The impacts of share pledging on firm investment timing and valuation

This paper applies a model in the real options framework to analyze the impacts of controlling shareholder's share pledging on corporate investment timing and valuation. We find that the optimal investment timing shows an inverted U-shape with the pledge ratio, indicating that share pledging exacerbates firms' over-investment and worsens firms' under-investment. Furthermore, share pledging hurts firms' option value unless active measures are taken to control the pledging risks. The maintenance requirement can keep controlling shareholder from irrational early investments and protect investors from severe wealth losses. In addition, our work can provide testable empirical implications.

Automated summary

This study applies a model in the real options framework to analyze the impacts of controlling shareholder's share pledging on corporate investment timing and valuation. The findings reveal an inverted U-shaped relationship between the pledge ratio and optimal investment timing, indicating that share pledging exacerbates firms' over-investment and worsens firms' under-investment. Additionally, the study shows that share pledging harms firms' option value unless active measures are taken to control the pledging risks. The maintenance requirement can mitigate irrational early investments by controlling shareholders and protect investors from significant wealth losses. Moreover, the study offers testable empirical implications.