Share Pledging and Corporate Default Risk: Evidence from the Chinese Stock Market

Abstract

In this paper, we assess the economic impact of share pledging by focusing on corporate debt default risk, the most disruptive events in the life of a corporation. Using Instrumental Variables and a regulatory change that increasing the possibility of share pledging as a quasi-exogenous shock, we establish that increased share pledging decreases corporate default risk. The baseline results are robust by eliminating the effect of financial crises, adding other control variables, constructing new PSM samples and use other proxies for default risk. Further tests show that the relation is attenuated in higher ownership concentration and lower ex-ante institutional ownership firms. Our results indicate that share pledging can be beneficial to shareholders and important stakeholders like creditors by reducing the likelihood of corporate default. Our paper throws additional light on the economic impact of share pledging. Although several studies argue that share pledging incentivizes corporate insiders to use corporate resources for private benefits and destroy firm value on the Taiwanese stock market, our findings indicate that share pledging facilitates external monitoring and enables creditors to protect themselves. Our overall findings are consistent with prior literature which shows that share pledging improves market value of Chinese A-share listed firms. We believe that as strong government intervention during market downturns may limit A-share listed firms’ exposure to downside risk associated, share pledging can play a more positive role in our setting.