Is pledging of shares really bad?

Is pledging of shares really bad?
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First Published: Wed, Feb 11 2009. 10 39 PM IST

Updated: Wed, Feb 11 2009. 10 39 PM IST
Disclosures by promoters who have pledged their shares are coming in thick and fast. The markets have now gotten accustomed to this and aren’t reacting negatively to every announcement about pledged shares. A case in point is Tata Tea Ltd, which disclosed on Wednesday that promoter Tata Sons Ltd has pledged 50% of its entire holding in the company. The company’s share price was unchanged because of the disclosure.
Indeed, a number of Tata group firms and other companies have disclosed that Tata Sons has pledged shares, but this hasn’t affected their share prices.
However, there are some firms, such as Micro Inks Ltd and UTV Software Ltd, whose shares took a beating after details about their promoters’ pledging of shares were announced. In the case of UTV, for instance, almost the entire stake of the promoters is pledged. The concern with promoters who have already pledged their entire stake in the company is that they now have little leeway. Any further fall in share prices may lead to margin calls by lenders and with no more shares left to be pledged, lenders could start selling the pledged shares in the market to recover their funds.
This is what happened in the case of Orchid Chemicals and Pharmaceuticals Ltd, where a fall in the company’s share price led to margin calls, which led to a further sharp fall in the shares.
But Orchid shares recovered smartly when Ranbaxy Laboratories Ltd started buying shares in large amounts from the open market. Orchid’s original promoter was stretched financially, which the market perceived negatively. However, this in turn paved the way for a possibility of a takeover by a stronger player, leading to a rise in the company’s shares. A takeover would even result in an open offer, which again is a positive for minority shareholders.
Of course, there is a period of disruption and it’s not clear if a strong buyer will emerge to offset each and every weak promoter. Another worry is that lenders may indulge in a fire sale of the pledged securities, leading to a sharp drop in share prices. But as far as the fundamentals of the business go, pledging of shares by the promoters has little or no impact.
In some cases, promoters have pledged their own shares in return for working capital loans for the firms. This can be seen as a sign of commitment to the company, akin to promoters hiking their stake in the company. Investors would do well to avoid companies led by promoters who thrive on leverage and have pledged shares to place bets in risky ventures. Also, if the markets plunge again to their October lows and margin calls pour in, the stocks of companies in which promoters have pledged a substantial part of their stake may be under serious pressure.
Write to us at marktomarket@livemint.com
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First Published: Wed, Feb 11 2009. 10 39 PM IST