The Causes and Consequences of Stock Pledging by Controlling Shareholders: The Case of Taiwan

THE CAUSES AND CONSEQUENCES
OF STOCK PLEDGING BY
CONTROLLING SHAREHOLDERS:
THE CASE OF TAIWAN
Alan T. Wang and Anlin Chen
ABSTRACT
The information of pledging stocks for liquidity by controlling shareholders of

publicly traded firms in Taiwan has been required to disclose since 1998. A
common perception by market practitioners in Taiwan is that stock pledging
by controlling shareholders is an indication of expropriation of firms. This
study first examines the determinants of the tendency that controlling share-
holders of firms in Taiwan pledge their stocks to financial institutions for
liquidity and then evaluates how stock pledging by controlling shareholders
affects their firms’ accounting and financial performances. Determinants of
firm attributes, market conditions, and corporate governance are identified.
The tendency of stock pledging by controlling shareholders has a negative
effect on accounting and financial performances. The negative effect on firm
performance is reduced when the firm has a higher level of working capital.
These findings indicate that stock pledging by controlling shareholders is an
indication of weak corporate governance when the firm has lower liquidity.
These findings may provide insights to the equity markets of the other coun-
tries in which public firms have more concentrated ownerships.
Keywords: Stock; pledging; corporate governance; cash holding; liquidity;

working capital; cash flow right; control right
JEL Classifications: G12; G32; G34
Advances in Pacific Basin Business, Economics and Finance, Volume 8, 99–129

Copyright © 2020 Emerald Publishing Limited
All rights of reproduction in any form reserved
ISSN: 2514-4650/doi:10.1108/S2514-465020200000008005
99
100 ALAN T. WANG AND ANLIN CHEN
1. INTRODUCTION
On September 4, 2015, the founder and the vice-chairman of Alibaba announced
that they were looking to borrow more than $2 billion against their stocks to
invest in the Hong Kong-based investment vehicle, Blue Pool Capital.
…borrowing against their stock could be a convenient way of diversifying their financial assets
beyond Alibaba while honoring their pledge at the company’s last earnings call not to sell down
when the lock-up period ends…
Alibaba’s spokesman said “Share financing is very common for founders and
senior executives who hold such a strong belief in the future growth potential of
their companies”.1,2 The Alibaba’s opening price dropped by $1.07, or 1.61%,
after the news had been announced.
Is it a good news or bad news from the perspective of investors or shareholders
when the controlling shareholders announce that they are to take out loans from
banks by pledging their stocks? Why do controlling shareholders borrow against
their shares? It is likely that they can borrow to buy more shares to reinforce their
control rights. If this is the case, they probably regard that stocks are undervalued
or have better growth opportunities, or they can expropriate firm resources at the
cost of other minority shareholders regardless of stock performance. Alterna-
tively, controlling shareholders borrow against their stocks simply for their per-
sonal liquidity purpose, which is irrelevant to the performance of the firms in the
future. Pledging stocks by controlling shareholders for liquidity may signal the
future prospects of the firm.
The purpose of this study is twofold. First, this study is to examine what types
of firms and under what circumstances that controlling shareholders tend to
pledge their stocks to borrow funds. Second, this study is to investigate the
performance of firms that their controlling shareholders take such an action. We
try to answer the first question from the perspectives of firm attributes, market
conditions and corporate governance. For the second question, we examine how
stock pledging by controlling shareholders is related to firm accounting and
financial performances.
It is well known that there are both benefits and costs for firms with large
ownership from the perspective of corporate governance. On the one hand, large
ownership can help monitor managers to reduce agency problems between
shareholders and managers (Jensen & Meckling, 1976; Shleifer & Vishny, 1986).
On the other hand, large ownership can have the problem of self-dealing, for
which large shareholders may extract rents from the firm through transactions
with affiliated firms and expropriate minority shareholders’ interests (Claessens,
Djankov, & Lang, 2000; La Porta, Lopez-de-Silanes, & Shleifer, 1999; Shleifer &
Vishny, 1997). Widely held corporations are prevalent in the United States and
1
http://fortune.com/2015/09/04/is-alibabas-jack-ma-looking-to-borrow-2-billion-against-
his-stock/
2
http://www.bloomberg.com/news/articles/2015–09-03/alibaba-chairmen-said-to-plan-2-
billion-loan-against-stock
The Causes and Consequences of Stock Pledging 101
Britain, but concentrated ownership is more common in other European and

Asian countries (Claessens et al., 2000; La Porta et al., 1999). Using publicly
traded corporations from eight Asian economies, Claessens, Djankov, and Lang
(2002) conclude that firm value increases with cash-flow ownership of the largest
shareholder, but falls when the controlling rights of the largest shareholders
exceed its cash-flow ownership. Others such as La Porta, Lopez-de-Silanes,
Shleifer, and Vishny (2002) and Lemmon and Lins (2003) also conclude that
the firm value is positively related to investor protection measures and to the cash
flow rights held by controlling shareholders, and negatively related to the devi-
ation of control right from cash flow right.
To maintain controlling rights in concentrated ownership corporations, there
are personal wealth constraints for large shareholders, because they need suffi-
cient wealth to own a significant percentage of shares. There are different ways
for large shareholders to maintain their controlling rights. For example, different
ownership structures such as multiple classes of shares with different voting
rights, cross-shareholding, or pyramid structures (Claessens et al., 2000; La Porta
et al., 1999) also reinforce and entrench the power of controlling shareholders.
Alternatively, large shareholders can pledge their shares to banks to obtain
liquidity to purchase more shares.
When controlling shareholders pledge their shareholdings for bank loans, this
leads to the deviation of control right from cash flow right and thus may lead to
minority shareholders expropriation. Specifically, when controlling shareholders
pledge their shares for bank loans, these shareholders are still the legal owners of
the shares pledged to banks and still have the controlling rights of the firms.
However, when the shares they pledge pay cash dividends, the value of the
collateral drops after the ex-dividend date. The shareholders who pledge their
shares in banks are required to use their cash dividends to buy more shares to
maintain the values of the collaterals. That is, if two investors own the same
amount of shares, one who has pledged shares and the other who has not, the one
who has pledged shares has less cash flow right than the other, even though they
both have the same controlling right.
Controlling shareholders pledge their shares to obtain bank loans for different
reasons. First, controlling shareholders can pledge publicly traded shares to obtain
more funds to buy more shares when the stock price is low to maintain their
control rights. They can increase their shareholding through financial leverage
without violating their wealth constraints. Second, when firms cannot finance their
projects, their controlling shareholders may pledge their shares to finance projects
with positive net present value (NPV) and increase shareholders’ wealth. For
example, controlling shareholders can use funds from pledging stocks to invest in
the stocks of the suppliers of their firms to increase the values of their firms.
Finally, shareholders may also pledge their shares for other personal liquidity
needs. For example, they can use the funds from pledging shares to invest in the
shares of other firms for their own investment purposes to increase their wealth.
Knowing the real purposes of stock pledging by controlling shareholders helps
understand whether stock pledging is good for the firm or not. However, outsiders
cannot observe the motives of shareholders’ stock pledging behavior.
Because stock pledge leads to the deviation of control right from cash flow
right, the behavior of pledging stocks has drawn the attentions by regulators. It
has become a trend around the world that the regulators of securities exchanges
mandate the publicly traded firms to disclose the information of stock pledging
by controlling investors. In 2006, the US Securities Exchange Commission (SEC)
started the requirement for footnote disclosure of the number of shares pledged as
collateral of named executive officers, directors and director nominees in the
proxy and information statements.3 Also, the Financial Services Authority (FSA)
of the United Kingdom clarified that the disclosure requirement in Disclosure
and Transparency Rules applied to every share pledging behavior of directors
and other persons discharging managerial responsibilities in listed companies
(FSA, 2009).4 Additionally, in India, the Securities and Exchange Board estab-
lished the disclosing requirement of controlling shareholders’ collateralized shares
if it exceeds 25,000 shares or 1% of the total shareholdings or voting rights in a
firm (SEBI, 2009).5
In Taiwan, directors, supervisors, managers, or shareholders who own 10% or
more of a company’s outstanding shares in public companies have been obliged
to report to the Securities and Futures Commission of Taiwan the percentage of
their shareholdings that are pledged for loans since 1998. Because of this unique
requirement, the data of stock pledging by large shareholders in Taiwan have
become available to researchers.6 The ownership structures of firms in Taiwan
are like those in many other East Asian countries in which large shareholders’
control power is enhanced through pyramid structures and cross-holdings among
firms. For example, voting right consequently thus normally exceeds formal cash
flow right (Claessens et al., 2000). Taiwan is a market that features relatively
weak protection for investors, firms with controlling shareholders, and pyramid
structures (Yeh & Woidtke, 2005). According to our conversation with market
practitioners in Taiwan, controlling shareholders generally pledge their shares to
buy their own stocks to keep their control rights so they can expropriate firm
resources, or to invest in shares of other firms for personal investment purposes
instead of focusing on the management of the firm. Stock pledging by controlling
shareholders is thus regarded as a negative signal by market practitioners at
large.
This study takes the advantage of the data availability for Taiwanese firms and
aims to find the answers to questions which have been rarely explored in the
3
U.S. Securities and Exchange Commission Final Rules Release Nos. 33-8732A:
Executive compensation and related person disclosure (http://www.sec.gov/rules/final/
2006/33-8732a.pdf).
4
In 2009, the Financial Services Authority (FSA) confirms that DTR 3 requires the
disclosure of the grant of security over shares (such as a pledge, mortgage or charge) by
persons discharging managerial responsibilities and their connected persons (http://
fshandbook.info/FS/html/handbook/DTR/3).
5
Amendment by Securities and Exchange Board of India: Substantial Acquisition of Shares
and Takeovers (http://www.sebi.gov.in/cms/sebi_data/attachdocs/1290401955123.pdf).
6
This is requirement is given by Taiwan Securities and Exchange Act No.25.
literatures. For example, if a firm has a higher degree of financial leverage or

