The impact of share‐pledging purposes on firm performance and innovation

• Published date: 01 January 2024
• Author: Xiao Jia,Ellen Jin Jiang,Rui Wang
• Date: 01 January 2024
• DOI: http://doi.org/10.1111/corg.12519

ORIGINAL ARTICLE

The impact of share-pledging purposes on firm performance

and innovation

Xiao Jia

1

| Ellen Jin Jiang

2

| Rui Wang

2

1

School of Economics, Huazhong University of

Science and Technology, Wuhan, China

2

International Business School, Xi'an Jiaotong

Liverpool University, Suzhou, China

Correspondence

Ellen Jin Jiang, International Business School,

Xi'an Jiaotong Liverpool University, Suzhou,

China.

Email: jin.jiang@xjtlu.edu.cn

Funding information

National Natural Science Foundation of China,

Grant/Award Number: 72002077

Abstract

Research question: Share pledging by controlling shareholders can be motivated by

business or personal purposes. We investigate whether the firm performance and

innovation outputs are different for firms with controlling shareholders pledging

shares to support their firm's financing (business-pledging firms) and those pledging

shares for increasing personal wealth (individual-pledging firms).

Research findings: Using data from publicly listed Chinese firms, we find that

business-pledging firms are associated with higher changes in Tobin's Q and more

patent outputs compared with individual-pledging firms. In additional tests, we show

that the impact of share-pledging purposes on firm performance and innovative out-

puts is more pronounced for Chinese non-state-owned enterprises, which have rela-

tively limited access to traditional bank loans.

Theoretical implications: In this study, we bring new empirical evidence to agency

theory, especially the “principal–principal”problem. We identify two inherently dif-

ferent purposes in share-pledging cases—business pledging and individual pledging.

We show that in business-pledging cases, pledgers' interests become more aligned

with outside shareholders, and pledgers have higher incentives to enhance firm value

and innovation productivity, relative to individual pledging. This paper adds to the

evidence on the bright side of share pledges.

Practitioner implications: This paper sheds light on the recent policy debate regard-

ing the costs and benefits of share pledging and has implications for regulators and

investors. Thus, it may be vital for publicly listed firms to disclose the purposes of

share pledging.

KEYWORDS

corporate governance, share pledging, controlling shareholders, firm performance, innovation

1|INTRODUCTION

Share pledging is a widely used financing tool for controlling share-

holders (the pledgers) to pledge a portion of their shares as collateral

to secure loans from lenders (the pledgees). Share pledging provides

corporate insiders the benefit of obtaining loans without jeopardizing

their control rights. More than 20% of United States (US) firms and

more than 70% of Chinese firms in 2019 had experienced share

pledging at least once (Zhu et al., 2021). Controlling shareholders may

pledge shares to increase personal wealth or inject money into the

underlying firms. Do these two purposes of share pledging have dif-

ferent impacts on firm performance and innovative outputs? This

study aims to address this research question.

If controlling shareholders use funding from share pledging to

increase personal wealth, they monetize the equity for personal use

without diminishing their voting rights. In turn, the divergence

Received: 20 April 2022 Revised: 10 February 2023 Accepted: 13 February 2023

DOI: 10.1111/corg.12519

116 © 2023 John Wiley & Sons Ltd. Corp Govern Int Rev. 2024;32:116–134.wileyonlinelibrary.com/journal/corg

between cash flow and control rights misaligns the incentives of con-

trolling shareholders with those of minority shareholders (Shleifer &

Vishny, 1997). According to agency theory, the divergence between

cash-flow rights and control rights may cause controlling shareholders

to expropriate minority shareholders and tunnel resources from firms

for their own benefits (Claessens et al., 2002). In line with this argu-

ment, the prior literature has shown that controlling shareholders'

share pledging can induce expropriation behaviors, such as tunneling

resources from firms (Kao et al., 2004), and have negative effects on

shareholder wealth (Dou et al., 2019). In the specific setting of

COVID-19, Xiao et al. (2021) showed that share pledging had a nega-

tive impact on firm value in the highly pandemic-affected regions in

China. Some studies provide evidence of the negative association

between share pledging and innovation input, measured by research

and development (R&D), and innovation output, measured by patents

granted (Pang & Wang, 2020; Wang et al., 2020).

