Pledged Promoter Holding

Pledging refers to the act of taking loans against the shares one holds. Sometimes, promoters of companies will raise funds, either for personal or professional use, by taking loans using shares of the company that they own as collateral.

Typically, the bank or NBFC lending money will lend an amount that is less than market value of the shares. For example, suppose X is the promoter of Aarti Industries. The total shares outstanding of the company is 10,000 and X holds 60% stake in the company i.e 6,000 shares. If the current market price of each share of Aarti Industries is Rs 20, then X’s total holding is worth Rs.1,20,000 (6000 * 20). X needs Rs.50,000 for his personal use and is planning to pledge some of the shares of Aarti Industries in order to raise the money. Suppose the bank lends Rs.80 for every Rs.100 collateral pledged, X will have to then pledge Rs.62,500 worth of shares to raise Rs.50,000. This translates to 3125 shares (62,500 / 20). So, out of the total shares outstanding 31.25% is pledged (3,125 / 10,000). The difference between the amount of collateral and the amount of money received as loan is the margin amount.

Now, if the share price of the company starts falling, the margin starts getting eroded and the lender can then ask X to either return some part of the loan or pledge more shares in order to make up for the margin shortfall. If X is not able to do so, the lender will then sell the shares in the stock market to raise the required amount and maintain the margin.

In case of volatile markets, holding shares of companies with high pledged percentage is very risky. This is because, if the stock price falls sharply, lenders will sell the shares and this sudden increase in supply of the shares will further push down the price of the stock and investors might incur significant loss.