At the end of a corporation's operating year, it must decide what to do with any profits it may have made. The corporation's options are similar to those an individual would have if he were in possession of excess funds after paying bills. The corporation may distribute profits as dividends to shareholders, save the profits in its treasury as cash holdings or invest the profits in itself to expand into new business areas or in outside investment vehicles that will generate interest on the money. A corporation is an independent entity under the law and has just as much right to buys stocks and other securities with its excess cash as any individual.
Corporations often invest in the securities of other corporations because they are short-term investments with a high level of liquidity. Stocks and other corporate equity and debt instruments may be easily sold through a stock exchange with the help of a broker, typically the same day as the decision to sell is made. The money is usually immediately available. Securities usually offer a higher rate of return than a bank savings account, so the corporation is able to generate additional income while still having the money readily available in case of an unexpected business need.
Rate of Return
Corporations have a fiduciary duty to shareholders to maximize profits. While some corporations might like to stockpile cash in case of a rainy day, the company's cash managers must take into account shareholder expectations and the best use for the money. Corporations invest in securities because the rate of return often makes them the best places to put money and still have it available.
Corporations sometimes buy the securities of other corporations to gain operating leverage over the target company. The corporation might buy common stock so it will have a vote on an important matter. It might invest in corporate debt instruments to put pressure on the company to make certain decisions or risk having its debt called in. A corporation might invest in another to be classed as an insider and be entitled to insider information.
Another reason for a corporation to invest in the securities of another corporation is to gain influence over that company's business decisions, sometimes with the goal of taking over the company. Buying up the company's shares on the market is a step toward a straight acquisition. Holding a majority of another corporation's stock would make the target company a subsidiary of the purchasing corporation.
- North Seattle Community College: Investments in Debt and Equity Securities
- FindLaw: What Actions Can a Corporation Take Under the Law?
- FindLaw Legal Dictionary: Subsidiary
- Internal Revenue Service. "Tax Information for Businesses." Accessed Nov. 26, 2019.
- Alphabet Inc. "G Is for Google." Accessed Nov. 24, 2019.
- Internal Revenue Service. "Definition of a Corporation." Accessed Nov. 26, 2019.
- American Bar Association. "Model Business Corporation Act, Subchapter C, Directors." Accessed Nov. 26, 2019.
- Internal Revenue Service. "Chapter 7 Bankruptcy: Liquidation under the Bankruptcy Code." Accessed Nov. 26, 2019.
Terry Masters has been writing for law firms, corporations and nonprofit organizations since 1995. Her online articles specialize in legal, business and finance topics. She holds a Juris Doctor and a Bachelor of Science in business administration with a minor in finance.