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Pledging of shares – Risk for Promoters and Investors & Prudence for Investment in companies with pledged shares

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Pledging Of Shares

Pledging of shares is a simple mechanism where promoters, in order to raise funds for either personal or company needs, pledge their holding shares to any financial institution. A phenomenon in which the promoter of an entity keeps his own stake as collateral for the borrowed funds; the debt can be for personal purposes or for the companies’ sake is known as pledging of shares.

Generally the loans provided is about 25-40 % of the collateral value, depending upon the liquidity in the market and the profile of the company and the promoter. Due to restriction on the part of banks to provide such funding, the Non Banking Financial Institutions (NBFC’s) are more active in providing such kind of loans.

What does it mean for Retail Investors

If an entity has raised funds by pledging their shares it means that the company has exhausted all other options of raising capital from the markets. Usually, pledging is used by the promoters as a last resort to raise capital.

If the promoters have raised the capital for the betterment of the business, investors need not worry, but if it has been raised for personal needs it sends a negative signal to the investors.

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Risk for the Promoters

The real problems begin when the share prices tumble for any reason, shares worth 200 crores are suddenly worth only 120cr. The lenders would ask for more shares as collateral. If the promoter cannot provide more shares, then the lender has the right to sell these shares in the market.

Risk for Retail Investors

After the SATYAM fiasco, where it was found that most of the shares held by the promoters were pledged, SEBI has made it mandatory to disclose details about pledging of shares. Unfortunately, some of the critical information as to why the shares have been pledged (for personal or corporate reasons), which can change your view about the stock have still not been made mandatory.

Indian Companies that have pledged Shares

As discussed above pledging can be risky for a promoter and can even make him lose his stake in the company. More than 800 companies have taken this route to raise capital. Despite being a risky offence, promoters still prefer it because it does not lead to dilution of their holdings.

List of Indian companies as that have pledged shares as a percentage of their holding:

% of Promoters holding pledged Number of Companies Major Companies
90%+ More than 60 Ansal Properties, United Spirits, Gujarat Pipapav Port
75-90 % Around 70 Wockhardt, Essar Oil, Orchid Chemicals, S Kumar Nations
More than 50 % More than 100 Alok Industries, Suzlon, JP Power, Everonn
Less than 50 % More than 500 Network 18, Tata Tele, Hero MotoCorp

Prudence for Retail Investors before investing in companies with pledged shares

Pledging of shares by companies’ promoters does not necessarily mean that the company should be avoided totally, but certain prudence should be shown while investing in such companies. Companies with large debt on their books and a large percentage of pledged shares should be avoided.

One should approach these stocks with a certain level of caution and investors with relatively low risk appetite should certainly avoid them. If the fundamental analysis of the company very well suggests company’s promoters intention of pledging the shares, then the decision to focus on buying company’s share can be made. Pledging when made to expand the business or invest in certain assets or projects which have high net present value, will definitely reap benefit in the future despite being the fact that the shares are pledged as collateral.

Thus it is very important that investors remain cautious about pledging of shares done by the company.

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Niraj Satnalika

Niraj is an MBA in International Business (Finance). Prior to this he completed B.Tech in Electronics and Instrumentation. He is currently working with Confederation of Indian Industry (CII), Kolkata in capacity of Consultant. Satnalika is actively involved with an NGO and works towards promoting education among the underprivileged.

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