Definition
Pledged shares are those shares that a stockholder uses as collateral to secure a loan. The lender retains the right to sell these shares to recover their money if the borrower defaults on the loan. It’s a way for shareholders to leverage their ownership stakes in a company without having to sell their shares.
Key Takeaways
- Pledged shares refer to the stock that shareholders put up as collateral to secure a loan. This could be because the shareholder doesn’t want to sell their shares but needs financing for personal or business purposes.
- When shareholders pledge their shares, they still maintain ownership of the shares, meaning they can still receive dividends and have voting rights. However, if the shareholder defaults on the loan, the lender has the right to sell the pledged shares to recover the loan amount.
- High levels of pledged shares can indicate potential risk for investors. This is because in the event of a market downfall, the lenders may sell off the pledged shares which can cause a sharp decline in the share’s value and destabilize the company.
Importance
Pledged Shares are significant in the world of finance as they are often used by promoters or company insiders as a way to secure loans needed to meet various business needs.
This process involves offering up company shares as collateral to lenders.
By monitoring the level of pledged shares, potential investors can gauge the financial stability of a company and the risks involved.
For instance, a high percentage of pledged shares could indicate financial distress and the potential for volatility, thereby increasing the risk for investors.
Thus, understanding pledged shares is crucial to making informed investment decisions.
Explanation
Pledged shares serve a key purpose in the financial world, often used as a means to secure funding or loans. When a shareholder, often a corporate promoter or even a retail investor, needs a loan or financing, they can pledge their shares as collateral to a lending institution. Lenders accept these as they hold inherent value and can be sold to recover funds in the event of default.
This allows shareholders to leverage their existing assets for additional funding without having to outright sell their shares and lose ownership and control. In addition, pledged shares can also be used to raise trading margin from a broker. During volatile market conditions, traders might not have immediate liquid assets to meet margin calls.
In such scenarios, traders can pledge their shares to their broker to maintain their positions. It’s important to note that while pledging shares can provide needed capital, it also comes with risks. If share prices fall significantly, lenders can sell off the pledged shares to recover their money, potentially causing significant loss to the shareholders who pledged their shares.
Examples of Pledged Shares
Kingfisher Airlines Case: In the early 2010s, the founder of Kingfisher Airlines, Vijay Mallya, pledged his shares to obtain loans to keep his airline afloat. When the company defaulted on its loans, the lenders took possession of the pledged shares.
Zee Entertainment Enterprises: In 2019, the Subhash Chandra-led Essel Group, which held a major stake in Zee Entertainment Enterprises, had to sell off a significant portion of their pledged shares due to debt. This occurred when they could not repay their loans on time, resulting in lenders selling the pledged shares in open market to recover the funds.
Reliance Group: In 2020, several financial institutions invoked the pledged shares of Anil Ambani’s Reliance Group due to the company’s inability to repay the borrowed money. This led to substantial decline in share prices and erosion in the total market value of the firm.
FAQs About Pledged Shares
What are Pledged Shares?
Pledged shares are those shares that the promoter of a company has pledged to a financial institution as security to raise funds.
What happens if the borrower can’t repay the loan taken against Pledged Shares?
If the borrower fails to repay the loan, the lender has the right to sell the pledged shares to recover the remaining debt.
How can I find out if a company has any Pledged Shares?
Information about pledged shares is typically available in the annual report of a company or can be found on financial websites that provide stock market data.
Why would a promoter Pledge Shares?
A promoter may pledge shares as a means to secure a loan without having to sell their shares, thus avoiding potential capital gains tax and maintaining ownership in the company.
What are the risks associated with Pledged Shares?
In a scenario where the share prices fall drastically, the borrower may fail to maintain the required margin, triggering the financial institution to sell the shares. This could result in further decrease of the share price due to oversupply, causing a substantial loss to the retail investors.
Related Entrepreneurship Terms
- Collateral: Property or other assets that a borrower offers a lender to secure a loan. If the borrower stops making the promised loan payments, the lender can seize the collateral to recoup its losses.
- Margin Call: A broker’s demand on an investor using margin to deposit additional money or securities so that the margin account is brought up to the minimum maintenance margin. This is sometimes colloquially referred to as a “fed call” or “maintenance call”.
- Secured Loan: A secured loan is a loan in which the borrower pledges some asset (e.g. a car or property) as collateral for the loan, which then becomes a secured debt owed to the creditor who gives the loan.
- Insider Trading: The trading of a public company’s stock or other securities (such as bonds or stock options) by individuals with access to nonpublic information about the company.
- Default: Failure to meet the legal obligations (or conditions) of a loan, for example when a home buyer fails to make a mortgage payment, or when a corporation or government fails to pay a bond which has reached maturity.
Sources for More Information
- Investopedia: A comprehensive source for finance and investing definitions, including information on pledged shares.
- Moneycontrol: An online resource for the latest updates on finance, market, investment strategies, and pledged shares.
- Economic Times: Covers a wide array of financial topics and current news, including pledged shares.
- Financial Express: An online newspaper focusing on business, finance, and stock markets. Articles on pledged shares are available.