more capital, are the controlling shareholders of this firm more likely to pledge
their shares to obtain more liquidity? Are the controlling shareholders more likely
to pledge their shares to obtain liquidity when the stock price is relatively lower?
Are the controlling shareholders more likely to pledge their shares to obtain
liquidity when their voting rights are relatively larger or smaller? The behavior of
stock pledging by controlling shareholders may not be directly related to the
attributes of their firms as it appears. However, because these shareholders have
control rights over their firms, thus the personality of these shareholders may
affect the way they control the firms and the business culture. For example, when
the controlling shareholders like to pledge their shares for more liquidity, their
firms are probably more likely to have higher degrees of financial leverage.
This study is also to examine how the stock pledging behavior of controlling
shareholders is associated with the firm performance. Because how the cash
flows from pledging stocks by controlling shareholders are used is not publicly
observable, we can measure how stock pledging by controlling shareholders is
related to firm performance and obtain more insights from the perspective of
corporate governance. If most controlling shareholders pledge their shares to
help the firm to finance projects with positive NPV, then stock pledging by
controlling shareholders is expected to be associated with good firm perfor-
mances. On the contrary, if stock pledging by controlling shareholders is
associated with bad firm performance, then stock pledging by controlling
shareholders can be regarded as a negative signal for firms’ corporate gover-
nance. We measure how the behavior of pledging stocks by controlling share-
holders affects the firms’ accounting as well as financial performances. Return
on assets (ROA) and return on equity (ROE) are used for accounting perfor-
mances, and the risk-adjusted returns on stocks based on the factor models of
Fama and French (1993) and Carhart (1997) are used for financial perfor-
mances. The results of firm performance help provide regulators and investors
the implications of the stock pledging behavior by controlling shareholders
when the information of stock pledging is disclosed.
Empirical literatures concerning stock pledging for firms in Taiwan are
limited. Exceptions include the following. Kao, Chiou, and Chen (2004), using
the sample of firms in Taiwan, find negative influences of stock pledging on
ROE and ROA. However, their sample period is limited to 1998–2000. Chen,
Kao, and Chen (2007) use annual data from 1998 to 2003 of firms in Taiwan
and find that stock collateral is negatively related to market-adjusted stock
return, which indicates firm value decreases with the level of stocks pledged.
Instead of the methods of Fama and French (1993) and Carhart (1997), the
market-adjusted return in Chen et al. (2007) is simply measured by the differ-
ence between the stock return and the market return. Others such as Lee and
Yeh (2004) conclude a higher stock-pledge ratio leads to a higher default risk.
Although these studies conclude stock pledging has negative impacts on firm
performances, stock pledging of controlling shareholders may not always have
negative effects on firms. For example, when the firm needs more cash for
projects with positive NPV, shareholders may pledge their shares to banks to
obtain more cash for the firm to invest in these projects. These studies cannot
differentiate positive or negative effects of obtaining liquidity from stock
pledging on firm performances.
This study uses the level of cash holdings or working capital as a proxy for
the purpose of their stock pledging. If a firm has a higher level of cash holdings
or working capital, the firm has better corporate governance. That is, if the
agency problem between the controlling shareholders and the minority share-
holders is less prevalent in a firm, the controlling shareholders will extract less
resource, including free cash flows of the firm, for their own benefits. The
relationship between corporate governance and cash holdings has been docu-
mented. Among others, Opler, Pinkowitz, Stulz, and Williamson (1999) find
that firms with strong growth opportunities and riskier cash flows tend to hold
high ratios of cash to total noncash assets, and firms that do well tend to
accumulate more cash than predicted by the static tradeoff model where
managers maximize shareholders’ wealth. Chen, Chen, Schipper, Xu, and Xu
(2012) state that in China it is a common perception that cash holdings of firms
is considered as a source of financing for the use of controlling shareholders, as
opposed to existing for the benefit of all shareholders. They find that the average
cash holdings of Chinese-listed firms decreased after the share split structure
reform, and the reduction in cash holdings is greater for firms with weaker
corporate governance and firms with more financial constraints. These indicate
that firms with weaker corporate governance and less growth opportunities tend
to have lower levels of cash holdings. Other studies such as Lai, Nguyen,
Sodjahin, and Soumaré (2018) also find that firms with low idiosyncratic
volatility, which captures discretionary efforts and risk-taking by managers,
have smaller cash reserves.
To summarize, this study distinguishes itself from the existing literatures as
follows. This study not only measures the effect of stock pledging on firm
performance, but also identifies the factors affecting the behavior of stock
pledging by controlling shareholders, which has not been examined in litera-
tures. These factors are from the perspectives of firm attributes, market con-
ditions, and corporate governance. Second, because the purposes of stock
pledging by controlling shareholders are not observable, this study controls the
levels of cash holding or working capital of the firm and investigates how and to
what extent that the level of cash holdings affects the association between stock
pledging and firm performance. It is found that, firm size, leverage, credit risk,
and percentage of board seats owned by controlling shareholders are positively
associated with pledge ratio. Cash flow right, price-to-book ratio, and beta are
negatively associated with pledge ratio. Family-controlled and cooperative
firms tend to have a higher pledge ratio, followed by professionals-controlled
firms, and finally state-controlled firms. The effects of pledge ratio on a firm’s
ROE and ROA are negative, but as the level of working capital increases, these
effects are mitigated. Pledge ratio has a stronger negative effect on the firm’s
risk-adjusted stock return than on its accounting performances, and the levels of
cash holdings and net working capital can also offset the negative effect of
pledge ratio on the firm’s risk adjusted return. Although the data are limited to
firms in Taiwan, the results of this study may provide insights to the firms in
foreign markets.
The sample period in this study is from 2000 to 2012, a much longer period
than the aforementioned literatures. Besides, in this study, both the accounting
and financial performances of firms with varying degree of stock pledging by
controlling shareholders are examined, and more robust models of risk-
adjusted returns are applied. Finally, this study also sheds light on how the
level of a firm’s liquidity affects the negative effect of stock pledging on firm
performances.
The remainder of this study is organized as follows. Section 2 describes the
determinants of stock pledging by controlling shareholders and variables that
affect firm performance. Section 3 describes the data set and the methodology of
this study. Section 4 reports the main empirical results. Section 5 concludes.
2. DETERMINANTS OF STOCK PLEDGING BY

CONTROLLING SHAREHOLDERS
The tendency of stock pledging by controlling shareholders can be affected by
the determinants of the demand and supply of bank loans. For example,
from the demand side, firms may have higher degrees of financial leverage
when controlling shareholders also have higher degrees of personal financial
leverage, because the management of these firms is directly or indirectly
affected by these shareholders. From the supply side, bank managers are more
willing to make loans to shareholders when the stock collaterals are of more
value and liquidity.
In this study, we use several measures of firms to examine how various factors
are related to stock pledging behavior of controlling shareholders. These factors
are from the perspectives of firm attributes, market conditions and corporate
governance. As mentioned above, the borrowers’ ability to repay loans is also an
important factor from the supply side of bank loans. It is not directly observable
and thus not included in the analysis of this study.
2.1. Firm Attributes

We consider firm attributes such as equity value, leverage and credit rating as
measures related to stock pledging behavior.
2.1.1. Capital
If a firm has a larger value of equity, its stocks have higher market liquidity. For
banks, they are more will to loan money to shareholders with high-liquidity
stocks as collaterals. Furthermore, the larger the firm’s capital, controlling
shareholders have more wealth constraint to maintain their percentage of shares
and thus they are more likely to pledge their shares to obtain additional funds to
purchase more stocks. These speculations imply a positive association between
the size of a firm’s capital and stock pledging by its controlling shareholders.
2.1.2. Leverage
Several advantages and costs of debt contracts have been mentioned in the lit-
eratures (Shleifer & Vishny, 1997). The benefit of debt contracts is the reduction
in the agency cost. Debt contracts debt contracts can prevent the manager from
investing in projects with negative NPV. Debt contracts can also force the
manager to sell assets for better uses. Lang, Ofek, and Stulz (1996) present evi-
dence indicating that leverage indeed curtails investment by firms with poor
prospects. Alternatively, there are costs associated with debt contracts as well.
Firms may be prevented from undertaking good projects because debt covenants
keep them from raising additional capital, or they may be forced to liquidate
when it is not efficient to do so (Harris & Raviv, 1990; Hart & Moore, 1994;
Stulz, 1990). However, when a firm’s degree of leverage is not large enough to
reach its budget constraint, controlling shareholders may increase the leverage of
the firm for investments which are beneficial to themselves but not to other
minority shareholders. From this perspective, leverage is positively associated
with agency cost between controlling shareholders and minority shareholders. If
stock pledging by controlling shareholders is an indication of weak corporate
governance, or will affect the leverage of the firm, the tendency of stock pledging
by controlling shareholders will be positively associated with the degree of
financial leverage of the firm.
2.1.3. Credit Rating

