Institutional Investors'Discretionary Decisions,Controlling Shareholders'Share Pledging and Corporate Governance Effects
The Third Plenary Session of the 20th Central Committee of the Communist Party of China has made a forward-looking and systematic top-level design for comprehensively deepening reform of the financial system.It has set clear goals for promoting high-quality financial development and accelerating the building of a nation with a strong finan-cial sector.As the cornerstone of the modern financial system,institutional investors play a crucial role in advancing cor-porate governance modernization and promoting the healthy and stable development of capital markets.However,their ability to make discretionary decisions to exert corporate governance effects has rarely been explored in the literature.This paper delves into whether and how institutional investors exert governance effects in the context of the prevalent and impactful phenomenon of controlling shareholders'share pledging in China.The unique advantage of this context lies in the fact that share pledging,as a neutral financing tool,exerts varying impacts on company operations according to the purpose of the pledged funds and the pledge ratio.Therefore,exploring whether institutional investors can correctly inter-pret the economic consequences of controlling shareholders'pledge decisions and make discretionary decisions to exert governance effects is of significant value for advancing corporate governance modernization and enhancing the capital market's ability to serve the real economy.Using historical data from Chinese A-share listed companies and institutional investors'holdings from 2007 to 2021,this paper finds that due to the majority of pledged funds being used by controlling shareholders themselves or other non listed entities,and the generally high pledge ratios,the impact on company operations with controlling shareholders'share pledging is predominantly negative.Consequently,institutional investors overall tend to inhibit controlling share-holders'share pledging.This result remains significant after employing difference-in-differences and instrumental vari-able methods,with a series of robustness checks supporting the conclusion.In terms of channel analysis,this paper finds that institutional investors mainly inhibit controlling shareholders'share pledging through"voice"and"exit",with evi-dent preferences and sequences in their use.Conversely,in situations where share pledging is beneficial to company op-erations,institutional investors promote controlling shareholders'share pledging through endorsement effects.Finally,the empirical results of this paper also show that institutional investors can significantly mitigate the negative impacts of con-trolling shareholders'share pledging on company performance and default risk,demonstrating significant corporate gov-ernance effects.The contributions of this paper are fourfold.First,we analyze the share pledging scenarios which may simultane-ously have positive and negative impacts on company operations,depicting institutional investors'discretionary decisions in different contexts.This work significantly differs from existing literature that explores institutional investors'roles in single-direction positive or negative scenarios.Second,the paper empirically tests the existence and utilization sequence and preferences of"voice"and"exit"channels,enriching the research on institutional investors'corporate governance channels.Third,considering that second-type agency problems are more critical under China's unique ownership struc-ture characteristics,this paper provides more accurate and direct evidence of the relationship between institutional inves-tors and second-type agency problems.Fourth,unlike existing research that mainly focuses on the economic conse-quences of share pledging,this paper expands the study of determinants of controlling shareholders'pledge decisions,em-phasizing the importance of institutional investors.This research offers the following four policy implications.First,regulatory authorities should continuously cultivate and develop institutional investors,especially encouraging value and long-term investments.Second,financial supervi-sion should be strengthened,particularly the supervision and punishment of listed company governance,with an emphasis on improving the rules for major shareholders'share reductions.Third,regulatory authorities should further standardize investor relations management of listed companies,reduce information asymmetry between listed companies and external investors,and better protect the interests of minority shareholders.Fourth,regulatory authorities should optimize policies for institutional investors'use of"voice"and"exit"channels to enhance their role in corporate governance.
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