Promoters generally pledge their shares as a guarantee for any long-term loan that can be taken at better rates. The reasons could be many – expansion plans of the company or sometimes the need for liquidity.
But, what makes promoters pledge their shares to raise cash? It’s because the climate for fund-raising has been tough of late and there is a big liquidity problem in the market right now, forcing promoters to sell/pledge their shares. Since 2010, the RBI has kept the interest rates tight, as a result of which credit has remained expensive and promoters have had to look for other options. Most of the companies where promoters had to increase their pledged holdings are from infrastructure, real estate and aviation.
But this procedure of raising funds involves a certain amount of risk, especially in a falling market. A bear market can put pressure on the promoter due to decline in the value of stocks. And once that happens, there are broadly two options available to the promoters – pay cash to meet the deficit or increase the existing holdings. It’s like being stuck in quicksand where you just can’t seem to find a way out. As the shares are kept as collateral, the lender has the option to sell the shares or take ownership of the company in case the promoter is unable to repay. There have been cases when promoters have pledged a specific amount when the stock price was high and later on when the prices were hit they had to further increase the holding amount with the lender. Mid- and small-cap companies are the worst-affected because lenders don’t grant them loans easily as share prices of such companies are most volatile to market movements.