Share pledging by controlling shareholders and accounting conservatism: evidence from India

We examine the relationship between accounting conservatism and pledging of shares by controlling shareholders of a firm. The shares are pledged as collateral for a loan. Controlling shareholders’ share pledging results in alterations to the payoff and risk structure for them. Since accounting numbers have valuation implications, pledging of shares by a controlling shareholder has an impact on accounting policy choices made by the firm. We study the impact of controlling shareholder share pledging on a specific accounting policy choice, viz. conservatism. We use a large data set from India comprising of 14,786 firm years with 1570 firms belonging to 58 industries for a period of 11 years (2009-2019). Our primary results show that pledging of shares by the controlling shareholders results in higher conditional conservatism and lower unconditional conservatism. Further analysis reveals that the relationship is stronger when the controlling shareholder holds a majority ownership in the firm. Additionally, our results show that for business group affiliated firms, which are unique to developing countries, both the conditional and the unconditional conservatism are incrementally lower when the controlling shareholder pledges the shares. For family firms with a family member as CEO, the conditional conservatism is incrementally higher and the unconditional conservatism is incrementally lower.

Finally, we show that our results hold when the pledge intensity variable is measured with a one-year lag and finally we show that conditional conservatism is incrementally higher in the year of the increase in the pledge and the year after, but there is no such incremental impact on unconditional conservatism. The results of our paper will be useful to policymakers, lenders, regulators and investors, as we empirically demonstrate that pledging firms behave differently with respect to accounting choices than non-pledging firms, and higher monitoring by investors, creditors and regulators need to be exercised with respect to pledging firms.

Other authors: Suhas M. Avabruth (Xavier Institute of Management, Bhubaneswar) and Palanisamy Saravanan (Indian Institute of Management Tiruchirappalli)