What Are Affiliated Companies?

Companies are affiliated when one company is a minority shareholder of another. In most cases, the parent company will own less than a 50% interest in its affiliated company. Two companies may also be affiliated if they are controlled by a separate third party. In the business world, affiliated companies are often simply called affiliates.

The term is sometimes used to refer to companies that are related to each other in some way. For example, Bank of America has many different affiliated companies including Bank of America, U.S. Trust, Landsafe, Balboa, and Merrill Lynch.

Companies may be affiliated with one another to get into a new market, to maintain separate brand identities, to raise capital without affecting the parent or other companies, and to save on taxes. In most cases, affiliates are associates or associated companies, which describes an organization whose parent has a minority stake in it.

Understanding Affiliated Companies

There are several ways companies can become affiliated. A company may decide to buy out or take over another one, or it may decide to spin off a portion of its operations into a new affiliate altogether. In either case, the parent company generally keeps its operations separate from its affiliates. Since the parent company has a minority ownership, its liability is limited, and the two companies keep separate management teams.

Affiliates are a common way for parent businesses to enter foreign markets while keeping a minority interest in a business. This is especially important if the parent wants to shake off its majority stake in the affiliate.

There is no single bright-line test to determine if one company is affiliated with another. In fact, the criteria for affiliation changes from country to country, state to state, and even between regulatory bodies. For instance, companies considered affiliates by the Internal Revenue Service (IRS) may not be considered affiliated by the Securities and Exchange Commission (SEC).

Affiliates Versus Subsidiaries

An affiliate is different from a subsidiary, of which the parent owns more than 50%. In a subsidiary, the parent is a majority shareholder, which gives the parent company’s management and shareholders voting rights. Subsidiary financials may also appear on the parent company’s financial sheets.

But subsidiaries remain separate legal entities from their parents, meaning they are liable for their own taxes, liabilities, and governance. They are also responsible for following the laws and regulations where they are headquartered, especially if they operate in a different jurisdiction from the parent company.

An example of a subsidiary is the relationship between the Walt Disney Corporation and sports network ESPN. Disney owns an 80% interest in ESPN, making it a majority shareholder. ESPN is its subsidiary.

SEC Rules Surrounding Affiliates

Securities markets around the world have rules that concern affiliates of the businesses they regulate. Here again, these are complex rules that need to be analyzed by local experts on a case-by-case basis. Examples of rules enforced by the SEC include:

• Rule 102 of Regulation M prohibits issuers, selling security holders, and their affiliated purchasers from bidding for, purchasing, or attempting to induce any person to bid for or purchase, any security which is the subject of a distribution until after an applicable restricted period has passed.
• Before disclosing nonpublic personal information about a consumer to a nonaffiliated third party, a broker-dealer must first give a consumer an opt-out notice and a reasonable opportunity to opt out of the disclosure.
• Broker-dealers must maintain and preserve certain information regarding those affiliates, subsidiaries, and holding companies whose business activities are reasonably likely to have a material impact on their own finances and operations.

Tax Consequences of Affiliates

In nearly all jurisdictions, there are important tax consequences for affiliated companies. In general, tax credits and deductions are limited to one affiliate in a group, or a ceiling is imposed on the tax benefits that affiliates may reap under certain programs.

Determining whether companies in a group are affiliates, subsidiaries, or associates is done through a case-by-case analysis by local tax experts.

What Is Adverse Selection?

Adverse selection refers generally to a situation in which sellers have information that buyers do not have, or vice versa, about some aspect of product quality. In other words, it is a case where asymmetric information is exploited. Asymmetric information, also called information failure, happens when one party to a transaction has greater material knowledge than the other party.

Typically, the more knowledgeable party is the seller. Symmetric information is when both parties have equal knowledge.

In the case of insurance, adverse selection is the tendency of those in dangerous jobs or high-risk lifestyles to purchase products like life insurance. In these cases, it is the buyer who actually has more knowledge (i.e., about their health). To fight adverse selection, insurance companies reduce exposure to large claims by limiting coverage or raising premiums.

Understanding Adverse Selection

Adverse selection occurs when one party in a negotiation has relevant information the other party lacks. The asymmetry of information often leads to making bad decisions, such as doing more business with less profitable or riskier market segments.

In the case of insurance, avoiding adverse selection requires identifying groups of people more at risk than the general population and charging them more money. For example, life insurance companies go through underwriting when evaluating whether to give an applicant a policy and what premium to charge.

Underwriters typically evaluate an applicant’s height, weight, current health, medical history, family history, occupation, hobbies, driving record, and lifestyle risks such as smoking; all these issues impact an applicant’s health and the company’s potential for paying a claim. The insurance company then determines whether to give the applicant a policy and what premium to charge for taking on that risk.

