Potential Drawbacks of Holding Companies

Groups like Tata, Reliance, and Aditya Birla run dozens of companies, and holding companies sit at the top of the pyramid. A holding company owns a controlling stake in one or more subsidiaries, letting one board direct many businesses through relatively modest capital. It is a powerful structure, but power without checks tends to create problems. Once you consolidate control across several legal entities, transparency, accountability, and fairness to smaller shareholders all become harder to guarantee. This post walks through the real, practical limitations of the holding company structure that every commerce student should understand before analysing group accounts.

What makes a company a holding company 🔗

Under the Companies Act, 2013, a company becomes a holding company when it controls the composition of another company’s board, or holds more than half its voting power or share capital. That other company then becomes its subsidiary. This structure lets a company that owns even 51% of another company’s shares treat it as a virtual extension of itself for management purposes, while the two remain separate legal entities in the eyes of the law. That separation is exactly where most of the limitations discussed below come from: control without full legal merger creates gaps that can be misused.

Concentration of economic power in a few hands 🔗

A holding company can control a subsidiary by owning just over half its shares. That subsidiary can, in turn, hold a controlling stake in a step-down subsidiary, and so on. With each layer, the amount of actual capital needed to control the whole chain shrinks, while the assets and revenues under command keep growing. This pyramid effect means a small group of promoters or directors can end up controlling businesses worth many times their real investment.

The IL&FS group is a well-documented example of how far this can go. Infrastructure Leasing & Financial Services was structured as a “hydra-headed” organisation with over 340 subsidiaries, joint ventures, and associate companies, layered so deep that even regulators struggled to map the group’s true exposure. When control is spread this thin across so many entities, ordinary shareholders and even lenders lose any real sense of who is accountable for what.

Room to create secret reserves 🔗

A secret reserve is a hidden cushion of undisclosed profit, created by deliberately understating assets or overstating liabilities so the balance sheet looks weaker than it really is. Holding companies find it easier to build these reserves because profits and losses can be shifted between the parent and its subsidiaries through internal transactions, pricing decisions, or the timing of dividend declarations. A subsidiary’s profits might be held back one year and released the next, purely to smoothen the group’s reported numbers rather than reflect actual performance.

This matters because secret reserves distort the picture for everyone who is not inside the boardroom, including minority shareholders, tax authorities, and lenders who rely on the financial statements to judge risk.

Difficulty in knowing the group’s real financial position 🔗

Because a holding company and its subsidiaries file separate financial statements as individual legal entities, anyone reading just the holding company’s standalone balance sheet gets an incomplete picture. Loans, guarantees, and cross-holdings between group companies can inflate the apparent scale of the business without adding any real value. A subsidiary might be heavily indebted while the parent’s own books look healthy, masking the group’s true risk.

Why consolidated financial statements are now compulsory 🔗

This exact problem is why Indian law now insists on group-level reporting. Section 129 of the Companies Act, 2013 requires financial statements to present a true and fair view of the company’s affairs, and its sub-section (3) goes further: any company with subsidiaries must also prepare a consolidated financial statement covering the whole group. As one legal analysis notes, this consolidation requirement mirrors global IFRS practice, which mandates combined reporting wherever one entity controls another. For B.Com students, this is the direct link between the accounting technique of consolidation and the real-world governance problem it was designed to fix.

Higher risk of mismanagement 🔗

When one set of directors effectively controls several companies at once, oversight gets thin. A director juggling responsibilities across five or six group entities cannot scrutinise each one the way an independent board would. Decisions taken “for the group” may not always suit an individual subsidiary or its own shareholders, and by the time problems surface, they have often spread across multiple companies rather than staying contained in one.

This is precisely what regulators found at IL&FS. An academic review of the collapse pointed to corporate governance lapses, poor risk management, and manipulated financial reporting across the group’s web of subsidiaries and joint ventures. A single point of control, once it fails, can bring down an entire network of companies with it.

