Pledging of shares by controlling shareholders and implications for foreign institutional investors

Offering shares as collateral (share pledging) to avail of business or personal loans has increasingly been used as a financing tool by controlling shareholders in developing economies such as India. With the focus on protecting the rights of minority shareholders, pledging of shares has been subject to scrutiny as academicians, regulators, and corporate governance experts have highlighted the detrimental effects of share pledging on the firm. This study raises awareness about share pledging for uninitiated foreign institutional investors (FIIs) looking to invest in developing economies. The study highlights the conditions, viz. motivation to pledge, degree of ownership, and quantum of pledge, under which share pledging may be concerning and when it may benefit the FIIs. We distinguish between pledging under different conditions and the implications arising under the outlined scenarios for FIIs. Our analysis provides potential investors with a comprehensive overview of pledging and its possible consequences for the firm. The study urges investors to take a more nuanced view of pledging rather than paint all of it with the same negative stroke.