Vaib­hav Agrawal,

Dalal Street Investment Journal - - SPECIAL REPORT -

Why do prompters pledge their shares?

Pro­mot­ers pledge their shares as a col­lat­eral when they are hav­ing tight liq­uid­ity con­di­tions and want to quickly raise funds. The com­pa­nies where there is a high pro­por­tion of pledged shares, the risk is higher than other com­pa­nies. In case pro­mot­ers are not able to re­pay the loan, lenders may choose to sell the shares par­tially/fully in the mar­ket in or­der to re­cover their dues. This can lead to a drop in the share price of that par­tic­u­lar com­pany. It may also re­duce the con­fi­dence of in­vestors/lenders in the man­age­ment.

Yes, it is a warn­ing sign and the same should be scru­ti­nised care­fully. It should also be seen whether the pro­mot­ers have been con­stantly pledg­ing their shares and have grad­u­ally in­creased their pledged shares. It is best to avoid the com­pa­nies if a high pro­por­tion of pro­moter's shares are pledged, es­pe­cially those com­pa­nies which are not well-man­aged. If any large cap, well-known name hap­pens to be in the list of such com­pa­nies, one need to look at per­cent of pledged share to the to­tal out­stand­ing shares. If this num­ber is mi­nus­cule, one can still go ahead and in­vest based on the fun­da­men­tals. In the case of high debt, stretched work­ing cap­i­tal, poorly gov­erned com­pa­nies, it is best to fully avoid such shares.

What are the risks associated with in­vest­ing in high­pledged com­pa­nies? Is high-pledg­ing by pro­mot­ers a warn­ing sign? What is the dif­fer­ence be­tween pledg­ing of shares by gen­eral share­hold­ers and pro­mot­ers?

One should look at the pro­por­tion of to­tal pledged shares to the to­tal out­stand­ing shares. Nev­er­the­less, pro­mot­ers pledg­ing their shares is al­ways a con­cern as any sell-off by lenders can re­duce pro­moter's stake in the com­pany and, in some cases, it may lead to loss of con­trol for the man­age­ment. In the case of gen­eral share­hold­ers, the shares change hands, but in most cases, the share­hold­ing pat­tern re­mains the same.

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