Insider Share-Pledging and Equity Risk
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Insider Share-Pledging and Equity Risk Ronald Anderson 1 & Michael Puleo 2 Received: 6 November 2017 / Revised: 9 January 2020 / Accepted: 13 January 2020 # Springer Science+Business Media, LLC, part of Springer Nature 2020
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. Keywords Pledged shares . Financial crisis . Corporate ownership . Financial risk JEL Codes G01 . G18 . G32 . G34
1 Introduction Managerial equity ownership constitutes a fundamental governance device in mitigating the conflict of interest between executives and shareholders (Jensen and Meckling, 1976). Morck, Shleifer, and Vishny (1988) and McConnell and Servaes (1990) document that managerial ownership positively influences firm value when managers hold low levels of equity, but firm performance deteriorates as ownership stakes become meaningfully larger. Core and Larcker (2002) find that excess returns in both accounting and stock performance increase following mandatory increases in executive stock ownership. More recently, Lilienfeld-Toal and Ruenzi * Michael Puleo [email protected] Ronald Anderson [email protected]
1
Department of Finance, Temple University, Philadelphia, PA, USA
2
Department of Finance, Fairfield University, Fairfield, CT, USA
Journal of Financial Services Research
(2014) document that CEO-ownership reverses the negative effect of weak governance and significantly improves stock-price performance. Yet, managers may wish to decouple portions of their wealth from the firm’s future prospects (Amihud and Lev, 1981; Jagolinzer, Matsunaga, and Yeung, 2007). Although outside shareholders bear only market risk, managers bear market and firm-specific risk. Executives often hold large, undiversified positions in the firm, and both their human and financial capital depends on firm performance. Insiders autonomously hedging or diversifying their ownership positions can unwind the incentives that boards of directors introduce to mitigate agency conflicts (Bettis, Bizjak, and Lemmon, 2001; Garvey and Milbourn, 2003; Bettis, Bizjak, and Kalpathy, 2015). We investigate a new and largely unexamined innovation in managerial ownership that potentially exacerbates agency conflicts between managers and shareholders – insider share-pledging. Share-pledges involve executives or directors borrowing capital from lenders and providi
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