How corporate governance is related to cost of debt can be characterized by
whether the firm’s future cash flows can cover debt obligations. Within the
framework of Jensen and Meckling (1976) agency theory, debt holders face two
types of agency costs that can increase default probability and reduce the values
of their debts. One is the conflict between managers and the stakeholders
(including shareholders and debt holders). Governance mechanisms that promote
better managerial decision making and limit opportunistic management behavior
benefit all external stakeholders, including shareholders and debt holders.
Ashbaugh-Skaife, Collins, and LaFond (2006) refer to this as the management
disciplining hypothesis. Sengupta (1998) finds a negative relationship between
firms’ disclosure quality ratings and the cost of debt financing as reflected in
realized yields on new debt issues. Bhojraj and Sengupta (2003) find that firms
with a higher percentage of outside directors on the board and with greater
institutional ownership enjoy lower bond yields and higher ratings on their new
debt issues. Ashbaugh-Skaife et al. (2006) find that firms’ overall credit ratings are
negatively associated with the number of blockholders that own at least a 5%
ownership in the firm, and positively related to overall board independence, and
board stock ownership. Their results suggest that weak governance can result in
firms incurring higher debt financing costs.
Alternatively, there is also a conflict between shareholders and debt holders.
Shareholders can use their voting power to encourage management to undertake
risky investments or engage in ownership changes that can harm bondholder
interests, which is referred to as the wealth redistribution hypothesis (Ashbaugh-
Skaife et al., 2006). These findings suggest that better corporate governance is
associated with better credit rating and lower cost of debt. If stock pledging by
controlling shareholders is an indication of weak corporate governance, the
tendency of stock pledging by controlling shareholders will be negatively asso-
ciated with the firm’s credit quality.
2.2. Market Condition

Controlling shareholders may pledge their stock to obtain liquidity for different
purposes based on different market conditions. For example, when the stock
price is relatively lower, shareholders may pledge their stocks to buy more stocks
of their firms at a lower price. Alternatively, when the stock price is relatively
higher, shareholders can borrow more from banks by pledging their stocks
because the values of the collaterals are larger.
2.2.1. Share Price

Controlling shareholders can pledge their shares when share price is low to
purchase more shares to prevent share price from plummeting or gain more
control of their firms. Alternatively, they can also pledge their shares for personal
liquidity purposes when share price is high. Because these incentives may lead to
different results for the level of stock price, how share price will affect share
pledging behavior depends on the purpose of stock pledging.
2.2.2. Beta
Beta is expected to be positively associated with default risk. This suggests that
Beta would be positively associated with bond yield and negatively associated
with rating. Bhojraj and Sengupta (2003) use data on all industrial bond issues
during 1991–96 and find beta is negatively associated with credit quality.
Alternatively, Chen, Chen, and Wei (2009) and Johnson, Boone, Breach, and
Friedman (2000) argue that insiders are expected to expropriate more when the
market is experiencing a downturn and less when the market is booming. This
negative relation between expropriation and market conditions can magnify the
systematic risk of a firm, which must be compensated by a higher required rate of
return. Second, better corporate governance lowers the cost of equity by reducing
the cost of external monitoring by outside investors. Furthermore, a larger beta
indicates the firm has a larger systematic risk, and banks may loan less to
shareholders who pledge these stocks for liquidity needs. Thus from the demand
side of the bank loans from stock collaterals, beta may have a positive association
with the level of stock pledging by controlling shareholders. But from the supply
side, this association is negative.
2.3. Corporate Governance

Literatures such as Lee and Yeh (2004) assume that stock pledging by controlling
shareholders is an indication of a corporate governance problem. Because the
issue of whether stock pledging by controlling shareholders is an indication of

weak corporate governance is about the deviation of control right from cash flow
right for controlling shareholders, this study considers the number of board seats
controlled by ultimate shareholders and their cash flow right as the corporate
governance variables.
2.3.1. Number of Board Seats

The number of board seats controlled by ultimate shareholders is defined as the
proportion of directors and supervisors who are ultimate shareholders in the
board.7 In Taiwan, shareholders used to be able to be elected as directors of
the board even if they do not have enough shares, as long as they have collected
enough proxies.8 These controlling shareholders may expropriate firms’ resources
at the costs of minority shareholders (Claessens et al., 2000; La Porta et al., 1999;
Shleifer & Vishny, 1997). Fields, Fraser, and Subrahmanyam (2012) find that
board quality is related to the costs of bank loans. They conclude that inde-
pendent, experienced, and diverse boards and lower institutional ownership
borrow more cheaply.
2.3.2. Cash Flow Right

Cash flow right is defined as the proportion of shares owned by the ultimate
shareholders. If the ultimate shareholders have more shares, the value of the firm
is more aligned with their wealth. As argued by Claessens et al. (2002) and La
Porta et al. (2002), deviation of control right from cash flow right leads to the
agency problem between controlling shareholders and minority shareholders:
firm value falls when the control rights of the largest shareholders exceed its cash
flow ownership. If controlling shareholders have more control right and less cash
flow right, they will be more likely to expropriate the firm’s resources at the cost
of minority shareholders.
2.3.3. Types of Control

This study considers four types of firm organizations: firms run by professional
managers, firms of cooperative type, firms controlled by founding families, and
firms controlled by the government. These types of firms have different effects on
corporate governance. This study considers these factors in how would they affect
the degree of leverage of the firm.
2.3.3.1. Professional Managers. If a firm is controlled by professional man-
agers, it is less likely that large shareholders will exert their rights to take
advantage of other minority shareholders by expropriating the firm’s resources.
However, if a firm is controlled by managers, agency problems (Jensen &
7
The ultimate shareholders who have the ultimate control over the firm, including the
founding family.
8
There are agencies who help collect proxies from small shareholders in Taiwan. In return,
small shareholders can obtain souvenirs or pecuniary rewards.
Meckling, 1976) may exist. Managers will benefit themselves with their control-
ling power. However, large shareholders have incentives to monitor and regulate
managers. From the perspective of corporate governance, if large shareholders
authorize managers to run their firms, they will be less likely to extract firms’
rents.
2.3.3.2. Cooperative. Shleifer and Vishny (1997) suggest that concentrated
ownership may not be optimal because nonshareholder constituencies such as
managers, employees, and consumers are left with too few rents and too little
incentive to make relationship-specific investments. In these situations, cooper-
atives might be a more efficient ownership structure.
2.3.3.3. Family-controlled Firms. Shleifer and Vishny (1997) argue that
shareholders with large undiversified ownership such as the founding family in a
firm have different incentives relative to small shareholders in a firm with
diversified ownership structure. Because they have to re-enter the debt markets
for financing and have an incentive to keep a good relationship with the bond-
holders. Thus the agency problem between the shareholders and bondholders is
reduced. Anderson and Reeb (2003) conclude that bond investors view founding
family ownership as an organizational structure that better protects their inter-
ests. Villalonga and Amit (2006) find that family ownership creates value only
when the founder serves as CEO of the family firm or as Chairman with a hired
CEO. A more recent study by Pan and Tian (2016), with the sample of listed firms
in China from 2006 to 2009, finds that the use of collateral for bank loans is
higher in family controlled firms. They argue that in China the risk of expro-
priation associated with family control leads to an increased credit risk and
higher collateral being required by banks.
2.3.3.4. State-controlled Firms. It is argued that state firms are controlled by
the public, but the de facto controlling rights belong to the bureaucrats. From the
perspective of corporate governance, state firms can be characterized by
concentrated ownership and little cash flows. If the bureaucrats have the control
rights, the goal of the state firm is to pursue their political purposes, not the
interests of the shareholders (Shleifer & Vishny, 1997). If a firm is partly owned
by the state, part of the cash flows will be used for other political purposes rather
than the optimization of firm value.
3. DATA AND EMPIRICAL METHODOLOGY

3.1. Sample Selection
The sample used in this study includes all listed firms in Taiwan Stock Exchange.
The sample excludes foreign issuers and financial institutions. For the models of
stock pledging determinations, a sample of 676 companies or 8,788 firm-year
observations is available after eliminating those with missing values. These data
are collected from the Taiwan Economic Journal (TEJ) database from 2000 to
2012. For the models of pledge determinants, the dependent variables include the
pledge ratio and the pledge dummy. The independent variables include those
related to firm attributes, market information, and corporate governance. They

are described as follows.
Pledge ratio (Pledge): the ratio of shares that are held by directors, supervisors
and large shareholders pledged to financial institutions to total shares they own.
Pledge dummy equals zero if the pledge ratio is zero in every year during the
whole sample period, and one if the pledge ratio is positive in every year during
the whole sample period.
Capital: Log of weighted average of the book value of equity.
Debt: Debt-to-asset ratio, which is defined as the ratio of total debts to total
assets.
TCRI: Taiwan corporate credit risk index, which is produced by TEJ and is
widely used by the practitioners and the academics for Taiwanese firms. TCRI is
in the scale from 1 to 10. The larger the TCRI score, the larger the credit risk.
Price-to-book ratio (PBR): Stock price-to-book value ratio, which is used to
measure the relative level of the stock price.
Beta (Beta): Measure of the systematic risk of the stock.
Cash flow right (CFR): The percentage of shares that are owned by the ulti-
mate shareholders.
Board seats controlled by ultimate shareholders (Seats): The ratio of directors
and supervisors who are the ultimate shareholders to the board size.
Deviation of control right from cash flow right (Deviation): The ratio of board
seats controlled by ultimate shareholders to the cash flow right. The larger the
ratio is, the larger the deviation of control right from cash flow right.
For accounting performances, this study uses ROE and ROA for performance
measures. This study considers the annual data of market value of the equity,
debt ratio, R&D expense ratio, ownership percentage by the board directors and
supervisors, and cash holding as the explanatory variables. For financial per-
formance, this study considers monthly stock returns with the controls from the
market model and the four-factor model of Fama and French (1993) and Carhart
(1997) as the dependent variables to examine how the degree of stock pledging
relates to the stock returns. The four factors include market excess return, small-
minus-big, high-minus-low, and momentum portfolios. These variables are
described as follows.
Size of the firm (MV): The market value of equity, which is defined as the price
of stock multiplied by the number of shares outstanding.
R&D expense (R&D): The R&D expense divided by the net sales in the last
period.
Ownership (Own): The percentage of ownership by the board directors and
supervisors.
Cash holding (Cash): This is defined as the cash and cash equivalents divided
by total assets. If a firm has a larger cash holding, it has a larger liquidity.
Return on equity (ROE): ROE is defined as
ordinary income
ROE ¼ 3 100%
average total shareholders’ equity
Return on assets (ROA): ROA is defined as
ordinary income 1 interest expense 3 ð1 2 17%Þ

ROA ¼ 3 100%
average total assets
where 17% is the business tax rate.

