation for early termination of the contract. In order to avoid the obligation to pay the former director very significant compensation amounts, it would be reasonable to provide in the contract as many grounds for dismissal of the director as possible, including among them various types of guilty actions of even the most insignificant nature.
When talking about the dismissal of the general director, special attention should be paid to the need to carry out this procedure as quickly as possible.
Example. The Charter of the subsidiary company (company “B”) states that its general director is elected and dismissed from his position based on a decision of the general meeting of shareholders of this company. The parent company (company "A"), which owns 77% of the voting shares of company "B", found out that the general director of the "subsidiary" created a number of commercial organizations that, at reduced prices, purchase the products of their own enterprise for subsequent sale. This causes significant harm not only to subsidiary “B”, but also to parent company “A”. Then the parent company decided to fire the unscrupulous director. According to the Charter of Company “B”, this requires:
· firstly, to initiate consideration by the Board of Directors of the subsidiary company of the issue of convening an extraordinary general meeting of shareholders of this company;
· secondly, hold a general meeting of shareholders and decide on the early termination of the powers of the general director.
From the moment of the meeting of the Board of Directors to the holding of the general meeting of shareholders, the established period of one month passed. During this time, company “B”, as a result of the activities of the general director, lost a large part of its property.
Of course, such a procedure for removing the general director of a subsidiary company cannot in any way suit the parent company. Indeed, during the procedure for removal from office, he will continue to perform his duties, realizing that his removal from office is only a matter of time. And it is impossible to make a decision to dismiss a director from office in any other way, since it will not be legitimate. To avoid such a situation, the parent company should establish in the Charter of the subsidiary the possibility for the Board of Directors to suspend the powers of the general director and form a temporary sole executive body of this company, which would be vested with the full power of the general director.
Thus, the action plan of company “A” could look like this: firstly, initiating a meeting of the Board of Directors on the suspension of the powers of the old general director and on the formation of a temporary sole executive body of the company (the candidacy, of course, is agreed with the parent company); secondly, holding a general meeting of shareholders, at which the powers of the previous general director are terminated and a new one is elected. We especially emphasize that this procedure for suspending the powers of a director is possible only if it is expressly provided for by the Charter.
Collegial executive body
The next model for managing a subsidiary is a combination of a collegial executive body, for example the board, and a sole executive body, for example the chairman of the board. It should be noted that this scheme is not as common as the one discussed above. This is due to many reasons, including the peculiarities of the domestic management system, which is characterized by an authoritarian rather than collegial approach to solving emerging problems. In addition, in this case, there is a “dispersion” of responsibility for incorrect management decisions.
However, the presence of a collegial management body also has its advantages: in particular, when solving complex, multifaceted problems, it is preferable to use a collective management body, and with its help you can create a fairly strong team of managers.
The formation of the board is carried out on the basis of the same principles as the election of the general director. In particular, members of the board can be elected either by the general meeting of shareholders or by the company's Board of Directors. At the same time, the election of members of the board and directly the chairman of the board can be carried out by various bodies. A striking example of this approach is RAO UES of Russia, where the board is elected by the company's Board of Directors, and the chairman of the board is elected by the general meeting of shareholders.
The activities of the board are regulated not only by the company’s Charter, but also by a special “Regulation on the Board of the Company”. This document, along with the sections contained in the Regulations on the sole executive body of the company (appointment and dismissal, rights and obligations, responsibilities), should include information on the procedure for holding meetings of the board. In other words, the mechanism for forming the agenda of meetings, the procedure for convening meetings, as well as making decisions.
Members of the Management Board, unlike members of the Board of Directors, are employees of the company, therefore a separate employment contract is concluded with each of them.
When deciding on the formation of a collegial executive body in a subsidiary, it is necessary to take into account one more important detail. As is known, parent companies, when forming the Boards of Directors of their subsidiaries, strive to evenly combine the number of representatives of the holding and directly leading managers of the subsidiary. However, with this method of managing the company, it is not possible to achieve the specified balance. This is due to the requirements of the law, which prohibits board members from constituting more than a quarter of the organization's Board of Directors. Consequently, it is necessary to either remove some of the smart managers from the board (but then what is the point of creating this body), or abolish the collegial executive body.
Management Company
The third model for managing subsidiaries is a scheme that is gaining increasing popularity among domestic holding companies - the transfer of powers of the sole executive body to the management organization. As a rule, the role of the management company is directly played by the parent company, which owns the shares of the subsidiary, which allows it to keep the entire power vertical of the subsidiary under control. However, I would like to warn against the dangers that await mainstream society in this situation.
According to current legislation, the management company is responsible for losses caused to the company. In this case, a claim for damages can be filed by any shareholder owning at least 1% of ordinary shares. There is no need to explain that in the course of business activities, various situations arise in which property damage to the company may be caused. In some cases, the parent company may even decide to file bankruptcy for its subsidiary in order not to pay the huge amounts of accounts payable left over from the previous management team. However, these steps will be negatively perceived by small shareholders of the subsidiary, who have the right to demand compensation for damages. Of course, the management company, being a holding company, has on its balance sheet shares of various enterprises, as well as quite serious property assets. Consequently, the court will easily recover these damages and may also preliminarily impose a security lien on the shares owned by the company, prohibiting them from voting. It is unlikely that this scenario will suit the mother society. In order to avoid such a situation, managers can be asked to separate the functions of the holding and the management organization. In other words, two legal entities are created. The balance sheet of the first focuses on shares and property assets, on the balance sheet of the second - only the amount of paid authorized capital (if it is a limited liability company, you can stop at the minimum amount - 10,000 rubles). The second company becomes the management company of all subsidiaries whose shares are owned by the first legal entity. Thus, even if the court obliges the management organization to pay for losses caused by deliberate bankruptcy, the penalty will be imposed only for the amount of the authorized capital, but the company’s participants will not suffer, because according to the law they are liable only to the extent of their contributions.
When deciding to transfer the powers of the sole executive body to a management organization, it is necessary to strictly follow the procedure for this process. The following sequential stages are distinguished:
· The board of directors of the company decides to propose to the general meeting of shareholders to transfer management functions to a specialized organization. At the same time, a decision is made to hold an extraordinary general meeting of shareholders;
· the extraordinary general meeting of shareholders decides to transfer management functions to a specialized company;
· The Board of Directors approves the terms of the agreement concluded with the management company;
· the chairman of the Board of Directors or another person authorized by this body signs an agreement with the management company.
Failure to comply with at least one of the above conditions indicates that management functions have not been transferred to a specialized company. This is confirmed by an incident that occurred last fall at a Russian enterprise.
Example. The parent company decided to take over the management functions of the subsidiary, in pursuance of which it convened a general meeting of shareholders, at which a corresponding decision was made. However, subsequently the main company abandoned its plans, fearing property liability for causing losses to the subsidiary, so the agreement on the transfer of functions of the executive body remained unconcluded.
The question arises: does the general director have the right to continue to perform his duties or is a decision of the general meeting of shareholders required to cancel the previous decision. In this case, despite the complexity of the relationship, the answer should be positive - the director continues to work until an agreement is signed with the management company. Therefore, in order to properly formalize the powers of the management company, strict adherence to the procedure established by law is necessary.
Having examined various models for managing the current activities of subsidiaries, it should be noted that there are no universal schemes that are equally acceptable for any company. In each specific case you need to look for your own management solution.
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