Insider Share-Pledging and Equity Risk

Abstract

Corporate insiders frequently borrow from lending institutions and pledge their personal equity as collateral for the loan. This borrowing, or pledging, potentially affects shareholder risk through changing managerial incentives or contingency risk. Using an exogenous shock to lending supply, we document a significant increase in risk arising from pledging. Difference-in-differences regressions indicate that insider pledging corresponds with a 16.5% relative increase in risk despite unchanged firm fundamentals. The empirical analysis supports contingency risk in linking pledging to volatility. Overall, our findings suggest that pledging allows influential insiders to extract private benefits of control at the expense of outside shareholders.