Does Pledging of Shares by Controlling Shareholders Always Destroy Firm Value?

Abstract

Controlling shareholders often pledge their ownership in the firm to offer collateral for either their personal loans or loans to the firm. Pledging of shares modifies their payoff structure, without altering their control rights. This modification in the payoff structure can influence the incentives of controlling shareholders and have real effects on firm value and performance. Using data from India, the study finds that share pledges for personal loans reduce the effective ownership of controlling shareholders and destroy firm value. On the contrary, share pledges for firm loans mitigate problems of limited pledgeability of cashflows and may increase the value of firms.