Consequences of Adverse Selection

A seller may have better information than a buyer about products and services being offered, putting the buyer at a disadvantage in the transaction. For example, a company’s managers may more willingly issue shares when they know the share price is overvalued compared to the real value; buyers can end up buying overvalued shares and lose money. In the secondhand car market, a seller may know about a vehicle’s defect and charge the buyer more without disclosing the issue.

The general consequence of adverse selection is that it increases costs since consumers lack information held by sellers or producers, creating an asymmetry in the market. This can also lower consumption as buyers may be wary of the quality of the products that are offered for sale. Or, it may exclude certain consumers that do not have access to or cannot afford to obtain information that could lead them to make better buying decisions.

One indirect effect of this is a negative impact on consumers’ health and well-being. If you buy a faulty product or dangerous medication because you don’t have good information, consuming these products can cause physical harm. Or, by refraining from buying certain healthcare products (e.g., vaccines), consumers may wrongly judge a safe intervention as overly risky.

Adverse Selection in Insurance

Because of adverse selection, insurers find that high-risk people are more willing to take out and pay greater premiums for policies. If the company charges an average price but only high-risk consumers buy, the company takes a financial loss by paying out more benefits or claims.

However, by increasing premiums for high-risk policyholders, the company has more money with which to pay those benefits. For example, a life insurance company charges higher premiums for race car drivers. A car insurance company charges more for customers living in high-crime areas. A health insurance company charges higher premiums for customers who smoke. In contrast, customers who do not engage in risky behaviors are less likely to pay for insurance due to increasing policy costs.

A prime example of adverse selection in regard to life or health insurance coverage is a smoker who successfully manages to obtain insurance coverage as a nonsmoker. Smoking is a key identified risk factor for life insurance or health insurance, so a smoker must pay higher premiums to obtain the same coverage level as a nonsmoker. By concealing their behavioral choice to smoke, an applicant is leading the insurance company to make decisions on coverage or premium costs that are adverse to the insurance company’s management of financial risk.

Another example of adverse selection in the case of auto insurance would be a situation where the applicant obtains insurance coverage based on providing a residence address in an area with a very low crime rate when the applicant actually lives in an area with a very high crime rate. Obviously, the risk of the applicant’s vehicle being stolen, vandalized, or otherwise damaged when regularly parked in a high-crime area is substantially greater than if the vehicle was regularly parked in a low-crime area.

How to Minimize Adverse Selection

Adverse selection by increasing access to information, thus minimizing asymmetries. For consumers, the internet has greatly increased access while reducing costs. Crowdsourced information in the form of user reviews along with more formal reviews by bloggers or specialist websites are often free and warn potential buyers about otherwise obscure issues around quality.

Warranties and guarantees offered by sellers can also help, allowing consumers to use a product risk-free for a certain period to see if it has flaws or quality issues and the ability to return them without consequence if there are issues. Laws and regulations can also help, such as Lemon Laws in the used car industry. Federal regulatory authorities such as the FDA also help ensure that products are safe and effective for consumers.

Insurers reduce adverse selection by requesting medical information from applicants in the form of requiring paramedical examinations, querying doctors’ offices for medical records, and looking at one’s family history. This gives the insurance company more information that an applicant may fail to disclose on their own.

Moral Hazard vs. Adverse Selection

Like adverse selection, moral hazard occurs when there is asymmetric information between two parties, but where a change in the behavior of one party is exposed after a deal is struck. Adverse selection occurs when there’s a lack of symmetric information prior to a deal between a buyer and a seller.

Moral hazard is the risk that one party has not entered into the contract in good faith or has provided false details about its assets, liabilities, or credit capacity. For instance, in the investment banking sector, it may become known that government regulatory bodies will bail out failing banks; as a result, bank employees may take on excessive amounts of risk to score lucrative bonuses knowing that if their risky bets do not pan out, the bank will be saved anyhow.

The Lemons Problem

The lemons problem refers to issues that arise regarding the value of an investment or product due to asymmetric information possessed by the buyer and the seller.

The lemons problem was put forward in a research paper, “The Market for ‘Lemons’: Quality Uncertainty and the Market Mechanism,” written in the late 1960s by George A. Akerlof, an economist and professor at the University of California, Berkeley. The tag phrase identifying the problem came from the example of used cars Akerlof used to illustrate the concept of asymmetric information, as defective used cars are commonly referred to as lemons. The takeaway is that due to adverse selection, the only used cars left on the market will ultimately be lemons.