However, the current literature provides generalized evidence

on the net effect of share ple dging and mainly reflects share pledgi ng

for controlling share holders' personal weal th gain. Prior studies miss

the point that controlli ng shareholders may transf er the funding

from share pledging back to firms and conduct valu e-enhancing

activities to benefit the underlying firms. Injecting funding back into

the underlying firms ali gns controlling shareh olders' interests more

closely to those of minority sha reholders and creates the inc entive

for controlling shareholders to prop up the firm using their own

resources (Friedman et al ., 2003). So far, there is little evidence on

whether and how different share-pledging purposes could result in

heterogenous economic consequences. We address this interesting

research question by inve stigating the impact of sh are-pledging

purposes on firm perfo rmance and innovative outputs. We evaluate

firm performance throu gh market valuation meas ured by Tobin's

Q. Tobin's Q is calculat ed as the sum of the market va lue of equity

and the book value of debt scale d by total assets. We measure th e

innovation outcomes usi ng the number of patents gra nted within

3 years of pledging.

This paper categorizes the purposes for share pledging into two

types: individual pledging and business pledging. “Individual pledging”

is for individual purposes, in which the controlling shareholders spend

funds from pledging on personal consumption or new investment

opportunities outside the firm. “Business pledging”is for business

purposes, in which controlling shareholders transfer funds from pledg-

ing to the underlying firms. For instance, Zhejiang Crystal-Optech Co.,

Ltd. announced on April 24, 2021, that the controlling shareholder

pledged 10 million shares to loan money back to the firm and finance

the operation of the company. Business pledging may also involve

strategic cooperation between two parties. For example, the control-

ling shareholder of Sunning Holdings Group (Sunning) pledged all its

shares to Alibaba in 2020

1

for loans to Sunning. The share pledge

allowed Sunning to meet the working capital requirement while lifting

the controlling shareholder's incentive to cooperate with Alibaba to

improve firm value. We define “business-pledging firms”as those at

which the controlling shareholders use share pledging directly to guar-

antee loans to the underlying firms or lend at least 30% of the funds

raised from pledging to the underlying firms. About 7% of the share

pledges in our sample fall into the business-pledging category.

We use data for Chinese listed firms from 2010 to 2018 to test

our research questions. We start in 2010 to avoid the impact of the

2008–2009 financial crisis on share pledging and firm operations. Our

sample ends in 2018, as regulation required higher scrutiny over share

pledging. In total, we include 548 business-pledging cases versus

7411 individual-pledging cases in the sample. We use the sample of

Chinese firms for the following reasons. First, share pledging is used

more prevalently in this emerging market, and share-pledging disclo-

sure is compulsory under the statutes enforced by the China Securi-

ties Regulatory Commission (CSRC), while rules on share-pledging

disclosure remain under debate in the US (Dou et al., 2019; Wang

et al., 2020). The prevalent use and disclosure of share pledges in

China provide us an ideal setting to examine share pledging–related

research questions. Second, the market characteristics in China allow

for in-depth understanding of share-pledging activities, as the dual-

credit system in China results in limited bank-loan financing and more

share pledging for non-state-owned enterprises (non-SOEs)

2

(e.g., Liu

et al., 2018). The different needs of financing and the gradual devel-

opment of the credit market in China provide cross-sectional hetero-

geneity and time variance in the share pledging in our sample.

Therefore, our sample is representative and allows us to conduct

in-depth analysis on this topic.

Summarizing our results, we find that business-pledging firms are

associated with a higher increase in Tobin's Q and more patent out-

puts than individual-pledging firms. In additional analysis, we show

that the impact of share-pledging purpose on firm performance and

innovative outputs is only significant for non-SOEs but not for SOEs,

consistent with the notion that the financing role of share pledging in

supporting firm operations to achieve profits is more important in

non-SOEs than in SOEs. Additionally, we show that business pledging

is associated with more positive market reactions than individual

pledging. We also rule out the alternative explanation that the results

may be driven by firms in financial distress. To check for robustness,

we employ propensity score matching (PSM) to mitigate the impact of

the self-selection problem and use different measurement definitions

for business pledging, and our results still hold.

In summary, our study makes three contributions. First, the exist-

ing literature on share pledging finds a negative effect of share pledg-

ing on firm value or innovation activities regardless of pledging

purpose (Dou et al., 2019; Pang & Wang, 2020). Our study fills in the

research gap by distinguishing different share-pledging purposes and

adding to the evidence on the bright side by showing that business

pledging may incentivize the pledger to enhance firm performance

and innovation outputs. Second, prior studies on agency theory show

that controlling shareholders may prop up or tunnel firm value,

depending on the alignment or divergence of cash-flow rights and

control rights (Cheung et al., 2006; Jiang et al., 2010; Lemmon &

Lins, 2003). We show that share pledging could be a new channel

through which such an agency problem arises. Third, our findings sug-

gest that share pledging could be a new mechanism of financing firms,

as we show that firms with limited access to traditional bank loans

JIA ET AL.117