Share pledging—a financial strategy where corporate executives use their stock holdings as collateral for personal loans—has long been controversial. While it allows executives to obtain liquidity without selling shares, it also introduces risks, such as margin calls that can trigger stock price declines. In our recent study, we uncover a key motivation behind this practice: CEOs use share pledging as a tax avoidance tool, allowing them to access liquidity without triggering capital gains taxes.

Using a comprehensive, hand-collected dataset of CEOs’ share pledging from 2006 to 2019, we provide the first systematic evidence that CEOs’ unrealized capital gains tax liabilities significantly influence their decision to pledge shares. Moreover, our findings suggest that firms and CEOs use share pledging to contract around CEOs’ personal tax liabilities.

The Tax Motivation Behind Share Pledging

In recent years, the practice of share pledging has gained considerable public attention due to its role in the tax planning strategy known as “buy, borrow, die.” This strategy allows wealthy individuals to avoid selling appreciated assets—and thus avoid incurring capital gains taxes—by borrowing against their equity holdings. Upon death, these assets are passed on to heirs with a stepped-up tax basis, effectively eliminating capital gains taxes altogether.

Despite the widespread speculation about the role of tax incentives in share pledging, empirical evidence has been scarce. Our study bridges this gap by systematically examining whether and how CEOs’ personal tax burdens influence their share pledging behavior.

Empirical Evidence: CEO Taxes and Share Pledging

To investigate the relationship between CEO tax burdens and share pledging, we construct a measure of CEOs’ unrealized capital gains tax liabilities on their equity holdings in their own firm. This metric captures the percentage of the CEO’s equity holdings that would be owed in federal and state capital gains taxes upon a hypothetical sale of shares. Our key findings include:

1. CEOs with higher tax burdens are significantly more likely to pledge shares: An interquartile increase in the CEO tax burden is associated with a 26 percent higher likelihood of pledging shares and a 25.9 percent increase in the value of shares pledged. Tests to assess the relative importance of various CEO and firm characteristics reveal that the CEO tax burden is the single most important factor in the decision to pledge shares.
2. The role of CEO wealth: CEOs with substantial outside wealth (e.g., diversified assets beyond their firm’s equity) are less likely to pledge shares, suggesting that share pledging serves as a liquidity mechanism for CEOs with limited alternative sources of funding.
3. The role of CEO power: More powerful CEOs—those with greater ownership stakes, longer tenures, or weaker board oversight—are more likely to engage in share pledging, highlighting the governance challenges associated with this practice.

The Firm’s Role: Responding to Institutional Pressure

Not all firms allow share pledging, particularly after 2012 when Institutional Shareholder Services (ISS), the largest proxy advisory firm in the U.S., issued a public statement discouraging the practice. In response, many firms adopted anti-pledging policies to align with ISS’ recommendations and mitigate governance concerns. However, our study finds that firms led by high-tax burden CEOs were significantly less likely to implement such restrictions, compared with firms with low-tax burden CEOs.

Moreover, for firms that did impose anti-pledging policies, we observe an interesting compensatory effect: CEOs who lost the ability to pledge shares subsequently received an average increase of 21.8 percent in cash pay. This suggests that firms and executives view share pledging as an implicit form of compensation, with tax deferral benefits that must be replaced when removed.

Policy and Governance Implications

Our findings shed new light on the role of personal taxes in corporate finance decisions. While share pledging is often criticized for increasing firm risk, it also serves as a valuable financial planning tool for executives facing substantial unrealized tax liabilities. This dual nature of share pledging presents a dilemma for policymakers, regulators, and corporate boards.

Conclusion

Share pledging remains controversial. Our study highlights the role of CEO taxes in driving share pledging and underscores the importance of aligning executive incentives with shareholder interests. Moreover, while our primary focus is on CEOs, we note that share pledging is generally believed to be widely used by wealthy individuals (including non-CEOs) to avoid taxes, but such data are rarely publicly available. By studying publicly available data on CEOs, we gain insight into the role of share pledging in wealthy individuals’ tax planning more broadly.

This post comes to us from Jon Underwood at the University of Iowa and Benjamin Yost at Boston College Carroll School of Management. It is based on their recent article, “CEO Taxes and Share Pledging,” available here.