Pledging shares against debt is a sure recipe for disaster, especially in a falling market. Around 31% companies out of 1,214 listed ones have actually pledged shares of more than 50% of their paid-up capital

In the backdrop of inadequate disclosure levels on share pledging, investment in such companies exposes an investor to severe price volatility, in case a promoter is not able to meet payments, or provide additional collaterals in a falling market, said a research agency. According to a report by Crisil Research, promoters of 31% of the 1,214 listed companies and with a market capitalisation of Rs100 crore or more, have pledged substantial portion of their shareholding. The total pledge works out to Rs1.1 lakh crore worth of market capitalisation as on 18 November 2011.

Promoters have pledged substantial portion of the shares in several popular companies. Such companies include Gujarat Pipavav (in which promoters have 100% of their holding), Tata Coffee (100%), Ansal Properties (97.74%), Koutons (97.03%), GTL (96.38%), Dunlop (91.89%), Kingfisher (90.93%), Gati (89.83%), United Spirits (89.64%), Gujarat NRE Coke (88.35%), JSL Stainless (87.69%), Spice Jet (86.16%), Essar Oil (83.99%), Bilcare (83.05%), S Kumars (83.03%), Omaxe (81.61%), Era Infra (80.9%), Orchid Chemicals (77.14%), McDowell Holdings (74.14%), Parsvanath (71.24%), KS Oils (70.28%) and Suzlon Energy (69.41%).

“In 2011, the capital markets have been highly volatile due to looming concerns of high domestic inflation, rising interest rates and tepid global economic environment. These concerns have triggered a fall in stock prices, creating pressure on the promoters who have pledged shares to make good the loss in the value of the collateral. Investors, especially retail investors, are generally oblivious of such details, and eventually incur losses because of sharp fall in prices,” said Mukesh Agarwal, senior director, Crisil Research.

The equity markets have been under phenomenal pressure. Stocks across the board have been shivering under selling pressure amidst of gloomy market scenario. While the markets are under pressure, the companies in which the promoters have pledged substantial portion of their shares will come under tremendous pressure, as there is a risk of margins calls getting triggered from the lenders.

Jagannadham Thunuguntla, strategist and head of research at SMC Global Securities said, “Leverage is like fire. If you know how to handle it, you can cook food. If you do not know how to handle, you can burn your fingers. The promoters of mid-cap and small-cap companies will need to find the solution to this problem very quickly, before things move out of hand.”

While the motive for pledging shares is very difficult to ascertain, promoters of larger corporates may able to withstand the margin pressures associated with pledged shares. Tarun Bhatia, director, Capital Markets, said, “Other than the Securities and Exchange Board of India’s (SEBI) current guideline, which require companies to disclose percentage of promoter holdings pledged, there are no regulations that make it mandatory for promoters to disclose other crucial details like purpose of funds raised through pledging of shares, price at which the initial pledging is made and the conditions under which the margin call will be triggered.”