The lemons problem exists in the marketplace for both consumer and business products, and also in the arena of investing, related to the disparity in the perceived value of an investment between buyers and sellers. The lemons problem is also prevalent in financial sector areas, including insurance and credit markets. For example, in the realm of corporate finance, a lender has asymmetrical and less-than-ideal information regarding the actual creditworthiness of a borrower.

The Bottom Line

Contrary to assumptions made by mainstream economic and financial models, information is not symmetrically accessible and available to all actors in a market. In particular, sellers and producers often have far more information about what they are selling than do buyers. This information asymmetry can lead to market inefficiencies via what is known as adverse selection. In insurance markets, applicants have more information about themselves than do insurers, meaning that they withhold key information about being higher-risk.

What Is the Advance/Decline (A/D) Line?

The advance/decline line (or A/D line) is a technical indicator that plots the difference between the number of advancing and declining stocks on a daily basis. The indicator is cumulative, with a positive number being added to the prior number, or if the number is negative it is subtracted from the prior number.

The A/D line is used to show market sentiment, as it tells traders whether there are more stocks rising or falling. It is used to confirm price trends in major indexes, and can also warn of reversals when divergence occurs.

The Formula for Advance/Decline (A/D) Line Is:


$\begin{aligned} &\text{A/D} = \text{Net Advances} + \begin{cases} \text{PA, if PA value exists} \\ \text{0, if no PA value} \\ \end{cases} \\ &\textbf{where:} \\ &\text{Net Advances} = \text{Difference between number of daily} \\ &\text{ascending and declining stocks} \\ &\text{PA} = \text{Previous Advances} \\ &\text{Previous Advances} = \text{Prior indicator reading} \\ \end{aligned}$​A/D=Net Advances+{PA, if PA value exists0, if no PA value​where:Net Advances=Difference between number of dailyascending and declining stocksPA=Previous AdvancesPrevious Advances=Prior indicator reading​

How to Calculate the A/D Line

1. Subtract the number of stocks that finished lower on the day from the number of stocks that finished higher on the day. This will give you the Net Advances.
2. If this is the first time calculating the average, the Net Advances will be the first value used for the indicator.
3. On the next day, calculate the Net Advances for that day. Add to the total from the prior day if positive or subtract if negative.
4. Repeat steps one and three daily.

What Does the A/D Line Tell You?

The A/D line is used to confirm the strength of a current trend and its likelihood of reversing. The indicator shows if the majority of stocks are participating in the direction of the market. 

If the indexes are moving up but the A/D line is sloping downwards, called bearish divergence, it’s a sign that the markets are losing their breadth and may be about to reverse direction. If the slope of the A/D line is up and the market is trending upward, then the market is said to be healthy.

Conversely, if the indexes are continuing to move lower and the A/D line has turned upwards, called bullish divergence, it may be an indication that the sellers are losing their conviction. If the A/D line and the markets are both trending lower together, there is a greater chance that declining prices will continue.

Difference Between the A/D Line and Arms Index (TRIN)

The A/D line is typically used as a longer-term indicator, showing how many stocks are rising and falling over time. The Arms Index (TRIN), on the other hand, is typically a shorter-term indicator that measures the ratio of advancing stocks to the ratio of advancing volume. Because the calculations and the time frame they focus on are different, both these indicators tell traders different pieces of information.

Limitations of Using the A/D Line

The A/D line won’t always provide accurate readings in regards to NASDAQ stocks. This is because the NASDAQ frequently lists small speculative companies, many of which eventually fail or get delisted. While the stocks get delisted on the exchange, they remain in the prior calculated values of the A/D line. This then affects future calculations which are added to the cumulative prior value. Because of this, the A/D line will sometimes fall for extended periods of time, even while NASDAQ-related indexes are rising.

Another thing to be aware of is that some indexes are market capitalization weighted. This means that the bigger the company the more impact they have on the index’s movement. The A/D line gives equal weight to all stocks. Therefore, it is a better gauge of the average small to mid-cap stock, and not the fewer in number large or mega-cap stocks.

Investopedia does not provide tax, investment, or financial services and advice. The information is presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Investing involves risk, including the possible loss of principal.

What Is Adjusted Gross Income (AGI)?

Adjusted gross income (AGI) is the figure that the Internal Revenue Service (IRS) uses to determine your income tax liability for the year. It is calculated by subtracting certain adjustments from gross income, such as business expenses, student loan interest payments, and other expenses. After calculating a taxpayer’s AGI, the next step is to subtract deductions to determine their taxable income.

The IRS also uses other income metrics, such as modified AGI (MAGI), for specific programs and retirement accounts.