Excess stock return (Excess Return): Monthly stock return adjusted for cash
and stock dividends in excess of 3-month T-bill rate.
The four factors of Fama and French (1993) and Carhart (1997) including
market excess return, small-minus-big, high-minus-low, and momentum portfo-
lios are directly available from TEJ database. These are computed in the same
ways as the methods in the original studys.
3.2. Methodology
3.2.1. Determinants of Stock Pledging by Controlling Shareholders
This study estimates the regressions of pledge ratio on firm characteristic vari-
ables, market variables, and corporate governance variables. This study first uses
the subsample for firms either with stocks pledged by directors, supervisors or
large shareholders at the end of each year from 2000 to 2012, or without stock
pledged at the end of each year from 2000 to 2012. If a firm has stocks pledged in
every year over the sample period, 1 is assigned to the dependent variable, and
0 if a firm has not stocks pledged in any year over the sample period. Then the
logit models with following specifications are estimated. The first model incor-
porates firm attributes as explanatory variables:
Pledge dummy ¼ b0 1 b1 Capital 1 b2 Debt ratio 1 b3 TCRI (1)
where Pledge dummy 5 0 if the firm has no stocks pledged by its directors,
supervisors or large shareholders in any year over the sample period. Pledge
dummy 5 1 if the firm has stocks pledged by its directors, supervisors, or large
shareholders in every year over the sample period. Capital is the log of capital in
thousand NT dollars, Debt is the debt-to-asset ratio and TCRI is the rating score
by Taiwan corporate credit risk index. bs are coefficients.
Then the logit models with market variables and corporate governance vari-
ables as explanatory variables are estimated, respectively. The model specifica-
tion with market variables is given as follows:
Pledge dummy ¼ b0 1 b1 PBRatio 1 b2 Beta (2)
where PBRatio is the price-to-book ratio and Beta is the beta measuring the
sensitivity to aggregate market.
The model with corporate governance variables (without the type-of-control
variables) as explanatory variables is then given as follows:
Pledge dummy ¼ b0 1 b1 Seats 1 b2 CFR (3)

where Seats is the percentage of seats of directors and supervisors owned by the
ultimate shareholders in the board. CFR is the percentage of shares that are
owned by the ultimate shareholders, which represents cash flow right.
Eq. (4) is the full model with all the explanatory variables in Eqs. (1)–(3), and
Eq. (5) is Eq. (4) augmented by the type-of-control variables:
Pledge dummy ¼ b0 1 b1 Capital 1 b2 Debt ratio 1 b3 TCRI

1 b4 PBRatio 1 b5 Beta 1 b6 Seats 1 b7 CFR (4)
and
Pledge dummy ¼ b0 1 b1 Capital 1 b2 Debt ratio 1 b3 TCRI 1 b4 PBRatio

1 b Beta 1 b Board seats 1 b CFR 1 type 2 of 2 control dummies (5)
5 6 7
3.2.2. Performances of Firms with Stock Pledging

This study further investigates how stock pledging by controlling shareholders
affects both the accounting and financial performances of the firm. The full
sample with or without stocks pledged by directors, supervisors or large share-
holders are all included. Instead of using stock pledging dummies as in Eqs.
(1)–(5), pledge ratio is used as the explanatory variable in accounting perfor-
mance as well as financial performance models.
For the effect of stock pledging on accounting performance, this study con-
siders several variables documented in the literatures as control variables. These
control variables include firm size, debt-to-assets ratio, R&D expense ratio
(Demsetz & Lehn, 1985; Morck, Shleifer, & Vishny, 1988), and ownership
(Morck et al. 1988). Firm size is used to capture the economy of scale (Hall &
Weiss, 1967). The market value of equity is used to account for the size effect on
the firm’s profitability. Besides, Demsetz and Lehn (1985) assert that size of the
firm, as measured by the market value of equity, is negatively related to the
ownership concentration. As argued by Morck et al. (1988), debt is related to tax
shield and, according to the pecking order theory, has a negative effect on the
firm’s profitability. Ownership concentration is a corporate governance variable,
because disparity between control right and cash flow right leads to a corporate
governance problem. They find that Tobin’s Q first increases, then decreases, and
finally slightly increases as the ownership by the board of directors rises. Wruck
(1989) finds that the announcement of a private sale of equity is accompanied by
a positive abnormal return. There is a significant relation between ownership
concentration and the change in firm value at the announcement of the private
sale, and the sign depends on the level of concentration. Joh (2003) documents
that low ownership concentration has a negative effect on Korean firms’
profitability.
As mentioned above, because the purposes of pledging stocks by the con-
trolling shareholders for liquidity are not observable, the cross-product term of
cash holding and pledge ratio is included in the regression models. This cross-
product term helps clarify how the level of cash holding affects the association
between the level of stock pledge and firm performance. All explanatory vari-
ables are lagged by one year. For the robustness of the results, fixed-effect and
random-effect models are both estimated. The models of ROE and ROA are
thus specified as:
ROE ¼ b0 1 b1 Pledgeð 2 1Þ 1 b2 MVð 2 1Þ 1 b3 Debtð 2 1Þ 1 b4 R&Dð 2 1Þ

1 b5 Ownð 2 1Þ 1 b6 Cashð 2 1Þ 3 Pledgeð 2 1Þ (6)
ROA ¼ b0 1 b1 Pledgeð 2 1Þ 1 b2 MVð 2 1Þ 1 b3 Debtð 2 1Þ 1 b4 R&Dð 2 1Þ

1 b Ownð 2 1Þ 1 b Cashð 2 1Þ 3 Pledgeð 2 1Þ (7)
5 6
For financial performances, pledge ratio is included as an extra explanatory

variable in the one-factor market model and the four-factor model of Fama and
French (1993) and Carhart (1997), respectively. The four-factor model says that
the return on a portfolio in excess of the risk-free rate is explained by its sensi-
tivity to the market return in excess of the risk-free rate, the difference between
the return on a portfolio of small stocks and the return on a portfolio of large
stocks (small-minus-big, SMB), the difference between the return on a portfolio
of high-book-to-market stocks and the return on a portfolio of low-book-to-
market stocks (high-minus-low, HML) and the equal-weight average of firms
with the highest 30% eleven-month returns lagged one month minus the equal-
weight average of firms with the lowest 30% eleven-month returns lagged one
month (Momentum). If pledge ratio has a positive (negative) marginal effect on
stock excess returns, controlling for these systematic risk factors, then pledge
ratio has a positive (negative) effect on risk-adjusted excess returns. Similar to
accounting performance equations, the cross product term of cash holding and
pledge ratio is also included in the regression models. These one-factor and four-
factor models are given by:
Excess Return ¼ b0 1 b1 Pledge 1 b2 Market (8)
and
Excess Return ¼ b0 1 b1 Pledge 1 b2 Market 1 b3 Pledge 3 Cash (9)
for one-factor models;
Excess Return ¼ b0 1 b1 Pledge 1 b2 Market 1 b3 SMB 1 b4 HML

1 b5 Momentum (10)
and
Excess Return ¼ b0 1 b1 Pledge 1 b2 Market 1 b3 SMB 1 b4 HML

1 b5 Momentum 1 b6 Pledge 3 Cash (11)
for four-factor models.

If the coefficient of Market is greater (smaller) than 1, then the sample port-
folio is riskier (less risky) than the market. If the coefficient of SMB is positive
(negative), then the sample portfolio is tilted toward smaller (larger) firms. If the
coefficient of HML is positive (negative), then the sample portfolio is tilted
toward stocks with a high (low) book-to-market ratio. Finally, a positive
(negative) coefficient for Momentum indicates that the stocks have been per-
formed well (poorly) in the recent past.
4. EMPIRICAL RESULTS
4.1. Stock Pledging Determinants
Table 1 reports the descriptive statistics of variables for firms without stocks
pledged by directors, supervisors and large shareholders every year throughout
the sample period in Panel A (no-pledge firms), and those for firms with non-zero
Table 1. Summary Statistics.

Variable Mean SD Min Median Max Obs.
Panel A: No-pledge firms

Pledge ratio (%) 0 0 0 0 0 2,080
Capital (in $ million) 2,260.20 3,859.23 83.19 1,199.12 39,270.26 2,080
Debt (%) 39.15 17.48 1.84 38.61 97.03 2,080
TCRI 5.40 1.35 2 5 9 2,080
PBR 1.58 1.24 0 1.21 14.17 2,080
Beta 0.84 0.33 20.39 0.85 2.02 2,080
Seats (%) 57.61 18.93 12.50 57.14 100 2,080
CFR (%) 36.80 17.61 0.37 35.76 99.38 2,080
Deviation 4.85 11.29 0.35 2.10 119.08 2,080
Panel B: Pledge firms
Pledge ratio (%) 29.92 23.55 0.02 24.42 100 1,781
Capital (in $ million) 10,925.15 19,501.10 306.00 4,248.04 184,109.03 1,781
Debt (%) 46.95 15.82 3.73 47.55 98.05 1,781
TCRI 5.09 1.75 1 5 9 1,781
PBR 1.19 0.79 0.11 0.98 6.81 1,781
Beta 0.89 0.31 20.25 0.92 1.84 1,781
Seats (%) 73.38 19.91 16.67 73.33 100 1,781
CFR (%) 27.80 15.81 1.38 25.26 97.13 1,781
Deviation 6.18 8.95 0.70 3.72 81.63 1,781
Notes: Pledge firms are firms with stocks pledged by directors, supervisors and large shareholders
at the end of each year throughout the whole sample period. No-pledge firms are firms without
stocks pledged by directors, supervisors and large shareholders at the end of each year through
the whole sample period. Variables include: capital in log (Capital), debt ratio (Debt), Taiwan
corporate credit risk index (TCRI), stock price-to-book ratio (PBR), beta coefficient (Beta),
board seats by ultimate shareholders (Seats), cash flow right (CFR) and deviation of control right
from cash flow right (Deviation).
Table 2. Differences in Means between No-pledge and Pledge Firms.

