The following post comes to us from Kenneth Ayotte, Professor of Law at Northwestern University, and Henry Hansmann, Professor of Law at Yale University.
The large modern business corporation is frequently organized as a complex cluster of hundreds of corporate subsidiaries under the common control of a single corporate parent. General Electric, for example, has over 1500 subsidiaries, most of them wholly-owned. What is the purpose of all these subsidiaries? Do they exist only as a means of avoiding taxation and regulation? Or are there real efficiency gains that subsidiaries can help unlock?
In our paper, Legal Entities as Transferable Bundles of Contracts, which was recently made publicly available on SSRN, we provide new theory and supportive evidence that help explain a relatively unexplored benefit of subsidiaries. We focus, in particular, on the advantages of subsidiary entities in enhancing the transferability of a business unit. The theory not only sheds light on corporate subsidiaries, but illuminates a basic function of all types of legal entities, from partnerships to nonprofit corporations.
Many of the modern firm’s key assets come in the form of bilateral contracts, in which both parties to the contract are exposed to performance risk from the other party. Take, for example, the movie rental company, Redbox, which is a wholly-owned subsidiary of Coinstar. Many of Redbox’s key assets are contractual, including agreements with movie studios to acquire DVDs, and revenue sharing agreements with companies like Wal-Mart that house Redbox kiosks. Real estate, such as corporate headquarters and processing facilities, are frequently acquired through long-term leases.