Controlling shareholder share pledging and tunneling: Evidence from an emerging market

ABSTRACT

This study investigates the impact of controlling shareholder share pledging (henceforth, share pledging) on tunneling in an emerging market. Using a large sample of Chinese-listed firms from 2004 to 2019, we find that the presence of share pledging results in a 9.7% increase in tunneling, and higher controlling shareholders’ pledging ratio is associated with more severe tunneling. The positive relationship between share pledging and tunneling is significantly stronger in non-SOEs than in SOEs. We also find that strong monitoring of multiple large shareholders, high analysts’ coverage, and strong institutional environment help mitigate the tunneling induced by share pledging. We further find that the cumulative abnormal returns around the interim announcements of share pledging are significantly negative. Overall, the findings in this study suggest an exacerbating effect of share pledging on tunneling in an emerging market when external monitoring and investor protection is relative weak.

KEYWORDS:

• Controlling shareholder share pledging
• tunneling
• multiple large shareholders
• analysts’ coverage
• institutional environment

JEL CLASSIFICATION:

• G14
• G30
• G34

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1. For example, Anderson and Puleo (2020) show that 26% of their randomly drawn samples from S&P publicly listed firms have insider share pledging; Singh (2018) reports that controlling shareholders of around half of listed firms in India have pledged shares at least once from 2009 to 2014. In China, according to data provided by the Chinese Stock and Market Accounting Research (CSMAR), firms with share pledging account for more than 40% of non-financial listed firms in the Chinese A-share stock market in 2019.

2. According to the data obtained from CSMAR database, given that there are 3,506 non-financial listed firms and 30,040 firm-year observations in the Chinese A-share stock market from 2004 to 2019, our sample accounts for 85.7% (3,003/3,506) of listed firms and 73.6% (22,111/30,040) of firm-year observations. Besides, the shares pledged by controlling shareholders in our sample account for 86.6% (1.141 × 10^12/1.318 × 10^12) of the total shares pledged by controlling shareholders in the Chinese A-share stock market from 2004 to 2009. Thus, our sample is representative.

3. PledgeRatio is not a strict contiguous variable because when a firm does not have share pledging, PledgeRatio is defined as zero. Thus, when using PledgeRatio as the independent variable, following Dhaliwal et al. (2016), we compare the difference of Tunneling (the dependent variable) between firms with and without share pledging.

4. For example, the industry-by-year fixed effect accounts for the transitory industry-wide factors, such as industry profitability shocks, which could affect controlling shareholders’ incentives to pledge shares and tunnel listed firms in a year.

5. Recent studies (e.g. Li et al., 2019; Liu & Tian, 2022; Meng et al., 2019) also employ this regulatory change as a quasi-natural experiment to identify the causal effect of share pledging.

6. We have also examined H2, H3a, H3b, and H3c using the DID model. The results basically support our hypotheses. For space consideration, we do not present these results.

7. Anecdotal evidence suggests that financial institutions are more willing to accept stocks with high liquidity and stable returns as collaterals. Thus, stock turnover rate, stock returns and the standard deviation of stock returns are likely to be related to the probability that controlling shareholders pledge shares.

8. We use the ±1% cut-offs so that the matched firms are very similar. We also use ±0.5%, ±2.5%, ±5% as cut-offs, the results are consistent.

Additional information

Funding

This research was funded by the Guangdong Philosophy and Social Sciences Youth Project (grant number: GD21YGL15) and the Guangdong Philosophy and Social Sciences ‘the 13th Five-Year Plan’ Youth Project (grant number: GD20YYJ07)