From Wockhardt to Deepak Fertilizers — promoters of these seven companies have pledged more shares last quarter

• The slowdown in the Indian economy and the COVID-19 pandemic have dried out liquidity in the market, forcing promoters to pledge their equity shares to raise money.
• While promoter pledges may not affect shareholders in a bullish economy, the Indian stock markets have had a bear run in 2020, crashing by nearly 25% this year.
• As a result, promoter pledges in several companies have gone up drastically, which can have an impact on shareholder wealth.
• In such a scenario, it is important to know what exactly promoter pledges mean and how they can have an affect on the share price of the company.

With the slowdown Indian economy and COVID-19 pandemic drying out the liquidity in the market, promoter pledging has hit new highs in 2020. This has resulted in increased volatility in the Indian market – something that hasn’t been seen since the 2008 recession.

A research report by Edelweiss has identified 7 companies in which promoter pledging has changed drastically between Q3, 2019 (Oct-Dec) to Q1, 2020 (since April).

Source: Edelweiss Research

Out of these 7 companies, promoters of 4 companies have pledged as many as 75% of their shares. In the other 3 companies, promoter pledging has declined from 85% to 0%.


What is promoter pledging?

Promoter pledging is a way of getting a loan from financial institutions by using shares of the company as collateral.

Promoters use the equity shares they own as collateral and obtain loans from banks, non-banking finance companies (NBFCs) and others. They then use these loans to meet their requirements.

Why you should care about promoter pledges

So far, this sounds like a regular loan.

However, in the case of promoter pledges, the risk factor for both the lender and the promoters is high. This is because, when promoters pledge their equity shares to obtain a loan, it is seen as if the promoters are cash-strapped in their personal capacity, which could be considered as a bad sign for their companies.

Source: BSE

This can further affect the share price of the company and the market sentiment, leading to a fall in the share prices and erosion of shareholder wealth.

In turn, when the share price falls, lenders will either ask the promoters to pledge additional shares to meet the collateral requirements, or they could ‘invoke’ the promoter pledge and sell them in the share market to recover their loans.

In either case, there is a risk of share price of the company falling further, leading to further erosion of shareholder wealth.

So, while promoter pledges are transactions between the promoters and the lenders, a high percentage of promoter pledge can lead to a fall in share price of the company, which can affect shareholders as well.

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