# Share pledge and accounting conservatism in share-pledging firms: Evidence from a natural experiment in China

## TL;DR

This study shows that when Chinese laws restricted share pledging, firms with pledged shares became more conservative in their financial reporting to avoid risks and satisfy creditors.

## Contribution

The paper provides direct evidence of creditors' demand for accounting conservatism in response to legal changes in share pledging.

## Key findings

- Pledging firms showed increased accounting conservatism after legal restrictions were introduced.
- The effect was stronger in firms with higher share pledging ratios and concentrated creditors.
- Conservatism reduced the risk of margin calls and stock price crashes.

## Abstract

This paper focuses on firms in which insiders pledge their shares as collateral for loans. By investigating a natural experiment—China’s enactment of provisions on share reductions that restrict pledge creditors’ cashing-out behavior—we find that pledging firms exhibited more conservative financial reporting after the implementation than non-pledging firms. This effect was pronounced in firms with a higher ratio of pledged shares, a longer maturation period of the pledged shares, and more concentrated pledge creditors. Additionally, we show that pledging firms increased their accounting conservatism after the shock, leading to a lower risk of margin calls and stock price crashes. The effect on accounting conservatism was stronger in firms with controlling pledgers or when the pledge creditors were banks. Our results remained consistent after we performed several robustness tests. These behaviors are economically logical because the provisions heighten creditors’ liquidity risk and the potential losses of loan default. Pledging shareholders embrace more accounting conservatism to mitigate creditors’ concerns about agency costs and avoid triggering margin calls. Our findings provide direct support that creditors have a real demand for accounting conservatism and highlight the impact of shareholder-creditor conflicts on the financial reporting policies of pledging firms.