The economic consequences of controlling shareholder share pledging: by evidence from China

The practice that insiders, including executives, directors, block shareholders, pledge shares as collaterals to secure loans from financial institutions is pervasive across the global capital markets. Given the emerging problems and scandals resulted from insider share pledging, regulators and outside shareholders regard insider share pledging as a significant corporate governance concern. Although a few studies have explored the economic consequences of insider share pledging, there are no studies investigating whether and how insider share pledging affect agency conflicts and information risk, which in turn could affect firms' cost of equity capital. This thesis fills this gap using a large sample of controlling shareholder share pledging (share pledging for short, henceforth) in Chinese capital market. Th is thesis consists of three self-contained research papers in the areas of share pledging, agency conflicts, information risks, and firms' cost of equity capital. The first paper (in Chapter two) examines how share pledging affects tunnelling (i.e., agency conflicts). This study documents a positive relation between share pledging and firm tunnelling. Specifically, the presence of share pledging leads to a 14. 9 % increase in tunnelling, which translates into an increase of 13.3 million RMB inter - corporate loans to the controlling shareholders. Moreover, this positive relation between share pledging and tunnelling in non - state - owned enterprises (group - affiliated firms) is stronger than that in state - owned enterprises (non - group - affiliated firms). This study also find s that strong monitoring of multiple large shareholders, high analysts' coverage, and strong institutional environment help mitigate the tunnelling level induced by share pledging, suggesting that better internal and external corporate governance mechanisms help curb the tunnelling behaviour induced by share pledging. By further investigation, this study finds that the cumulative abnormal returns (CARs) around the interim announcements of share pledging are significantly negative, suggesting that the market anticipates and penalizes the tunnelling activities induced by share pledging. Finally, the results show that share pledging impairs firm performance which is consistent with the tunnelling story of share pledging. Overall, the findings suggest that share pledging exacerbates firm tunnelling in an emerging market when external monitoring and shareholder protection is relative weak. The second paper (in Chapter Three) examines how share pledging affects corporate disclosure quality (i.e., information risk). This study documents a negative relation between share pledging and corporate disclosure quality. Specifically, the presence of share pledging leads to 5.56 times decrease in disclosure quality. Moreover, this negative relation between share pledging and corporate disclosure quality in non - state - owned enterprises is stronger than that in state - owned enterprises. These results suggest that the margin call pressure and the related risk of losing control rights resulted from share pledging provides controlling shareholders with incentives to manipulate corporate disclosure. Further, iv this study has explore d the channels that controlling shareholders use to manipulate corporate disclosure. The results show that share pledging leads to upward earnings management, optimistic management forecasts, and decreased conditional accounting conservatism. Finally, this study finds that, as corporate disclosure quality decreases, share pledging exerts an incremental negative effect on firm value. The Third paper (in Chapter Four ) examines how share pledging affects firms' cost of equity capital. This study document s a positive relation between share pledging and firms' cost of equity capital. Specifically, firms with share pledging have a cost of equity capital that is 24.6 basis points higher than do firms without share pledging, which implies an additional annual cost of 14.7 million RMB for an average firm with share pledging to finance with equity. This study also has explored the channels through which share pledging increases cost of equity capital. The results suggest that share pledging increases firms' cost of equity capital by imposing information risk and agency conflicts on outside investors. By cross - sectional analysis, this study finds that the positive association between share pledging and cost of equity capital is more pronounced in firms with higher level of information asymmetry, non - state - owned enterprises, firms with weaker monitoring of multiple large shareholders, and firms with weaker regional institutional environment. By further investigation, this study also documents a positive relation between share pledging and firms' systematic risk, suggesting that the information risk s and agency conflicts related to share pledging are non - diversifiable. Finally, this study finds that firms with share pledging have a cost of debt that is 23.6 basis points higher than do firms without share pledging, which implies an additional annual cost of 5.3 million RMB for an average firm with share pledging to finance with debts. The findings in this thesis contribute to the current debate regarding economic consequences of the controversial financial innovation, namely, insider share pledging, and provide policy implications for regulators and investors.