Used as a Tool: When Esops Meet Controlling Shareholders’ Share Pledging in an Emerging Market

Abstract

We examine whether firms adopt an employee stock ownership plan (ESOP) to motivate employees to maximize shareholder value or rather to serve as a tool for controlling shareholders to exploit minority shareholders by shortchanging them in the presence of share pledging (SP). We show that an SP firm is more likely than a non-SP firm to adopt an ESOP. Additional analysis suggests that: 1) when a firm has an ESOP (conditional on SP), its total factor productivity does not increase, 2) an SP firm with an ESOP engages in more real earnings management in terms of discretionary expenses, more negative news hoarding, and more related-party transactions, 3) when a firm has severe agency problems or the margin call risk is high, it is more likely to adopt an ESOP. Collectively, these findings suggest controlling shareholders exploit ESOPs as a tool to seek private benefits at the expense of other shareholders.

Keywords: Employee stock ownership plans, share pledging, exploitation and consent, principal-principal agency problems