Controlling shareholders’ equity pledges and properties of analysts’ earnings forecasts

Abstract

Purpose

We adopt an information risk view and argue that higher levels of pledge risk incurred by insiders incentivize opportunistic financial disclosure and impair the quality of information available to analysts to forecast firm performance.

Design/methodology/approach

We sample Chinese listed companies from 2010 to 2022. Following the literature, we apply established models to measure and test analysts’ forecasting accuracy/dispersion related to controlling shareholders pledging equity and the amount of margin call pressure. Analyst characteristics and nonfinancial disclosures proxied by CSR reports are also examined as factors likely to influence the relationship between pledge risk and analysts’ forecast quality.

Findings

We find that analysts’ earnings predictions are less accurate and more dispersed as the proportion of shares pledged (pledge ratio) increases and in combination with greater margin call pressure. Pledge ratios are significantly associated with several information risk proxies (i.e. earnings permanence, accruals quality, audit quality, financial restatements, related party transactions and internal control weaknesses), validating the channel through which equity pledges undermine analysts’ forecast quality. The results also demonstrate that forecast quality declines for a wide variety of analysts’ attributes, including high- and low-quality analysts and analysts from small and large brokerage firms. Importantly, nonfinancial disclosures, as proxied by CSR reporting, improve analysts’ forecasts.

Originality/value

We extend the literature by demonstrating that incremental pledge risk increases non-diversifiable information risk; all non-pledging shareholders pay a premium through more diverse and less accurate earnings forecasts. Our study provides important policy implications with economically significant costs to investors associated with insider equity pledges. Our results highlight the benefits of nonfinancial disclosures in China, which has implications for the current debate on the global convergence of CSR reporting.

Citation

Kent, R., Long, W., Yang, Y. and Yao, D. (2024), "Controlling shareholders’ equity pledges and properties of analysts’ earnings forecasts", Journal of Accounting Literature, Vol. ahead-of-print No. ahead-of-print. https://doi.org/10.1108/JAL-01-2024-0005