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What is a Promoter Pledge? -Pledging of Shares by Promoters and How it Impacts Stock

  • Marisha Bhatt
  • Dec 02 2021
  • 5 minutes
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Most investors go through company fundamentals while trying to analyse a stock for investment. This includes various factors, such as financial ratios, management efficiency, etc. However, one factor that is often missed by many investors is the promoter pledge. It is important to consider the number of promoter’s shares to learn about any possible financial issues in the company. Here, we will explain the concept of promoter pledge from an investor perspective while highlighting important aspects surrounding the same.

What is pledging of promoters’ shares?

Pledging of promoters’ shares can be commonly seen among most listed Indian companies. A promoter is an individual or a firm that is responsible for the company’s incorporation. When a company is just starting off, most of its shares are held by its promoters. Promoters can also be a group of shareholders who own a majority stake in the company and manage its daily affairs.

A company constantly needs funds to carry out its regular operations or for expansion plans. For this, it can either raise equity capital, issue corporate bonds, or reach out to a bank for a business loan, etc. For borrowing a loan, the company will have to provide some form of collateral to the bank. This is where a promoter’s pledge comes into picture as financial institutions and banks often ask companies to provide promoter’s shares as collateral against the loan. This is, in essence, pledging of promoter’s shares. 

When do companies use promoter pledge?

Companies generally use promoter pledge against loans when all sources of finance are non feasible. Thus, a promoter pledge could be a sign of possible financial troubles in the company. Although SEBI regulates promoter pledge of shares for listed companies, there are no rules surrounding unlisted companies. For unlisted companies, it is enough to pass a board resolution for pledging of shares.

Impact of promoter pledge on stock prices

Since a major proportion of a promoter’s wealth is often held in the form of shares, pledging of shares can help entrepreneurs to easily raise finance when needed. 

While pledging shares, lenders and promoters generally agree on a minimum contract value for the shares to build a margin of safety against loans. However, in case there is a sudden event resulting in the stock prices falling sharply, the value of the collateral starts to shrink. In such cases, the lender will ask the promoter to add more collateral to maintain the loan-to-collateral value. This is called a margin call. This can either be covered by the promoter covering the difference or by pledging more shares. 

In case the promoter is unable to meet the margin call, the bank may invoke the pledge by selling the pledged shares in the stock market to realise the money. When multiple lenders together invoke promoter pledges, it can result in large-scale stock price fall. 

How does promoter pledge concern investors?

Let’s understand the impact of promoter pledge with an example:

Suppose a company’s stock is priced at Rs. 100. 

The promoters pledge 50 shares valued at Rs. 5,000 to take a loan from a bank. Consecutively, the stock price of the company falls to Rs. 80 and, as a result, the value of the 50 shares held by the bank as collateral falls to Rs. 4,000. 

Thus, the bank will ask the promoters to pledge additional shares or the pledged shares will be sold in the open market. This can result in a further fall in the stock prices and the percentage of pledged shares will increase. Investors may, therefore, end up losing value of their investment in the company over time.

Although promoters pledging personal share holdings to banks should not affect the company operations, especially one that has good cash flows or strong fundamentals. However, companies that have a high proportion of promoter pledge are considered risky by investors. This is because it raises doubts whether promoters are cash-strapped in their personal capacity. It can also indicate debt problems in the company’s group ventures. 

During a bull market, promoter pledge is not considered an issue since higher stock prices help to raise the value of the collateral pledged against the loans borrowed from lenders. However, in bear markets, a sharp decline in stock prices can trigger margin calls that result in a downward spiral in stocks.

Conclusion

Investors must keep a close watch on promoter pledging since companies that have high pledging can experience high stock price volatilities. Investors can find the information on pledged shares on stock exchange websites since SEBI mandates publicly listed companies to disclose this information along with the shareholding pattern on a quarterly basis to NSE and BSE.

FAQs

How do companies pledge shares?

To pledge shares, a promoter must initiate a request using the trading terminal. After the request is received, the trading terminal sends it to NSDL/CDSL for confirmation. NSDL/CDSL will authenticate the request and, once approved, the collateral margin is made available for trading to the promoters.

What is a haircut?

A haircut is the percent difference between an asset’s market value and the value available to be used as collateral.

What do you mean by promoter share?

Promoter shares are equity shares of a company that are held by Promoters.

Who can buy the right share?

A rights issue is mainly used by a cash-strapped company to raise additional capital for paying down debt. Shareholders can buy right shares at a discount for a certain period.

What is BV per share?

Book value per share (BVPS) is the ratio of equity shares available to common shareholders by the number of total outstanding shares. It represents the minimum value of a company’s equity and estimates a firm’s book value on a per-share basis.

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