Recently, we went through the audited accounts of a large investment holding company and its 100%-owned subsidiary. The subsidiary is involved in the fee management business, which is generally speaking, a cash cow business model.

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As we dug into the numbers, straight off the bat, five intriguing things stood out as follows:

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1. Administrative Expenses:

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This company's yearly spending on administration rose from RM540mil in 2009 to RM605mil in 2010. The statement in the annual report stated that this increase in spending was made in order to expand its marketing capabilities to third-party clients. It is, of course, interesting to learn that the company needed an additional RM65mil just to market itself.

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2. Total Net Loss:

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The company incurred such a loss to the tune of RM60mil in 2010. This loss would have been bigger if not for an adjustment, that is, the Profit on Disposal of Investments totalling RM30mil. One has to wonder if this sale was just to manage the net loss for the financial year, or was this really the best timing for the investment to be sold.

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3. Cash Flow:

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There was at an operating loss as a result of the business activities noted above. The subsidiary, however, still managed to pay RM72mil in dividends to its parent company despite their bad results.

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4. Directors' Remuneration:

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The company's six directors had had a significant raise, that is, from RM15mil in 2009 to RM18mil in 2010. Plus, the Performance Bonus for the year under review amounted to RM21mil. However, given that there were some directors who left during the financial year, and who would have received severance pay and bonuses, we estimated that the remaining six directors earned a total package of at least RM12mil, thus averaging RM2mil per director. The company also stated in its books that its highest-paid director received RM6mil in cash as emoluments, as well as RM12mil in deferred awards. We had to wonder how the bonuses were calculated for the financial year, given the loss incurred.

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5. Remuneration Per Staff:

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In its annual report, the company stated that it had a total of 200 investment management staff and 120 administrative staff. This adds up to a total workforce of 320, resulting in a total staff cost of RM360mil. This works out to a significant average annual cost per employee. Evidently, the staff force is all well paid and one would assume that they should be delivering results for the subsidiary.

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Besides these red flags, we also noted that this half a billion company, which is wholly owned by a bigger corporation, received a RM72mil loan from its parent. In the same financial year, this loss-making subsidiary company paid its parent a fat dividend. What this means, basically, was that this subsidiary was operating at a loss, subsequently borrowed money from its parent and then paid out dividends back to its parent.

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Savvy investors would immediately ask: Why would a group of related companies act like that?

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To begin with, the parent company here is obviously managing its risks by taking as much out of its subsidiary as it can without causing the latter a crisis in cash flow. As 2010 was a loss-making year for the subsidiary, the dividends were distributed from past profits. So why did the wholly-owned subsidiary borrow just to pay out the dividends?

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The short answer: Because, should the subsidiary be wound up, the parent company's loan would rank equal in the long queue of creditors.

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Of course, it may be far-fetched to think that this subsidiary is at risk of being wound up, but because this risk is possible, its parent has acted in that way to manage the Sources of Funds and Dividend Policy. Also, if the payment from the subsidiary is in the form of a dividend, the parent will be able to show an income, rather than a loss, in its own books. A repayment will, of course, mean a loss is still shown.

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To be sure, at the end of the day, we can at best only speculate as to what the subsidiary's board of directors discussed and debated at their meetings. It is amazing, though, that such a subsidiary had the luxury of spending such a large amount ahead of its income. Some, of course, may call it investing for the future.

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But, as we found in its accounts, this subsidiary's cost structure is already too stretched to be reasonably profitable in the long term. The main concern now is that if the subsidiary folds, its parent and its parent's shareholders will be affected. Clearly, the board of directors at both the subsidiary and parent level are starting to dig a deep hole, which could possibly tip not only the subsidiary but also the parent into.

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All shareholders need to get the heads-up on this and demand the board's members to explain their rationale for making these types of decisions. We have all seen that many types of these short-term ad hoc board decisions will eventually lead to an unnecessary hair cut down the road.