Variables Mean Difference t-statistic
No-pledge Pledge (Pledge–No-pledge)

Panel A: Firm attributes
Ln(Capital) 14.12 15.46 1.34 41.44***
(0.02) (0.03)
Debt 39.15 46.95 7.80 14.55***
(0.38) (0.37)
TCRI 5.40 5.09 20.31 25.99***
(0.03) (0.04)
Panel B: Market variables
PBR 1.58 1.19 20.39 211.37***
(0.03) (0.02)
Beta 0.84 0.89 0.05 4.96***
(0.01) (0.01)
Panel C: Corporate governance variables
Seats 57.61 73.38 15.77 25.10***
(0.42) (0.47)
CFR 36.80 27.80 29.00 214.52***
(0.41) (0.35)
Deviation 4.85 (0.25) 6.18 (0.21) 1.33 24.09***
Notes: Pledge firms are firms with stocks pledged by directors, supervisors and large shareholders
at the end of each year throughout the whole sample period. No-pledge firms are firms without
stocks pledged by directors, supervisors and large shareholders at the end of each year through
the whole sample period. Two-sample t tests with unequal variances. The numbers in parentheses
are standard errors of the means. Variables include: capital in log (Capital), debt ratio (Debt),
Taiwan corporate credit risk index (TCRI), stock price-to-book ratio (PBR), beta coefficient
(Beta), board seats by ultimate shareholders (Seats), cash flow right (CFR) and deviation of
control right from cash flow right (Deviation).*** indicates significant at 1% significance level.
stocks pledged by directors, supervisors and large shareholders every year

throughout the sample period (pledge firms). Then t-tests for the null hypotheses
that the means of each variable for pledge firms and no-pledge firms are equal are
also conducted. These t-statistics are reported in Table 2.
For firm attributes, it can be observed that the mean and the median of capital
are larger for pledge firms. This is consistent with the expectation that, from the
demand side of loans, controlling shareholders have more wealth constraint to
maintain their percentages of shares and controls in a large firm, so they are more
likely to pledge shares to obtain loans from banks. From the supply side, banks
are more willing to grant loans when the collaterals are stocks of larger firms.
The degree of financial leverage is also related to the tendency that controlling
shareholders pledge their shares to obtain liquidity. On the one hand, debts can
help reduce the agency cost between shareholders and managers by preventing
managers from investing in bad projects, on the other hand debts also limit firms
to invest in good projects. As mentioned earlier, when a firm’s degree of leverage
is not large enough to reach its budget constraint, controlling shareholders may
increase the leverage of the firm for investments which are beneficial to them-
selves but not to other minority shareholders. Controlling shareholders can
expropriate more firm resources at the costs of other minority shareholders. If a
firm’s capital structure decisions are determined by those who tend to pledge their
shares to increase their personal financial leverage, the firm is more likely to have
a higher degree of financial leverage as well. Thus, the tendency that controlling
shareholders pledge their shares is larger when the firm’s degree of financial
leverage is higher. Table 1 indicates that both the mean and median of debt ratio
are higher for pledge firms.
It can also be found that the pledge firms have better credit quality (smaller
mean TCRI score than no-pledge firms). This is in contrast with the expectation
that a firm with better corporate governance has a better credit quality. It is likely
due to the fact that a firm with a larger capital is associated with a better credit
rating or lower TCRI score, the controlling shareholders tend to pledge more
shares when the firm’s capital is larger. Because of the confounding effect of
capital, TCRI score may be negatively related to the tendency that controlling
shareholders pledge shares to obtain liquidity. Besides, from the supply side of
bank loans, banks are more willing to make loans when shares of firms with
better credit ratings are used as collaterals.
For market variables, it is likely that a firm’s shareholders tend to pledge their
shares when the firm’s stock price is low, because shareholders can use the funds
from banks by pledging shares to purchase more shares of their own companies at
a lower price to increase their percentage of ownerships. Table 1 illustrates that
shareholders tend to pledge shares when the mean and median of firms’ price-to-
book ratio are smaller. This is again consistent with the expectation. Regarding
the risk of stocks as the collaterals for bank loans, beta measures a firm’s
sensitivity to the aggregate market and a firm’s cost of equity. Table 1 indicates
that pledge firms have larger betas on average. This is consistent with the intu-
ition that a firm with weak corporate governance tends to have larger cost of
capital.9
When controlling shareholders have more cash flow rights, they are less likely
to expropriate rents from firms at the costs of other minority shareholders (Jensen
& Meckling, 1976). It is expected when controlling shareholders have more cash
flow rights, they are less likely to pledge their shares to obtain funds for other
purposes. When controlling shareholders have more board seats, they can pledge
their shares to obtain cash for other personal purposes such as investment in other
firms’ equities without compromising their control rights in the firm. From
Table 1, it can be observed that, for pledge firms, controlling shareholders tend to
have smaller cash flow right, and more percentage of board seats controlled.
Finally, the results for the deviation of control right from cash flow right again
9
Chen et al. (2009) argues that insiders are expected to expropriate more when the market
is experiencing a downturn and less when the market is booming which exacerbate a firm’s
systematic risk.
reinforce our argument. Controlling shareholders of pledge firms tend to have

larger deviation of control right from cash flow right, suggesting these share-
holders have more incentive to pledge their shares to obtain liquidity.
Overall, the preliminary results reported in Table 1 indicate that, for most of
the variables except TCRI credit rating score, pledge firms tend to have weaker
corporate governance. The tendency that controlling shareholders pledge their
shares is positively associated with firm size, financial leverage, beta, percentage
of board seats controlled by them, and the deviation of voting right from cash
flow right, and negatively associated with price-to-book ratio and cash flow right.
However, pledge firms do not have a higher TCRI score (lower credit quality)
than no-pledge firms on average, contradicting our expectation, although the
difference in the means of TCRI score is small between pledge and no-pledge
firms. Furthermore, the means of these variables are also shown significantly
different. Table 2 illustrates that the null hypothesis the difference between the
means of each variable for pledge and no-pledge firms is zero is rejected for all the
variables.
Table 3 reports the correlation coefficient matrix. Unlike Table 1 and Table 2,
Table 3 uses the full sample to calculate the correlation coefficients. That is, the
sample used here includes not only the firms included in the sample for Table 1 or
Table 2, but also the firms of which the controlling shareholders either have or
have not pledged their stocks for only a fraction of the sample period.
From the results reported in the column under the heading of Pledge in
Table 3, not all the correlation coefficients between pledge ratio and the other
variables have the same signs as those given in Table 2. The exceptions include
TCRI score and the deviation of control right from cash flow right. In Table 2
TCRI score is larger for no-pledge firms, but the correlation coefficient between
TCRI score and pledge ratio is positive in Table 3. The deviation of control right
from cash flow right is larger for pledge firms in Table 2, but the correlation
coefficient between these two variables reported in Table 3 is negative even
though it is very small. These are probably due to different samples used in
Table 2 and Table 3.
Capital is positively associated with credit quality, and debt is negatively
associated with credit quality, consistent with the expectations. Furthermore, it is
noteworthy that the number of board seats of the controlling shareholders (as a
percentage of total board seats) is positively associated with pledge ratio and
capital. This is consistent with the speculation that if the firm size is larger, to
maintain the control rights these shareholders have to pledge their shares to
obtain more funds to purchase more shares or voting proxies. This speculation is
also supported by the negative correlation coefficient between cash flow right and
capital. Price-to-book ratio is negatively associated with TCRI score, suggesting
equity price has been discounted by credit risk.
Corporate governance is expected to be positively associated with credit
quality. The correlation coefficients between TCRI and corporate governance
variables such as number of board seats, cash flow right and deviation of control
right from cash flow right are all very small even though some signs are in conflict
with expectations. Number of board seats of controlling shareholders is
118
Table 3. Correlation Matrix.
Pledge Ln(Capital) Debt Ratio TCRI PBR Beta Seats CFR Deviation
Pledge 1
Ln(Capital) 0.3392 (0.00)*** 1
Debt Ratio 0.2645 (0.00)*** 0.1555 (0.00)*** 1
TCRI 0.105 (0.00)*** 20.4458 (0.00)*** 0.286 (0.00)*** 1
PBR 20.1912 (0.00)*** 20.0873 (0.00)*** 20.1488 (0.00)*** 20.3126 (0.00)*** 1
Beta 0.0498 (0.00)*** 0.3364 (0.00)*** 0.0389 (0.02)** 20.1342 (0.00)*** 0.0392 (0.00)*** 1
Seats 0.3054 (0.00)*** 0.3631 (0.00)*** 0.0882 (0.00)*** 20.0681 (0.00)*** 20.1665 (0.00)*** 0.0582 1
ALAN T. WANG AND ANLIN CHEN

