De-jargoned | Pledging of shares

Raising money through pledging of shares has its own downside
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First Published: Thu, Nov 29 2012. 08 32 PM IST
Updated: Fri, Nov 30 2012. 10 56 AM IST
A recent note from Morgan Stanley Research highlighted that at the end of the September quarter, promoters pledged their holdings in 790 companies and the value stood at 10.1% of the market capitalization of these companies, the highest in last four quarters. The value of pledged shares stood at Rs.1.42 trillion, 10% higher than that in the previous quarter. The top five among large companies that pledged promoters’ shares include United Spirits Ltd (98%), Housing Development and Infrastructure Ltd (96%), Suzlon Energy Ltd (96%), Pipavav Defence and Offshore Engineering Co. Ltd (92%), and Wockhardt Ltd (87%).
What is pledging of shares?
Promoters of companies, at times, in order to raise capital for the business pledge their shares with the lenders as collateral. This means that if the company defaults on payments, the lenders can recover the cost by selling pledged shares in the open market. There could be various reasons for this kind of pledging. There is a chance that the company already has high debts and lenders are not willing to lend more, but are willing to lend against some security. Promoter shares in that case work as security. From the promoters’ point of view, the offering of shares as collateral could help the company secure loans in time and at cheaper rate of interest.
The downside
Raising money through pledging of shares has its own downside. First, in the event of default or delay, the lender can sell the shares in the market, leading to higher supply of the company’s shares and sharp downward movement in prices and erosion of market capitalization.
Second, in the event of a sharp fall in the market due to shift in the general mood, which also leads to falling share prices of the company whose shares have been pledged, may force the lender to sell as the value of pledged share may now be closer to or lesser than the funds loaned. Selling by the lender will increase the supply of shares and prices will fall further. Falling prices may also force other investors to exit and could become a vicious cycle, leaving the small investor trapped.
Should you worry?
Pledging may not always lead to extreme consequences and could well be in the interest of the company as it helps secure funds in time. However, if you own a company where the promoter has pledged large holdings, it is sufficient reason for enquiring and getting a little deeper into the numbers. There is a chance that your company has high debt on its books and promoters have pledged a large part of their holding. If that is the situation, you may want to reconsider your investment decision.
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First Published: Thu, Nov 29 2012. 08 32 PM IST
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