One way out of the share pledging quagmire: Evidence from mergers and acquisitions

Share pledging by controlling shareholders is accompanied with a risk of control transfer when stock price decline triggers a margin call. This situation motivates controlling shareholders and firms to initiate value-enhancing activities to manage the pledging quagmire. Using a sample of Chinese listed firms, we find that firms with pledging controlling shareholders are more likely to implement mergers and acquisitions (M&As) than other firms. Their M&As also perform better, regardless of whether using short- or long-term stock returns or operating income as the performance measure. Furthermore, the positive effect of share pledging on M&As is more pronounced in non-state-owned enterprises, firms with individual controlling shareholders (especially families), firms with better governance, and firms with higher financial capabilities. Additional analyses on deal types also show that firms with pledging controlling shareholders are more likely to engage in diversified, non-affiliated, and cash-financed acquisitions. These results consistently suggest that M&As may effectively eliminate firms' pledging risks and that share pledging mitigates shareholders' conflict of interest regarding M&A decisions.