(0.00)***
CFR 20.1781 (0.00)*** 20.2281 (0.00)*** 20.0631 (0.00)*** 0.0746 (0.00)*** 0.0323 (0.00)*** 20.3061 0.1735 1
(0.00)*** (0.00)***
Deviation 20.0071 (0.66) 0.2294 (0.00)*** 20.0434 (0.00)*** 20.121 (0.00)*** 0.0327 (0.05)** 0.2069 0.0749 20.2953 1
(0.00)*** (0.00)*** (0.00)***
Notes: Variables include: capital in log (Capital), debt ratio (Debt), Taiwan corporate credit risk index (TCRI), stock price-to-book ratio (PBR),
beta coefficient (Beta), board seats by ultimate shareholders (Seats), cash flow right (CFR) and deviation of control right from cash flow right
(Deviation). N 5 7,599. *** indicates significant at 1% significance level.
negatively associated with TCRI score, and cash flow right is positively associ-
ated with TCRI score. Both contradict expectations. Deviation of control right
from cash flow right is negatively associated with TCRI score, again inconsistent
with the expectation.
Finally, unlike literatures documented in which beta is positively associated
with credit risk, Table 3 indicates that beta is negatively associated with TCRI
score, inconsistent with the expectation. Beta is negatively associated with cash
flow right and positively associated with the deviation of control right from cash
flow right. These may indicate that systematic risk is negatively associated with
corporate governance.
Although some of the preliminary results which have been reported so far
are not consistent with the expectation that the tendency of stocks being
pledged by controlling shareholders is associated with weak corporate gover-
nance, these are based on the univariate analysis. Because sometimes these
variables are interrelated, the variables under consideration are jointly analyzed
by the logit and Tobit models next. For the logit model, the dependent variable
is zero when a firm is in the “no-pledge” category and one when a firm is in the
“pledge” category. No-pledge firms mean the firms for which pledge ratios are
zero each year throughout the whole sample period, and pledge firms mean the
firms for which pledge ratios are non-zero each year throughout the whole
sample period. For the Tobit models, the full sample of firms, including firms
not only in the pledge or non-pledge categories but also those not in these two
categories (for example, some firms’ pledge ratios are non-zero for only a few
years but not the whole sample period), is used where the dependent variable is
pledge ratio.
4.2. Logit Models

Table 4 illustrates the estimations of logit models of stock pledging. If the firm’s
controlling shareholders have their stocks pledged (pledge firm), then the value
of the dependent variable is one, and zero otherwise (no-pledge firm). Eq. (1) is
the logit model with firm attributes as independent variables. The level of
capital, debt ratio, and TCRI are found to have positive and significant effects
on stock pledging by controlling shareholders. From the demand side, if a firm
has larger capital, the controlling shareholders have to borrow more funds by
pledging stocks to maintain their control rights through buying more shares or
voting proxies. From the supply side, if a firm has a larger capital size, it is likely
that banks are more willing to lend to shareholders with the firm’s stocks as
collaterals. Controlling shareholders of firms with larger debt ratio and TCRI
score (higher credit risk) are also found more likely to pledge their shares to
obtain liquidity. These coefficients have the same signs as the signs of the
correlation coefficients between these variables and pledge ratio reported in
Table 3. It is also noteworthy that in Table 1 no-pledge firms have higher TCRI
score than pledge firms. The results reported in Table 4 indicate that TCRI
score has a positive effect on the probability that controlling shareholders
pledge their shares to obtain liquidity when the effects of firm size and financial
Table 4. Estimation of Logit Models.

Variable Eq. (1) Eq. (2) Eq. (3) Eq. (4) Eq. (5)
Intercept 227.7610 22.2462 20.0556 224.0590 225.8305

(227.96)*** (217.24) *** (20.52) (221.48)***(222.23)***
Capital (in log) 1.7253 1.5092 1.6109
(27.81)*** (20.88)*** (21.55)***
Debt (%) 1.0125 0.0173 0.0138
(4.42)*** (5.76)*** (4.45)***
TCRI 0.3101 0.2262 0.1981
(9.23)*** (5.83)*** (4.99)***
PBR 20.4309 20.1382 20.1082**
(210.73)*** (22.96)*** (22.03)***
Beta 0.6616 (6.09)*** 21.4374 21.4960
(29.00)*** (28.97)***
Seats (%) 0.0478 0.0292 0.0251
(23.89)*** (11.82)*** (9.85)***
CFR 20.0401 20.0280 20.0327
(217.08)*** (29.13)***(210.21)***
D1 0.9782
(5.61)***
D2 1.2249
(7.81)***
D3 21.5467
(24.01)***
Pseudo R-square (%) 32.15 17.13 3.28 35.59 39.19
Obs 3,746 3,861 3,630 3,537 3,537
Log likelihood 21751.0321 22,183.355 22,432.0585 21,547.3171 21,488.7165
Notes: Pledge dummy is regressed on capital in log (Capital), debt ratio (Debt), Taiwan
corporate credit risk index (TCRI), stock price-to-book ratio (PBR), beta coefficient (Beta),
board seats by ultimate shareholders (Seats), cash flow right (CFR) and dummies for types of
control. D1 id for family-controlled firms, D2 5 1 is for cooperative firms, D3 5 1 is for state-
controlled firms, and all dummies are zero for firms controlled by professionals. Numbers in
parentheses are t-statistics. *** and ** indicate significant at 1% and 5% significance levels,
respectively.
leverage have been controlled. The results of Eq. (1) indicate these variables can
explain the tendency that controlling shareholders pledge shares to obtain
liquidity to a certain degree. The pseudo R-square is more than 30%, suggesting
these variables are important determinants for stock pledging by controlling
shareholders.
Eq. (2) is the logit model with only corporate governance variables as
explanatory variables. Board seats exhibits a positive effect on the probability
of stock pledging by controlling shareholders. If the controlling shareholders
have more control over the firm, they are more likely to pledge shares to obtain
liquidity to maintain their control rights through buying shares or voting
proxies or to invest in other firms to increase their wealth. Cash flow right
exhibits a negative effect on the level of stock pledging. These results indicate
that the larger the control and the smaller the cash flow right, controlling
shareholders are more likely to pledge their stocks to obtain more funds. Again
the signs of the coefficients of these two variables are consistent with the signs of
correlation coefficients between these variables and pledge ratio in Table 3.
Eq. (3) concerns the market variables with stock pledging by controlling
shareholders. It is found that price-to-book ratio is negatively related to the
tendency of stock pledging by controlling shareholders. This is consistent with
the view that when the stock price is relatively low, controlling shareholders are
more likely to pledge stocks to buy more shares to maintain their control right.
Beta is expected to be positively related to credit and market risks. If beta is
positively associated with credit risk and agency problem, the positive associ-
ation between beta and the tendency that the controlling shareholders pledge
their shares is consistent with the expectation that stock pledging by controlling
shareholders is an indication of agency problem. The results of Eq. (3) indicate
that beta has a positive association with the tendency of stock pledging by
controlling shareholders.
Eq. (4) incorporates all the firm attributes, corporate governance and market
variables as the explanatory variables in the logit model. Most of the coefficients
have the same sign as in previous models except beta. The sign of beta becomes
negative and very significant in Eq. (4). It is likely that when capital and the
degree of financial leverage have been controlled, negative coefficient of beta
reflects the marginal effect that banks are less willing to loan to shareholders with
riskier stocks as collaterals.
Eq. (5) resembles Eq. (4), but with types of firms as extra explanatory vari-
ables. The results show that all the signs of the coefficients of the previous
explanatory variables are the same as those in Eq. (4). The coefficients of all the
type-of-firm dummies are also significant. The results indicate that shareholders
of cooperative firms are most likely to pledge stocks, followed by family-
controlled firms, firms controlled by professional managers and finally state-
controlled firms.
Overall, the results of Table 4 can be summarized as follows. First, controlling
shareholders of firms with larger capital, degree of leverage, credit risk, are more
likely to pledge shares to banks to obtain more funds. Second, banks are more
willing to loan to shareholders of firms with large capital and smaller beta. When
ultimate shareholders have more control and less cash flow rights, they are more
likely to pledge shares to obtain more funds. Regarding the type of the firm,
shareholders of family-controlled firms are most likely to pledge shares to obtain
more funds, followed by cooperative firms, firms controlled by professional
managers, and finally state-controlled firms. Finally, regarding the market vari-
ables, when the stock price is relatively lower, controlling shareholders are more
likely to pledge shares to obtain more funds.
The pseudo R-squares indicate that firm attributes have the most explanatory
power (32.15%), followed by corporate governance variables (17.13%) and finally
market variables (3.28%). When all the variables including types of the firms are
included, the pseudo R-square is as large as 39%, indicating these variables can
explain whether controlling shareholders pledge their shares to obtain liquidity
well.
4.3. Tobit Models

For the robustness of the results from logit models, the Tobit models are applied
to re-estimate these models, but with pledge ratio instead of pledge dummy as
the dependent variable. Tobit models are known to have the advantage of
estimating the models when a fraction of observations of the dependent variable
are censored (when pledge ratio is zero in our case). The results are reported in
Table 5. Because the dependent variable is the pledge ratio instead of pledge
dummy, the sample size is larger than that for logit models. This is because
some firms have zero pledge ratios for some years and non-zero for the other
years during the sample period. These firms are not categorized as pledge or
non-pledge firms.
Table 5 illustrates that, for Eq. (1), Capital, Debt, and TCRI have positive and
significant effects on stock pledging by controlling shareholders. For Eq. (2),
Table 5. Estimation of Tobit Models.

