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.