Larger organisations in particular may have tens or even hundreds of wholly- or partly-owned subsidiaries, which raises the question of how to govern them. Simply put, should they be governed at subsidiary level or at group level? And how does the role of the director change as a result? Interestingly, these questions arise in 100%-owned subsidiaries, as well as in those where the group has a majority stake or even a large minority holding. This chapter reflects on the diversity of best practices from different environments in the hope of inspiring further governance evolution in this area.

The issue of subsidiary/holding governance is becoming even more important for three reasons:

• the rise of national interests;
• increasingly engaged financial actors;
• the dynamics of business transformation.

As countries around the world increasingly seek to assert their national interests, their regulators and governments are asking for governance decisions to take place in their country and not at international headquarters. They have thus started imposing decision powers at national governance level, including in banks and insurance companies. National interests must now be protected in many areas, such as financial stability, health, and food safety. Regulators are asking for national subsidiaries to have effective boards, not just boards on paper.

As a result, subsidiaries of international groups must often go beyond complying with national laws. They must also ensure that governance, strategic decisions, and the management of any failures all protect that country's national interest. These issues therefore need to be considered at national or local level as part of a decision process. Group governance can no longer simply be imposed at national level. National boards of international groups are thus becoming more significant.

Second, previously passive financial actors, including sovereign wealth funds, increasingly regard governance as a key risk. They are therefore becoming more engaged in nominating or influencing board members, leading to what can effectively become a subsidiary/holding relationship, albeit at the other end of the spectrum to the fully owned subsidiaries of many groups. These financial actors are so proactive, creative, and resourceful that they are helping to redefine subsidiary/holding governance.

Finally, and most importantly, business transformation has shaken traditional organisational structures. Companies confronted with the reality of natural selection need to evolve and innovate. Often, this entails self-cannibalisation or diversification, which are best achieved in external but controlled entities. One classic example of this is Nestlé and Nespresso. Similarly, Russia's Sberbank developed its IT capabilities by creating an external entity. This was so successful that it became the largest player in the country; Sberbank then reintegrated it. Ant Financial and Alibaba are another good example. Firms may also need to separate previously joint activities in order to be able to sell or restructure that business more easily.

The art of subsidiary governance is to balance alignment with the holding company or group with the independence of a subsidiary's decision-making. This balance will vary depending on context. For example, the oil majors keep a tight rein on their subsidiaries, joint ventures, and production-sharing agreements. The boards of these entities have strict rules to follow, directors are direct employees of the owner, and decisions are clearly brought back to group level whenever something critical happens. The group tightly controls structures (including the shareholder agreement, board organisation, and committees) and also culture (as reflected in board practices, the notion of independence, and the style of board discussions).

At the other end of the spectrum, many financial actors, including sovereign wealth funds, tend to take a slightly looser approach. For example, the International Finance Corporation (IFC), the investment arm of the World Bank group, nominates independent external directors to be board members of its investee companies, sometimes even when the IFC holds a large stake. Similarly, Temasek, the sovereign wealth fund of Singapore, mostly uses independent directors and allows quite a bit of freedom of structure in its subsidiaries, even the fully owned ones. In the latter case, shared culture will typically ensure a certain level of consistency between the fund's overarching objectives and the decisions of its subsidiaries.

In subsidiary governance, the two main levers for adjusting the intensity of control or independence are structures and culture.

Structures

Some groups have embedded strong structures in their subsidiary governance. These can emanate from the original shareholder agreement. For example, board representation, or structures such as committee choices and chair nominations, can be clearly set out in the structuring of the organisation. In some family businesses, the representation of different family members across the group's various subsidiaries provides a basic structure. My team and I work with a family where the siblings and their children hold board positions in different subsidiaries according to their own skillsets. In addition, the siblings sit on the group board along with independent directors.

Some of the most sophisticated structures for subsidiary governance are found in the oil and gas industry. For example, I work with a national oil company that has more than 100 subsidiaries. The group proceeded by mapping these subsidiaries in terms of their strategic importance and the governance influence that the group has (some are joint ventures with strong foreign partners). The group then mapped board decisions across three dimensions:

• Long-term value, typically including strategy and capital expenditure decisions.
• Short-term performance, including the annual budget, operational organisational matters, and individual performance.
• Organisational health, including HSE (Health, Safety and Environment) responses, risk reviews, and board effectiveness.

Within these categories, about 25 typical decisions are mapped. A decision is then taken as to whether the owner representatives on the board should be proactive in representing the group, or whether the directors should have the responsibility to choose. A director who proactively represents the owner might engage in mandatory consultation with the group at the appropriate level – such as an asset manager within the group or an individual responsible for governance.

The structure thus allows for a complete mapping of the group's engagement at subsidiary level, depending on the nature of the subsidiary, the group's willingness to engage, and the type of decision considered. It also illustrates the duality of ownership representation on these boards, as some decisions are taken fully independently while others require direct group representation. The clarity brought by the system is valuable.

Culture

Another way to tune subsidiary governance is through the culture embedded within boards and within directors themselves. This is a strong driver of success, as organisations such as Temasek have shown. Indeed, culture may appear to be the best driver of successful subsidiary governance, or even investee governance. This happens when truly independent directors share the same fundamental values – notably integrity, a sense of purpose, and responsibility – and the same overarching national or organisational objectives, and then decide freely what is right for the organisation.

The challenge for the group is thus to drive a well-aligned culture across subsidiaries while preserving the spirit of independence that is fundamental to good governance. This is often quite difficult. More tightly controlling groups risk having a small number of like-minded directors who lack the diversity and competitiveness of their peers in a more open group. Best practices thus include fostering a natural selection process among board members themselves, with those most able to combine alignment and independence rising further faster.

To help develop alignment, a group should organise regular sessions that bring together directors from different subsidiaries. These gatherings should focus on key dimensions such as essentials of governance effectiveness, as well as other timely issues such as cybersecurity or geopolitics, for example. Ideally, the sessions will use multiple formats and shapes (lecturers, speakers, panels, and brainstorming groups), and take place throughout the year to ensure engagement and continuous education.

In some contexts, these culture elements have become very solid. Think, for example, of the role of the party in the governance of China's state-owned institutions – including through the professionalism of Huijin, the Chinese sovereign wealth fund department dedicated to the governance of financial institutions.

There is a risk of driving the subsidiary governance process too much through culture and not enough through structures. The risk is that the homogeneity of board members will make governance less effective, especially when creativity and innovativeness matter. It is thus important to welcome some disruption and encourage a true diversity of perspectives when governing subsidiaries. This can be done within the framework of common values that are well appreciated by all involved.

By establishing the right structures and culture, groups and organisations can fine-tune subsidiary governance to their purpose. The key is to balance independence and alignment. The most engaged groups determine the level of alignment they want at each subsidiary and then create it through these two levers. And in the next chapter, we discuss how boards can enhance entrepreneurial leadership.