Variable Eq. (1) Eq. (2) Eq. (3) Eq. (4) Eq. (5)
Intercept 27.2214 229.2169 4.8817 25.6330 25.8299

(230.25)*** (219.47)*** (3.42)*** (219.91)*** (220.47)***
Capital (in log) 0.4345 0.3550 0.3663
(29.41)*** (19.48)*** (19.85)***
Debt (%) 0.0036 0.0048 0.0044
(3.74)*** (4.80)*** (4.39)***
TCRI 0.0984 0.0711 0.0596
(9.41)*** (6.03)*** (5.01)***
PBR 27.4557 20.0799 20.0729
(215.77)*** (25.42)*** (24.94)***
Beta 1.4772 20.3979 20.4112
(1.07)*** (27.94)*** (28.06)***
Seats (%) 0.4805 0.0062 0.0054
(22.96)*** (8.00)*** (6.75)***
CFR 20.3307 20.0092 20.0099
(212.26)*** (29.31)*** (29.64)***
D1 0.2466
(4.18)***
D2 0.2436
(5.48)***
D3 20.3901
(23.78)***
Pseudo R-square (%) 9.61 1.37 0.65 10.25 10.95

Obs 8,292 8,676 7,873 7,598 7,598
Log likelihood 25,129.78 221,801.21 220,860.20 24,702.46 24,666.10
Notes: Pledge ratio is regressed on capital in log (Capital), debt ratio (Debt), Taiwan corporate
credit risk index (TCRI), board seats by ultimate shareholders (Seats), cash flow right (CFR),
stock price-to-book ratio (PBR), beta coefficient (Beta) and dummies for types of control. D1 id
for family-controlled firms, D2 5 1 is for cooperative firms, D3 5 1 is for state-controlled firms,
and all dummies are zero for firms controlled by professionals. Numbers in parentheses are
t-statistics. *** indicates significant at 1% significance level.
Seats and CFR have a positive and negative effect on pledge ratio, respectively.
For Eq. (3), pledge ratio by controlling shareholders is large when PBR is
smaller, consistent with the result in Table 4. Although the coefficient of beta is
positive, it is not statistically significant. For Eq. (4), the full model without
dummies of control types, all the signs of coefficients are consistent with those
reported in Table 4. In particular, beta again has a negative and significant effect
on pledge ratio when all the explanatory variables are included. The signs of the
coefficients of the explanatory variables in Eq. (5) are again consistent with those
reported in Table 4. However, unlike those in Table 4, the coefficient of D2 is
close to that of D1, indicating firms of both cooperative and family-controlled
types tend to have the highest pledge ratio, followed by the firms of the profes-
sional type and finally those of the state-controlled type.
4.4. Firm Performances

4.4.1. Accounting Performance
For accounting performances, both fixed- and random-effect models are used to
estimate Eqs. (6) and (7), respectively. The results of accounting performances are
reported in Table 6. Hausman tests for random-effect models versus fixed-effect
models for both Eqs. (6) and (7) indicate significant results. That is, fixed-effect
models are preferred. The percentage of stocks pledged by board directors,
supervisors, and large shareholders has a negative effect on both ROE and ROA.
However, the effect of stock pledge on ROE is only marginally significant at 10%
significance level. For ROA, the random-effect model yields a significant and
negative effect of stock pledging, but not significant when fixed-effect model is
used, even though the sign is still negative. The interaction term of stock pledge
and cash holding has no significant results for both ROE and ROA regardless of
whether the random or the fixed-effect model is used.
For control variables, market value of equity is shown to have a positive and
very significant effect on ROE and ROA under the various estimation methods.
Except the case of ROA with fixed-effect model, debt ratio has a negative and
significant effect on ROE and ROA. R&D expense ratio also has a negative and
significant effect on ROE and ROA with both types of estimation methods. These
are quite consistent with intuitions. Finally, ownership concentration has a
positive and significant effect on ROE and ROA. It indicates that ownership
concentration by board directors and supervisors has a positive effect on
accounting performance.
Accounting performance models of Table 6 are re-estimated, but with the
interaction term of pledge ratio and net working capital used. The results are
reported in Table 7. Pledge ratio is found again to have a negative and significant
effect on ROE and ROA for both random- and fixed-effect models. The coeffi-
cients of the interaction term of pledge ratio and net working capital are positive
and significant for ROE models, but not or marginally significant for ROA
models. The signs of the coefficients of the other control variables are consistent
with those reported in Table 6. Overall, Table 7 shows that pledge ratio has a
negative effect on both ROE and ROA in the next year. The negative effect of
Table 6. Accounting Performance with Cash Holding Effect.

Dependent ROE (Eq. (6)) ROA (Eq. (7))
Variable
Random Effect Fixed Effect Random Effect Fixed Effect
Constant 230.9315 221.2441 10.0411 23.3470 (21.42)

(25.43)*** (23.49)*** (24.81)***
Pledge(21) 20.0396 (21.90)* 20.0414 (21.92)* 20.0155 20.0115 (21.38)
(21.96)**
MV(21) 1.7619 (7.24)*** 1.3162 (5.03)*** 0.6933 (7.74)*** 0.3482 (3.43)***
Debt(21) 29.3285 27.2796 22.8432 20.5040 (20.65)
(24.88)*** (23.63)*** (23.96)***
R&D(21) 20.1827 20.1500 20.0886 20.0805
(23.90)*** (23.03)*** (25.05)*** (24.19)***
Own(21) 0.1063 0.1125 0.0494 0.0519 (4.96)***
(4.21)*** (4.17)*** (5.26)***
Pledge(21)* 0.0811 (0.58) 0.1257 (0.87) 20.0487 (20.91) 20.0312 (20.56)
Cash(21)
Within-group 1.40 1.43 1.04 1.23
R-square (%)
Between-group 10.81 9.53 20.09 10.54
R-square (%)
Adj.(Overall) 6.85 6.24 9.65 5.24
R-square (%)
Notes: Return on equity (ROE) and return on assets (ROA) are regressed on lagged explanatory
variables including pledge ratio (Pledge), market value of equity (MV), debt ratio (Debt), R&D
expenses ratio (R&D), percentage of ownership by board directors, supervisors and large
shareholders (Own), and the cross-product term of pledge ratio and cash holding ratio (Pledge
3 Cash), respectively. The number of observations is 5,829. Both random-effect and fixed-effect
models are estimated. Both Hausman tests for ROE and ROA indicate significant results and
fixed-effect models are preferred to random-effect models. Numbers in parentheses are z-statistics
for random-effect models and t-statistics for fixed-effect models. ppp and p indicate significant at
1% and 10% significance levels, respectively.
pledge ratio on ROE is reduced when the level of working capital is larger. This
phenomenon indicates that when a firm has more working capital, controlling
shareholders pledge their stocks for the liquidity purposes which are less detri-
mental to the firm’s ROE in the future. This is consistent with Opler et al. (1999)
and Chen et al. (2012) in which a firm with potential and good corporate
governance tends to hold more cash.
4.4.2. Financial Performance

Like the case for accounting performance, random- and fixed-effect models are
used to estimate Eqs. (8)–(11), respectively. One-factor model uses the excess
return of market portfolio as the control variable, and four-factor model uses the
excess returns of market (Market), small-minus-big (SMB), high-minus-low
(HML) and momentum (Momentum) portfolios of Fama and French (1993)
and Carhart (1997) as the control variables. The results are reported in Table 8. It
can be found that pledge ratio has a negative and very significant effect on stock
Table 7. Accounting Performance with Working Capital Effect.

Dependent Variable ROE (Eq. (6)) ROA (Eq. (7))
Constant 230.5963 220.8037 29.8953 23.1719

(25.37)*** (23.42)*** (24.74)*** (21.34)***
Pledge(21) 20.0517 20.0502 20.0267 20.0220
(22.87)*** (22.70)*** (23.89)*** (23.05)***
MV(21) 1.7294 (7.10)*** 1.2794 (4.88)*** 0.6780 (7.55)*** 0.3319 (3.26)***
Debt(21) 28.5804 26.5452 22.4785 20.1474
(24.41)*** (23.20)*** (23.39)*** (20.19)***
R&D(21) 20.1813 20.1483 20.0893 20.0809
(23.88)*** (23.00)*** (25.10)*** (24.22)***
Own(21) 0.1076 (4.26)*** 0.1133 (4.21)*** 0.0505 (5.38)*** 0.0529 (5.06)***
Pledge(21)* 0.1437 (2.02)** 0.1542 (2.11)** 0.0437 (1.61) 0.0509 (1.80)*
Working Capital(21)
Within-group 1.47 1.50 1.09 1.29
R-square (%)
Between-group 10.85 9.62 19.60 9.99
R-square (%)
Overall 7.02 6.43 9.69 5.24
R-square (%)
Notes: Accounting performance with cross-product term: Pledging and working capital. Return
on equity (ROE) and return on assets (ROA) are regressed on lagged explanatory variables
including pledge ratio (Pledge), market value of equity (MV), debt ratio (Debt), R&D expenses
ratio (R&D), percentage of ownership by board directors, supervisors and large shareholders
(Own), and the cross-product term of pledge ratio and working capital (Pledge 3 Working
Capital), respectively. The number of observations is 5,829. Both random-effect and fixed-effect
models are estimated. Both Hausman tests for ROE and ROA indicate significant results and
fixed-effect models are preferred to random-effect models. Numbers in parentheses are z-statistics
for random-effect models and t-statistics for fixed-effect models. ppp, pp and p indicate significant
at 1%, 5% and 10% significance levels, respectively.
excess returns for all equations in the one-factor and four-factor model, regardless
if the cross product term of pledge ratio and the level of cash holding is included
or not. The cross-product term of pledge ratio and cash holdings has a positive
but marginally significant effect for the fixed-effect equations of both one-factor
and four-factor models. These findings indicate that pledge ratios have a very
significant negative effect on a firm’s risk-adjusted return. This implies that stock
pledging by controlling shareholders are tilted toward the hypothesis that con-
trolling shareholders extract rents from the firm at the cost of other minority
shareholders. The phenomenon is marginally alleviated when the level of the
firm’s cash holdings is higher.
Finally, Eqs. (9) and (11) are re-estimated but the cross product terms are
replaced by the cross product term of pledge ratio and net working capital. The
results are reported in Table 9. The results are consistent with those in Table 8,
but the coefficients of the cross product term of pledge ratio and net working
capital remain positive and become very significant. These reinforce the argument
126
Table 8. Financial Performance with Cash Holding Effect.
Model Eq. (8) Eq. (9) Eq. (10) Eq. (11)
Random Effect Fixed Effect Random Effect Fixed Effect Random Effect Fixed Effect Random Effect Fixed Effect
Constant 0.6385 0.6826 0.6321 (9.83)*** 0.6714 (8.48)*** 0.4077 (6.54)*** 0.4617 (6.03)*** 0.4025 (6.44)*** 0.4525 (5.89)***
(9.96)*** (8.65)***
Pledge 20.0050 20.0081 20.0075 20.0129 20.0054 20.0092 20.0075 20.0133
(22.03)** (21.99)** (22.42)** (22.69)*** (22.26)** (22.34)** (22.50)** (22.87)
Market 1.0598 1.0598 1.0594 1.0591 0.9984 0.9984 0.9981 0.9978
(144.03)*** (143.76)*** (143.87)*** (143.48)*** (135.42)*** (135.18)*** (135.26)*** (134.87)***
SMB 0.5404 0.5402 0.5402 0.5397
(38.16)*** (38.10)*** (38.15)*** (38.06)***
HML 0.4340 0.4339 0.4339 0.4338
(45.07)*** (45.00)*** (45.06)*** (44.99)***
20.0644 20.0647 20.0646 20.0652
ALAN T. WANG AND ANLIN CHEN

