Firms with pledged shares less likely to 'manipulate' earnings

Companies with pledged shares are less likely to have manipulated earnings, especially over periods extending beyond a year, with lenders keeping a close watch on their books.

Pledging of shares is a process whereby shareholders, often promoters in a company, borrow money by offering their stock as security for the capital they get. The Securities and Exchange Board of India had required companies to disclose data on pledged shares, through a notification in January 2009.

A preliminary draft of a research paper dated this June, titled 'Do insiders who pledge their shares manipulate reported earnings?' suggested promoters were less likely to manipulate earnings after pledging, in spite of a strong incentive to do so.

"Our results suggest that pledging reduced the likelihood of accruals-based earnings management. Potential monitoring by lenders deters (this)," says the paper, authored by Srinivasan Rangan from IIM Bangalore; Aman Asija, IMImobile, and Vijaya Bhaskar Marisetty, RMIT University. The study isn't complete.

It said the time period in question also mattered, with the second year of pledging showing a greater deterrent impact.

"However, when we distinguish between first-time and continuing pledgers, we find the former record positive discretionary accruals, while continuing pledgers record significant negative discretionary accruals. In the first year of the pledge, the incentive to manage accruals upward is sufficiently important that it dominates any deterrence caused by monitoring by lenders. Alternatively, lender monitoring of pledgers is low in that year," it said.

This changes after the year has passed. "After the first year, either the first year's earnings management reverses and/or the deterring effect of lender monitoring becomes strong enough that firms record negative discretionary accruals," it said.

One out of every five of BSE 500 companies have pledged shares, according to a Business Standard analysis of data from data-provider Capitaline. There are currently 142 companies with pledged shares among these companies, for whom an average of 17.36 per cent of the total company shareholding had been pledged, showed data from the June quarter.

Eleven companies have more than 50 per cent of their total shareholding pledged. Sixteen others have 34-50 per cent.

An analysis of promoter shareholding showed promoters had pledged more than 90 per cent of their shares in 11 companies. Eight others had more than 80 per cent of promoter shares pledged. Forty-one had more than half of promoter holding pledged.

Companies with the largest percentage of pledged shares are from the infrastructure, real estate, power and shipping sectors.

PLEDGED SHARES=CLEANER BOOKS

* Companies with pledged shares have lower instances of earnings management, says study

* Earnings management is measured by examining relationship between operational earnings, sales, assets and extraordinary items in accounts

* Study looked at data from time pledging disclosures began(2009) till 2013

* Realty, infrastructure and power companies are amongst the sectors with high promoter pledging, shows latest data

* 142 out of BSE 500 companies have pledged shares, according June quarter figures

* 17.35 per cent is the average pledged shareholding (of total stake) amongst these companies

* 32.76 per cent is the average promoter shareholding pledged amongst these companies