Promoter Pledging: Definition & Importance

In recent weeks, the stock market investors have been hit by major sharp swings in stock prices after the news of high promoter pledging and sale of pledged shares by lending institutions. In such incidents, the share prices of Reliance ADAG group, Apollo Hospitals, and Essel/ Zee group have dipped nearly 15-30 percent.

How come the promoter pledging could affect the share prices this much and become the reason for sharp swings in the stock market.

So, what is promoter pledging and why is it important?

Promoter Pledging: Definition

If we put it simply, it is taking a loan against the shares one holds to himself/herself. Whether you are an investor or promoter, you can take a loan against the shares. The promoters are the majority of the shareholder group that handles the company’s day-to-day affairs. In doing so, when there is a need to raise funds, very often, these promoters, of listed companies pledge some or all of their shares as collateral to banks on-banking financial companies in exchange of money needed as a loan.

This is one way of borrowing money from lenders to invest in the business and the company’s operations.

These company promoters are no different from normal people. Just like us, they approach the bank for a temporary loan where the bank asked them the same thing to provide the collateral on the basis of which it can give you the loan. Except for one thing, when one of us approach the bank, the bank held property, shares, or gold jewelry as collateral but in case, of company promoters, it held the shares to give loan against them.

Why is it Important? – Promoter Pledging

As we said earlier, the pledging of shares helps in generating quick wealth in a short period of time. Many corporations and entrepreneurs raise funds with the help of promoter pledging where the ownership is retained by promoters while pledging shares. However, there are certain risks of pledging a large proportion of shares to the lenders in order to raise funds, especially in volatile markets.

The higher the pledging, higher the volatility will be in the share’s price of the company. It is because when the share prices fall, the overall value of pledged shares falls. If that happens, the pressure will automatically increase on promoters to increase more assets as collateral. Sometimes banks or other non-banking lenders sell the pledged shares if the price of the stock fall closer to the value agreed in the contract between two parties.

But, it usually happens when the promoter failed to meet the margin call.

In India, over 5000 listed companies, promoters of nearly 4274 companies have almost pledged all of the shares to the lenders, according to the analysis report by SEBI. On them, around 286 companies have pledged more than 50% of their shares.