Momentum
(26.43)*** (26.46)*** (26.45)*** (26.50)***
Pledge 3 Cash 0.0362 (1.33) 0.0683 (1.90)* 0.0303 (1.15) 0.0586 (1.68)*
Within-group 26.41 26.41 26.41 26.42 31.34 31.34 31.34 31.34
R-square (%)
Between-group 5.76 5.60 5.58 5.14 6.26 6.00 6.12 5.65
R-square (%)
Overall 26.33 26.33 26.34 26.33 31.24 31.24 31.25 31.24
R-square (%)
Notes: Financial performances with cross-product term: Pledging and cash holding. Excess stock return is regressed on pledge ratio, the interaction term of
pledge ratio and cash holding, controlled by the excess returns of market, small-minus-big and high-minus-low portfolios. Number of observations is 58,094.
Numbers in parentheses are z-statistics for random-effect models and t-statistics for fixed-effect models. Hausman tests for the null hypothesis of
random-effect model yield no significant results for all equations. ***, ** and * indicate significant at 1%, 5% and 10% significance levels, respectively.
Table 9. Financial Performance with Working Capital Effect.

Variables Eq. (9) Eq. (11)
Constant 0.6275 (9.76)*** 0.6699 (8.46)*** 0.3971 (6.35)*** 0.4497 (5.85)***

Pledge 20.0070 20.0109 20.0074 20.0119
(22.67)*** (22.54)** (22.90)*** (22.87)***
Market 1.0593 1.0592 0.9979 0.9977
(143.89)*** (143.53)*** (135.27)*** (134.92)***
SMB 0.5402 0.5399
(38.15)*** (38.08)***
HML 0.4339 0.4338
(45.06)*** (44.99)***
Momentum 20.0648 20.0652
(26.47)*** (26.50)***
Pledge 3 Working 0.0231 (2.19)** 0.0302 (2.06)** 0.0225 (2.22)** 0.0294 (2.08)**
Capital
Within-group 26.42 26.42 31.34 31.34
R-square (%)
Between-group 6.08 5.86 6.57 6.26
R-square (%)
Overall 26.34 26.34 31.25 31.25
R-square (%)
Notes: Financial performances with cross-product term: Pledging and working capital. Excess
stock return is regressed on pledge ratio, the interaction term of pledge ratio and working capital,
controlled by the excess returns of market, small-minus-big and high-minus-low portfolios.
Number of observations is 58,094. Numbers in parentheses are z-statistics for random-effect
models and t-statistics for fixed-effect models. Hausman tests for the null hypothesis of random-
effect model yield no significant results for both equations. *** and ** indicate significant at 1%
and 5% significance levels, respectively.
that pledge ratio is positively associated with agency problem in which the
controlling shareholders might expropriate the firm’s resources, and, like the case
for ROE, this negative association is offset by the level of net working capital.
5. CONCLUSIONS
The common perception by market practitioners in Taiwan is that stock pledging
by controlling shareholders signals corporate governance problems between the
controlling shareholders and minority shareholders. Using data from firms listed
in the Taiwan Stock Exchange, this study first examines the determinants of the
tendency that controlling shareholders pledge their shares to banks for liquidity
from the perspectives of firm attributes, market, and corporate governance. The
results indicate that the size of the capital, debt ratio, credit risk, and the number
of board seats controlled by the ultimate controlling shareholders are positively
associated with the tendency that controlling shareholders pledge their shares.
Cash flow right of the controlling shareholders, price-to-book ratio, and beta are
negatively associated with the tendency that controlling shareholders pledge their
shares. Second, this study finds that the tendency of stock pledging by controlling
shareholders has a negative effect on accounting as well as financial perfor-
mances. This negative effect is smaller when the firm has a higher level of working
capital. These empirical findings are consistent with the perception that stock
pledging by controlling shareholders is an indication of weak corporate gover-
nance, and the capital market has reacted negatively accordingly.
Based on the empirical results of this study, stock pledging by controlling
shareholders is more likely an indication of weak corporate governance if the firm
has a lower level of working capital. A possible explanation is that if the firm has
more liquidity, it is less unlikely that controlling shareholders pledging their
shares will undermine the firm’s performance due to self-dealing behaviors.
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The Causes and Consequences of Stock Pledging by Controlling Shareholders: The Case of Taiwan

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THE CAUSES AND CONSEQUENCES

The information of pledging stocks for liquidity by controlling shareholders of

Keywords: Stock; pledging; corporate governance; cash holding; liquidity;

JEL Classiﬁcations: G12; G32; G34

Advances in Paciﬁc Basin Business, Economics and Finance, Volume 8, 99–129

Britain, but concentrated ownership is more common in other European and

literatures. For example, if a ﬁrm has a higher degree of ﬁnancial leverage or

2. DETERMINANTS OF STOCK PLEDGING BY

2.1. Firm Attributes

2.1.3. Credit Rating

2.2. Market Condition

2.2.1. Share Price

2.3. Corporate Governance

issue of whether stock pledging by controlling shareholders is an indication of

2.3.1. Number of Board Seats

2.3.2. Cash Flow Right

2.3.3. Types of Control

3. DATA AND EMPIRICAL METHODOLOGY

related to ﬁrm attributes, market information, and corporate governance. They

Return on assets (ROA): ROA is deﬁned as

ordinary income 1 interest expense 3 ð1 2 17%Þ

where 17% is the business tax rate.

Pledge dummy ¼ b0 1 b1 Capital 1 b2 Debt ratio 1 b3 TCRI (1)

Pledge dummy ¼ b0 1 b1 PBRatio 1 b2 Beta (2)

Pledge dummy ¼ b0 1 b1 Seats 1 b2 CFR (3)

Pledge dummy ¼ b0 1 b1 Capital 1 b2 Debt ratio 1 b3 TCRI

Pledge dummy ¼ b0 1 b1 Capital 1 b2 Debt ratio 1 b3 TCRI 1 b4 PBRatio

3.2.2. Performances of Firms with Stock Pledging

ROE ¼ b0 1 b1 Pledgeð 2 1Þ 1 b2 MVð 2 1Þ 1 b3 Debtð 2 1Þ 1 b4 R&Dð 2 1Þ

ROA ¼ b0 1 b1 Pledgeð 2 1Þ 1 b2 MVð 2 1Þ 1 b3 Debtð 2 1Þ 1 b4 R&Dð 2 1Þ

For ﬁnancial performances, pledge ratio is included as an extra explanatory

Excess Return ¼ b0 1 b1 Pledge 1 b2 Market (8)

Excess Return ¼ b0 1 b1 Pledge 1 b2 Market 1 b3 Pledge 3 Cash (9)

for one-factor models;

Excess Return ¼ b0 1 b1 Pledge 1 b2 Market 1 b3 SMB 1 b4 HML

Excess Return ¼ b0 1 b1 Pledge 1 b2 Market 1 b3 SMB 1 b4 HML

for four-factor models.

Table 1. Summary Statistics.

Panel A: No-pledge ﬁrms

Table 2. Differences in Means between No-pledge and Pledge Firms.

No-pledge Pledge (Pledge–No-pledge)

stocks pledged by directors, supervisors and large shareholders every year

reinforce our argument. Controlling shareholders of pledge ﬁrms tend to have

ALAN T. WANG AND ANLIN CHEN

4.2. Logit Models

Table 4. Estimation of Logit Models.

Intercept 227.7610 22.2462 20.0556 224.0590 225.8305

4.3. Tobit Models

Table 5. Estimation of Tobit Models.

Intercept 27.2214 229.2169 4.8817 25.6330 25.8299

Pseudo R-square (%) 9.61 1.37 0.65 10.25 10.95

4.4. Firm Performances

Table 6. Accounting Performance with Cash Holding Effect.

Constant 230.9315 221.2441 10.0411 23.3470 (21.42)

4.4.2. Financial Performance

Table 7. Accounting Performance with Working Capital Effect.

Constant 230.5963 220.8037 29.8953 23.1719

ALAN T. WANG AND ANLIN CHEN

Table 9. Financial Performance with Working Capital Effect.

Constant 0.6275 (9.76)*** 0.6699 (8.46)*** 0.3971 (6.35)*** 0.4497 (5.85)***

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Constant 0.6275 (9.76)* 0.6699 (8.46)* 0.3971 (6.35)* 0.4497 (5.85)*