What is meant by the term ‘holding company’?Dear Teenteen readers: let’s talk about a slightly difficult topic? Have you ever heard the term a “holding company?” You may have heard of a “stock company” but a holding company may be unfamiliar.
A holding company is a company that owns (or holds) other companies (subsidiaries) and supervises their performance. There are many companies called “some name or other” Holdings. Holding companies take part in the management plans of their subsidiaries, which is a major difference from owning shares in other companies simply for investment purposes.
Holding companies originated in the United States in the late 19th century. Since large firms were banned from colluding to raise product prices, some companies came up with the measure of setting up holding companies. Having operated this system for a time, many firms discovered a lot of merits to holding companies, and gradually improved the concept to its current shape.
Korea blocked the holding company system out of fear that conglomerates would monopolize the market. The reasoning was that one company having multiple subsidiaries might allow it to dominate the market.
However, the government allowed the establishment of holding companies after the foreign currency crisis of the late 1990s. It was meant to boost corporate transparency as the holding company system publicly exposes major shareholders and makes it easy for holding companies to do away with business units that show poor performance. In addition, the system’s simple shareholding structure makes the stock trading process simpler.
Holding companies are often described as “a company belonging to a large conglomerate that has a major stake in other affiliates.” But its legal qualification is defined by the fair trade law. Currently, holding companies meeting the qualification in Korea total 31 (including four financial holding companies) ― including LG Corp. and GS Holdings Corp. LG Corp. has such subsidiaries as LG Electronics, LG Chem and LG Telecom. GS Holdings Corp. has GS Caltex, GS Retail and GS Homeshopping.
There are two subtypes of holding companies: pure holding companies and corporate holding companies. Pure holding companies are not engaged in business activities such as manufacturing, distribution and sales, but instead set up management plans and oversee their subsidiaries. Their key source of profit is dividends from the subsidiaries, in proportion to their business performance. Corporate holding companies are often called mixed holding companies, which run their own businesses and at the same time take the unique role of holding companies.
As mentioned earlier, holding companies follow certain legal boundaries. Let’s take a deeper look into the regulations. First, holding companies should have secured 30 percent or more of the stake in each of their subsidiaries (for non-listed subsidiaries, 50 percent). Stake ownerships between subsidiaries are prohibited by the law. Holding companies having financial firms and non-financial firms as subsidiaries are forbidden, too. The debt ratio of holding companies should be lower than 100 percent. (The Fair Trade Commission is considering plans to raise the ceiling to 200 percent.)
Why do many companies try to convert themselves into holding companies, despite such complicated regulations? More than anything else, they can solidify corporate transparency.
The so-called jaebeol, local conglomerates, have very complicated shareholding structures. For example, there are two types: Company A holds shares in Company B and vice versa (cross shareholding) or company A holds shares in Company B and B holds in C and C holds shares in A (circulatory shareholding). Under these circumstances, poor business showing by one subsidiary deals a direct blow to the other subsidiaries.
Besides, the chairman of the group can easily control the subsidiaries with a small portion of stocks through such a complex web of stockholding. This means it can hurt independent management by each subsidiary, thus degrading corporate efficiency.
The holding company system simplifies the stockholding structure, and thus enhances transparency. Subsidiaries can concentrate on their own business without the burden of financing sister companies under the same holding company. However, it is far from easy for enterprises to set up holding companies.
First, it takes a lot of capital. Let’s take the example of Samsung Group. Suppose it plans to establish a holding company and have Samsung Electronics as a subsidiary. Samsung Electronics’ market value is currently 100 trillion won and to meet the qualification of a holding company (securing 30 percent of stake in each subsidiary) will take 30 trillion won.
Even if the group borrows 20 trillion won in bank loans by raising the debt ratio ceiling to 200 percent, it still needs to pay out 10 trillion won from its own pocket. The cash needed for securing shares in other subsidiaries may amount to trillions of won. It is practically impossible for any conglomerate chairmen to come up with such huge amounts.
For this reason, conglomerates are constantly asking the government to lower the shareholding ratio in subsidiaries from 30 percent to 20 percent. They also complain that the government is pressuring them to establish holding companies although the holding company system is not the only method to enhance corporate transparency.
Companies still have vastly different views over the holding company system.
by Lee Hyun-sang
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