Of course this possibility of increasing the debt of the subsidiaries can be guarded against, and the investor who is not willing to take this chance should be sure that it is guarded against. To safeguard the situation the stock of the subsidiaries should be de posited as collateral security for the bonds of the holding company. Though the directors of the holding company should be left free to vote the stock except in the event of default, the trust deed under which the stock is de posited should contain a covenant that the subsidiaries shall not incur any additional debt. The entire discussion in this chapter has obviously assumed that the bonds of the subsidiaries are outstanding in the hands of investors, and therefore exist as a claim against the earnings of the subsidiaries which must be satisfied before the holding company can get any revenue from the earnings.
Examples presented to illustrate the prin ciples involved have been those of a corpora tion which is entirely a holding company; that is, one not doing any operating directly at all. Such examples were chosen for the sake of simplicity. If a corporation is partly an operating company and partly a holding com pany, the same situations may arise with respect to that part of the earnings which are derived as a result of the operations of the subsidiaries. And if the corporation which is offering securities for sale does not own all of the stock of another corporation, but only a majority, or an amount sufficient to control, or even any amount of stock less than that, the same principles apply so far as the earn ings derived as a result of the ownership of that stock are concerned. If the corporation owns less than a controlling interest in the stock of another corporation, one considering the securities of the holding company will ordinarily regard the stock owned as simply in the nature of an investment, and place a value on it as such.
In the chapter in the first volume on "Financing an Expansion " we discussed the creation of subsidiaries as a device to enable the giving of a first mortgage or other direct lien on specific assets when the existence of a blanket mortgage created by the existing corporation would prevent the creation of any claim ahead of or equal to it if the corpora tion should own the specific assets directly. The relationship of a holding company and a subsidiary may arise when one corporation desires to have an interest in another, but cannot advantageously buy all of the stock, or a sufficient amount to effect a merger. Or, if it can buy all of the stock, legal reasons as the necessity of a public service corpora tion operating in a given State having a char ter from that State — may make it necessary or expedient to maintain separate corpora tions.
Legal reasons for the desirability of main taining separate corporate entities, the ad vantage of financing with the large issues of the securities of a holding company rather than with the relatively small issues of the directly operating units, and the better or ganization possible if the directly operating units are bound together by a holding com pany, make very real advantages which have fostered the growth of holding companies especially in the public service field. Our dis cussion has several times indicated the ad vantage of the large issue in the possibility of making the security known and creating an active market. This chapter has simply pointed out the need for full information.