Fraud in inter-company transactions 🔗

Because a holding company and its subsidiaries deal with each other constantly, buying goods, lending money, providing guarantees, and sharing services, there is ample scope to manipulate the terms of these transactions. Goods can be transferred at artificially high or low prices to shift profit from one company to another, often to reduce tax outgo or to prop up a weak subsidiary’s numbers before it goes to the market for fresh funding.

Recognising this risk, Indian company law places related-party transactions between group companies under close scrutiny: Section 188 of the Companies Act requires board and, in larger transactions, shareholder approval for dealings between a holding company and its subsidiary, precisely because such transactions are not automatically presumed to be fair.

The IL&FS wake-up call 🔗

The most cited Indian example of this limitation playing out is, again, IL&FS. The Serious Fraud Investigation Office alleged that the group’s parent and key subsidiaries borrowed short-term funds based on window-dressed financials, then lent this money onward to project subsidiaries at high interest rates. In effect, inter-company lending was used to disguise the group’s true financial stress for years before it defaulted on nearly ₹91,000 crore of debt in 2018. It remains a textbook case of how inter-company transactions, left unchecked, can hide problems rather than solve them.

Forced appointment of directors on subsidiary boards 🔗

Because a holding company controls the voting power in its subsidiary, it can appoint directors of its own choosing to the subsidiary’s board, regardless of what the subsidiary’s other shareholders might prefer. These nominee directors typically act in the interest of the parent company first, which can mean decisions at the subsidiary level are driven by group strategy rather than by what is best for that specific company and its own minority investors. Employees and shareholders of the subsidiary often have little real say in who governs the company they have invested in or work for.

Oppression of minority shareholders 🔗

Minority shareholders in a subsidiary are particularly vulnerable in a holding-subsidiary structure. The parent company, holding a majority stake, can push through resolutions, control dividend policy, and structure inter-company deals in ways that primarily benefit the wider group rather than the subsidiary’s own smaller investors, who have limited ability to object or exit.

What the law offers as a remedy 🔗

Indian company law does provide a route for redress. Sections 241 and 242 of the Companies Act, 2013 allow a member meeting a minimum shareholding threshold to approach the National Company Law Tribunal for relief against oppressive or prejudicial conduct, and the Tribunal has wide powers to regulate the company’s affairs, remove directors, or order a fair buyout of shares. But this remedy involves litigation, time, and cost, which is exactly why the underlying structural risk is worth understanding rather than relying only on after-the-fact legal recourse.

A quick summary 🔗

None of this means holding company structures are inherently harmful. They exist because they genuinely help businesses diversify, raise capital efficiently, and manage risk across different ventures. But every one of these limitations is exactly why consolidated accounting, related-party disclosure norms, and minority protection laws exist in the first place. Understanding the weaknesses is what makes the accounting safeguards make sense.

What do you think? If you were designing accounting rules for group companies today, would consolidated financial statements alone be enough to catch problems like the ones seen at IL&FS, or does the risk lie more in how boards and inter-company transactions are governed day to day?

References

1. https://corporate.cyrilamarchandblogs.com/2024/03/holding-subsidiary-relationship-legal-regulatory-architecture/
2. https://www.business-standard.com/amp/article/companies/il-fs-systemic-structural-flaw-119032001078_1.html
3. https://e-book.icsi.edu/Actpagedisplay.aspx?PAGENAME=17512
4. https://blog.ipleaders.in/section-129-of-companies-act-2013/
5. https://www.researchgate.net/publication/391536257_The_IL_and_FS_Financial_Statement_Fraud_A_Failure_of_Governance_Auditing_and_Regulation
6. https://blog.ipleaders.in/transactions-between-holding-subsidiary-companies/
7. https://www.newsclick.in/ilfs-fiasco-former-executives-auditors-held-responsible-scam
8. https://corporate.cyrilamarchandblogs.com/2025/09/majority-stake-minority-fate-reverse-oppression-under-the-companies-act-2013/