Understanding Adjusted Gross Income (AGI)

As prescribed in the United States tax code, AGI is a modification of gross income. Gross income is simply the sum of all the money you earned in a year, which may include wages, dividends, capital gains, interest income, royalties, rental income, alimony, and retirement distributions, before tax or other deductions. AGI makes certain adjustments to your gross income to reach the figure on which your tax liability will be calculated.

Many U.S. states also use the AGI from federal returns to calculate how much individuals owe in state income taxes. States may modify this number further with state-specific deductions and credits.

Common Adjustments

The items subtracted from your gross income to calculate your AGI are referred to as adjustments to income, and you report them on Schedule 1 of your tax return when you file your annual tax return. Some of the most common adjustments are listed here, along with the separate tax forms on which a few of them are calculated:

• Alimony payments (for divorces filed before Jan. 1, 2019)
• Early withdrawal penalties on savings
• Educator expenses
• Employee business expenses for armed forces reservists, qualified performing artists, fee-basis state or local government officials, and employees with impairment-related work expenses (Form 2106)
• Health Savings Account (HSA) deductions (Form 8889)
• Moving expenses for members of the armed forces (Form 3903)
• Self-employed Simplified Employee Pension (SEP), Savings Incentive Match Plan for Employees of Small Employers (SIMPLE), and qualified plans
• Self-employed health insurance deduction
• Self-employment tax (the deductible portion)
• Student loan interest deduction

How to Calculate Adjusted Gross Income

If you use software to prepare your tax return, it will calculate your AGI once you input your numbers. If you calculate it yourself, you’ll begin by tallying your reported income for the year. That might include job income, as reported to the IRS by your employer on a W-2 form, plus other income, such as dividends and miscellaneous income, reported on 1099 forms.

Next, you add any taxable income from other sources, such as profit on the sale of a property, unemployment compensation, pensions, Social Security payments, or anything else that hasn’t already been reported to the IRS. Many of these income items are also listed on IRS Schedule 1.

The next step is to subtract the applicable adjustments to the income listed above from your reported income. The resulting figure is your AGI. To determine your taxable income, subtract either the standard deduction or your total itemized deductions from your AGI. In most cases, you can choose whichever gives you the most benefit.

For example, the standard deduction for tax returns for married couples filing jointly was $25,900 in 2022, rising to $27,700 in 2023, so couples whose itemized deductions exceed that amount would generally opt to itemize, while others would take the standard deduction.

The IRS provides a list of itemized deductions and the requirements for claiming them on its website. Your AGI also affects your eligibility for many of the deductions and credits available on your tax return. In general, the lower your AGI, the more significant the number of deductions and credits you will be eligible to claim, and the more you’ll be able to reduce your tax bill.

An Example of AGI Affecting Deductions

Let’s say you had some significant dental expenses during the year that weren’t reimbursed by insurance, and you’ve decided to itemize your deductions. You are allowed to deduct the portion of those expenses that exceed 7.5% of your AGI.

This means that if you report $12,000 in unreimbursed dental expenses and have an AGI of $100,000, you can deduct the amount that exceeds $7,500, which is $4,500. However, if your AGI is $50,000, the 7.5% reduction is just $3,750, and you’d be entitled to deduct a larger amount of that $12,000, in this case $8,250.

Adjusted Gross Income (AGI) vs. Modified Adjusted Gross Income (MAGI)

In addition to AGI, some tax calculations and government programs call for using what’s known as your modified adjusted gross income, or MAGI. This figure starts with your AGI, then adds back certain items, such as any deductions you take for student loan interest or tuition and fees.

Your MAGI is used to determine how much, if anything, you can contribute to a Roth individual retirement account (Roth IRA) in any given year. It is also used to calculate your income if you apply for Marketplace health insurance under the Affordable Care Act (ACA).

Many people with relatively uncomplicated financial lives find that their AGI and MAGI are the same number or very close.

Adjusted Gross Income vs. Gross Income vs. Taxable Income

Your gross income is all of the money you’ve earned in a year that isn’t exempt from taxation. This can be in the form of salary, wages, interest, dividends, capital gains, and so on.

Your adjusted gross income takes that amount and takes out certain qualified expenses and adjustments.

Taxpayers can then take either the standard deduction for their filing status or itemize the deductible expenses they paid during the year. You’re not permitted to both itemize deductions and claim the standard deduction. The result is your taxable income.

Frequently Asked Questions

The Bottom Line

Adjusted gross income, or AGI, is your gross income after it has been adjusted for certain qualified deductions that are permitted by the Internal Revenue Service (IRS). These qualified deductions reduce an individual’s gross income, thus reducing the taxable income that they will ultimately have to pay taxes on. You can save money come tax season by lowering your AGI, which will lower your taxable income, in turn. However, many of the adjustments allowed for AGI are specific for particular circumstances that may not apply to everyone.