In the world of business, the stakes are always high, and one wrong move can lead to spectacular failures. A common practice among CEOs, pledging shares to secure loans, has seen significant growth in the past decade. However, this strategy can backfire, sometimes leading to devastating consequences.
The allure of this technique is understandable. It offers CEOs access to cash without having to shrink their stake in the business they’re running. The surge in equity markets and record-low interest rates have made it even more appealing. According to data, nearly half of U.S. CEOs have used this technique to secure loans.
When Pledging Shares Go Wrong
Take the case of Charif Souki, co-founder of Tellurian Inc. Once America’s best-paid executive, Souki pledged 25 million shares of his Houston-based natural gas firm in 2017 to secure loans for real estate investments. However, things took a turn for the worse when Tellurian’s stock hit a three-year low and virtually all of Souki’s stake was seized by lenders. Worth about $250 million at the time of the pledge, the shares were sold for a mere $37 million.
Jason Zein, a finance professor at the University of New South Wales’ business school, warns about the perils of share pledges. He notes that these are often sensitive to fluctuations in interest rates and can quickly unravel if the market conditions are unfavorable.
Andy Moore, CEO of the investment banking arm of B. Riley Financial Inc., and Nima Ghamsari, CEO of Blend Labs Inc., have also experienced the pitfalls of pledging shares. Moore was forced to sell about $1.3 million worth of shares when B. Riley’s stock hit a three-year low. Ghamsari, on the other hand, has offloaded about $1.5 million of stock in the fintech company since the start of last year, as the value of the shares he had pledged plummeted.
The Risk of Pledged Share Sales
What makes pledged share sales particularly devastating is that executives are often compelled to sell their stock at the worst possible time: when it’s trading at multiyear lows. The stakes sold since the start of last year were worth more than $330 million at the time the pledges were first disclosed.
“If the market swings like during the levels in the financial crisis, there can be huge impacts,” warns Jihun Bae, assistant professor at the Rotterdam-based Erasmus School of Economics.
Despite the risks, pledging stock is a common method for executives to diversify their wealth. Oracle Corp. Chairman Larry Ellison and Mat Ishbia, owner of the Phoenix Suns, have both put up company shares to fund their lavish lifestyles.
The Impact of Rising Rates
Another factor to consider is the impact of rising interest rates. Gregory Garrabrants, CEO of Axos Financial Inc., sold pledged stock to help pay borrowing costs when the financial firm’s stock was falling. The benchmark interest rate for federal funds in the U.S. has surged from almost zero to more than 5%, putting pressure on borrowers who don’t have secured fixed monthly repayments for their loans.
While pledging shares can offer short-term benefits, the potential risks can be significant. As these cautionary tales show, it’s crucial for executives to carefully consider their options before making such high-stake decisions.
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