Understanding Cross-Holding: Risks & Implications

Cross holding, also referred to as cross shareholding, describes a situation where one publicly-traded company holds a significant number of shares of another publicly-traded company. The shares owned of the second publicly-traded company are referred to as a cross-holding of the first company.

Cross holdings present potential valuation problems for financial analysts, as they can result in double counting unless the cross holding is specifically addressed. Such double counting of equities would obviously render a company’s valuation inaccurate.

It is also necessary to take cross holdings into account when potential merger or acquisitionMergers & Acquisitions (M&A)Mergers and acquisitions (M&A) refer to transactions between two companies combining in some form. Although mergers and acquisitions (M&A) are used deals arise. The company that cross holds securities of another company may own enough shares to vote down a potential merger deal – or to demand changes to the deal’s structure – that the second company is considering.

Owning substantial cross holdings in other publicly-traded companies is especially common in Germany and Japan. In other countries, such as the United Kingdom, some cross-holding interests are specifically prohibited by law.

Summary

• Cross holding describes the situation where one publicly-traded company holds a significant number of the outstanding shares of another publicly-traded company.
• Cross holdings present potential valuation problems for financial analysts, where double counting of the value of equity can occur.
• Whether cross holdings are good or bad for companies and the country’s overall economy is strongly debated.

How Cross Holding May Create Valuation Problems

It’s easy for cross holdings to get double-counted when a financial or market analyst is trying to value a company. The value of cross held equity shares could be counted first when doing a valuation of the company that issued the shares. Then, it is counted again when valuing the other company’s assets that cross holds those equity shares.

Cross holdings are not limited to a single occurrence. One publicly-traded company may cross hold stock shares in several other corporations. The most obvious example is Berkshire Hathaway (NYSE: BRK.A), a huge conglomerate that wholly owns several subsidiary companies and with substantial cross holdings in several other companies.

For example, as of mid-2020, Berkshire Hathaway held more than 25% of the stock shares of The Kraft Heinz Company (NASDAQ: KHC) and more than 15% of the total outstanding shares of the American Express Company (NYSE: AXP).

Pros and Cons of Cross Holding

The practice of cross holding stock shares in other companies attracts both defenders and critics.

Advocates of cross holdings argue that it adds support to both companies involved, as it is in both companies’ financial interests for not only themselves to succeed as a business enterprise but also for the other company to be successful.

If Company A holds shares of Company B’s stock, it wants Company B to be successful so that its cross holdings will increase. Company B also wants Company A to prosper, as it would be detrimental to Company B’s stock price if Company A were financially forced to suddenly sell off all of the shares it holds of Company B stock.

Proponents of the value of cross holdings also point out that the practice may protect the company whose shares are cross held by another company from a potential hostile takeoverHostile TakeoverA hostile takeover, in mergers and acquisitions (M&A), is the acquisition of a target company by another company (referred to as the acquirer) by going directly to the target company’s shareholders, either by making a tender offer or through a proxy vote. The difference between a hostile and a friendly, as the number of shares cross held may be sufficient to foil the takeover attempt.

In addition to the potential valuation problems already mentioned, critics of cross holding argue that investments in cross holdings are often an inefficient use of capital – that the capital invested in another company’s stock could be more effectively used if directly invested in expanding the core business of the cross-holding company.

The critics also point out that, in the event of a major recession or another economic downturnEconomic DepressionAn economic depression is an occurrence wherein an economy is in a state of financial turmoil, often the result of a period of negative activity based on the country’s Gross Domestic Product (GDP) rate. It is a lot worse than a recession, with GDP falling significantly, and usually lasts for many years., the practice of cross holding is likely to create a domino effect, where the financial failure of one company could lead to the financial failure of other companies that own significant cross holdings of the first company’s stock.

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