Which of the following would be the BEST evidence that an investor who owns 19% of the common stock of an investee exercises significant influence over the investee?
a. The investor and investee sign an agreement under which the investor surrenders significant ownership rights.
b. The investor is not represented on the investee’s board of directors.
c. The second largest investor owns only 3% of the investee’s outstanding stock.
d. The investor tries and fails to obtain financial information from the investee.
The correct answer and explanation is:
The correct answer is c. The second largest investor owns only 3% of the investee’s outstanding stock.
Explanation:
Significant influence over an investee is typically indicated when an investor has the ability to participate in the decision-making processes of the investee, particularly in financial and operating policies. In accounting terms, significant influence is generally presumed when an investor owns between 20% and 50% of the voting stock of the investee, though other factors may also be relevant.
Now, let’s break down the options:
- a. The investor and investee sign an agreement under which the investor surrenders significant ownership rights.
This option would actually indicate the opposite of significant influence. If the investor surrenders ownership rights, it reduces their ability to exercise influence over the investee. - b. The investor is not represented on the investee’s board of directors.
While being on the board may help establish significant influence, it is not a strict requirement. A 19% stake can still provide significant influence, even if the investor is not formally represented on the board. Other factors, like the size of the stake relative to other shareholders, are more important. - c. The second largest investor owns only 3% of the investee’s outstanding stock.
This is the best indicator of significant influence. If the investor owns 19% of the stock, and the next largest shareholder holds only 3%, this implies that the investor has a dominant position among the minority shareholders. This would allow them to influence key decisions, even without majority ownership. - d. The investor tries and fails to obtain financial information from the investee.
While trying to obtain financial information may suggest some level of interest, the failure to do so does not directly indicate significant influence. It could simply indicate a lack of cooperation, rather than an absence of influence.
Therefore, the best evidence of significant influence is option c, where the investor holds a substantial percentage of stock relative to the other shareholders, increasing their ability to affect the investee’s decisions.