Share pledging by controlling shareholders and accounting conservatism: evidence from India

Abstract

PurposeThe purpose of this paper is to examine the relationship between accounting conservatism and pledging of shares by controlling shareholders of a firm to obtain a loan. The pledging of shares by the controlling shareholders of a firm results in alterations to the payoff and risk structure for these shareholders. Since accounting numbers have valuation implications, pledging of shares by a controlling shareholder has an impact on accounting policy choices made by the firm. The purpose of this paper is to examine the impact of controlling shareholder share pledging to obtain a loan on a specific accounting policy choice, namely, conservatism.Design/methodology/approachThe paper uses a large data set from India comprising 14,786 firm years consisting of 1,570 firms belonging to 58 industries for a period of 11 years (2009–2019). The authors use ordinary least square regression with robust standard errors. The authors conduct robustness checks and the results are consistent across alternative statistical methodologies and alternative measures of the primary dependent and independent variables.FindingsThe primary results show that pledging of shares by the controlling shareholders results in higher conditional conservatism and lower unconditional conservatism. Further analysis reveals that the relationship is stronger when the controlling shareholder holds a majority ownership in the firm. Additionally, the results show that for business group affiliated firms, which are unique to developing countries, both the conditional and the unconditional conservatism are incrementally lower when the controlling shareholder pledges the shares. For family firms with a family member as CEO, the conditional conservatism is incrementally higher and the unconditional conservatism is incrementally lower. Finally, the authors show that the results hold when the pledge intensity variable is measured with a one-year lag and finally, the authors show that conditional conservatism is incrementally higher in the year of the increase in the pledge and the year after, but there is no such incremental impact on unconditional conservatism.Research limitations/implicationsThe research is limited to the listed firms in India. Since majority of the listed firms are controlled by families and the family firms around the world are heterogeneous the findings of the research may not be applicable to other countries.Practical implicationsThe study has implications for policy-making and monitoring of the pledging by the controlling shareholders. It also helps the investors in making investment decisions with respect to family firms in India.Originality/valueThe study is unique as it focuses on the relationship between pledging of shares by the controlling shareholders and its impact on accounting conservatism. To the best of the authors’ knowledge, this is the first research integrating these two aspects.