Why pledging got a bad name

Last fortnight, when at least 100 companies had disclosed that they had pledged their holdings, the debate wasn’t centred around which head honchos had used their shares to raise funds, but rather on which ones hadn’t yet revealed this information to the stock exchanges. After all, but for a handful of high-profile conglomerates, virtually every promoter of India Inc.’s elite companies has admitted to pledging shares for many years now. The most popular end-use of the funds raised was either to increase the promoters’ stakes in their respective companies or to give additional guarantees to financiers (especially banks) for loans taken.

Companies in which shares are pledged are looked at with disdain these days on Dalal Street—particularly after it came to light that the disgraced B. Ramalinga Raju, Promoter of Satyam Computer Services, had kept a chunk of his holding with lenders. For instance, the stock price of media & entertainment firm UTV Software declined sharply after one of its promoters, Ronnie Screwvala, disclosed that most of his holding in the company was pledged. Similarly, ink maker Micro Inks’ share price declined when the German promoter MHM Holdings said its entire 70.5 per cent share is pledged. Asian Paints suffered a similar fate.

But, does pledging really deserve a bad name? One argument in favour of promoters is that they know what’s best for companies that they themselves have built from scratch. So, when pledging their shares, they will be careful about not getting into a position whereby they lose control of the company. Also, the funds they’re borrowing are ostensibly for their companies’ good— either for an expansion or to fund acquisitions. Tata Power and Tata Sons (the promoter of key Tata companies) disclosed that they pledged shares of Tata Teleservices Maharashtra for providing security for borrowings of the telecom company. These funds would go into expansion of telecom network.

“Banks usually hypothecate assets, land building or personal assets of promoters while disbursing loans to the companies. The share collateral gives an added comfort to the bank and it’s usually not co-related to the amount of loan,” says a senior executive at a Mumbaibased PSU bank.

The flip side of promoters’ apparent eagerness to create shareholder value by borrowing against their shareholding is that the exercise is fraught with danger, particularly in a falling market. Also, there have been occasions when promoters have been buying shares from the open market to ‘support’ their stock price with money raised from pledged shares. But this can backfire when financiers decide to sell the pledged shares if the stock falls before a certain level or if the promoter is not able to bring in additional shares— a ‘top-up’ in finance jargon—to make up for the difference caused by the erosion in price. The initial objective of jacking up the price will be swiftly countered by lenders offloading and even by unsympathetic traders, who would be wondering why the relevant disclosures weren’t made at the time of pledging.

—Additional Reporting by Rachna M. Koppikar