Income Extraction by Parent Companies from Subsidiaries and Associates: Evidence from Intracompany Transactions within U.S. Bank Groups

This paper identifies how parent companies extract income from partially owned subsidiaries and associates to potentially boost reported earnings. Analyzing a unique intracompany transaction dataset from U.S. parent bank holding companies (BHCs), we employ a combination of difference-in-differences and regression discontinuity designs. Specifically, we compare parent BHCs with full shareholdings to those with 95% or more average shareholdings in subsidiaries and associates, after the 2015 Federal Reserve's Guidance on removing shareholder protection agreements. Our findings reveal that parent BHCs with full shareholdings charge relatively lower interest rates on loans and lower various fees to subsidiaries and associates. These effects are more prominent for parent BHCs with small profits. Furthermore, within the same parent BHCs, fully owned subsidiaries exhibit higher ROA compared to partially owned subsidiaries with 95% or more shares held by the same parents, subsequent to the 2015 Guidance. The results are particularly pronounced for subsidiaries located closer to parent BHCs. Our study provides the first direct evidence of parent companies tunnelling resources from partially owned subsidiaries and associates, highlighting an unintended consequence of the Federal Reserve's Guidance.