Share Pledging and Financial Constraints in China

Abstract

We investigate the relationship between the intensity of share pledging activities and the level of financial constraint. Using a sample of Chinese publicly listed firms from 2003 to 2018, our main findings are fourfold. First, we document that the high financial constraint level may motivate insiders to use share pledging as an alternative funding source and an expropriation mechanism. Second, share collateralization can cause a subsequently more constrained financing condition. Third, investors may raise more concerns about the existence of share collateralization than the proportion of pledged shares in a firm. Fourth, we find evidence that share pledging made by the controlling shareholder is likely to mitigate financial constraints in the following year. Our results are robust to alternative measures of share pledging, an alternative definition of financial constraint, and an instrumental variable for dealing with endogeneity problems. Our findings provide insights into rationales behind and consequences of share pledging activities, which have important implications for financially constrained firms and regulators in emerging markets.

Keywords: Share pledge, Financial constraint, Controlling shareholder

JEL Classification: G32, G35