22 APPLIED FINANCE LETTERS VOLUME 12, 2023 EQ UITY PLEDG E, PLEDG O R TYPE A ND INVESTMENT EFFIC IENC Y KA RREN LEE- HWEI KHA W 1* , JIA YING C HEN 2 , MUHAMMAD AWAIS GULZAR 2 , AHMAD HA KIMI TA JUDDIN 3 1. Mo na sh Unive rsity Ma la ysia 2. Unive rsity o f Wa ika to , C hina 3. Ta ylo r’ s Unive rsity, Ma la ysia * C o rre sp o nd ing Autho r: Ka rre n Le e -Hw e i Kha w , the Sc ho o l o f Busine ss, Mo na sh Unive rsity Ma la ysia . * Ka rre n.Kha w@ monash.edu A b stra c t Eq uity p le d g ing is susc e p tib le to a g e nc y p ro b le m s a nd sub sta ntia l risk, re sulting in ine ffic ie nt c o rp o ra te inve stme nt. We sho w tha t the ne g a tive im p a c t is no t just ind uc e d b y c o ntro lling sha re ho ld e rs b ut a lso p le d g e d b y no n-c o ntro lling sha re ho ld e rs. O ur re sults a d d tha t SO Es w ith c o ntro l rig hts via c o ntro lling sha re ho ld e rs o r a c tua l c o ntro lle rs c a n m itig a te inve stm e nt ine ffic ie nc y p ro b le m s. We c o nc lud e tha t p le d g o r-typ e m a tte rs a nd the im p a c t o f no n-c o ntro lling sha re ho ld e rs' p le d g e s sho uld no t b e ne g le c te d . Ke ywo rd s: a g e nc y p ro b le m , e q uity p le d g e , c o ntro lling sha re ho ld e rs, no n- c o ntro lling sha re ho ld e rs, a c tua l c o ntro lle r, inve stm e nt e ffic ie nc y JEL C o de s: G3 1. Intro d uc tio n Eq uity p le d g ing is a sta nd a rd fina nc ing m e tho d fo r c o ntro lling sha re ho ld e rs in C hina to ra ise c a p ita l w hile re ta ining the ir c o ntro l rig hts. The m a rke t fo r e q uity p le d g ing in C hina is e no rm o us. In 2021, p le d g e d sha re s ha d a m a rke t va lue o f 4.18 trillio n yua n (re fe r to Ta b le 1). Stud ie s find tha t c o ntro lling sha re ho ld e rs' p le d g e s e xa c e rb a te a g e nc y c o nflic ts d ue to m a rg in c a ll stre ss (C ha n e t a l., 2018; C ha uha n e t a l., 2021). If p le d g o rs fa il to sa tisfy the m a rg in c a ll w he n the p le d g e d sha re p ric e fa lls b e lo w the thre sho ld , p le d g e e s c a n fo rc ib ly se ll the sha re s, a nd p le d g o rs risk lo sing c o ntro l. The re fo re , c o ntro lling sha re ho ld e rs a re inc line d to c ha ng e the ir inc e ntive s a nd influe nc e c o rp o ra te d e c isio ns in va rio us w a ys to a vo id m a rg in c a lls. O ne w a y is to a lte r c a p ita l inve stm e nt risk tha t c a n im p a ir c o rp o ra te inve stm e nt e ffic ie nc y. Ple d g e d firm s a re inc e ntivize d to lo w e r c a p ita l inve stm e nt risk (C ha uha n e t a l., 2018) b y re d uc ing c a p ita l e xp e nd iture s, inc lud ing R&D e xp e nse s, c o m p a re d to no n-p le d g e d firm s to ke e p the p e rso na l b e ne fits o f p le d g ing (Do u e t a l., 2019). Insid e rs te nd to fo rg o risky b ut p ro fita b le inve stm e nt o p p o rtunitie s (Do u e t a l., 2019) to m o d e ra te inve stm e nt risk d ire c tly re fle c te d in the firm 's sto c k re turn vo la tility a nd future sto c k p ric e c ra sh risk, c a using und e rinve stm e nt p ro b le m s. In c o ntra st, p le d g e d firm s m a y ha ve a la rg e r risk a p p e tite b e c a use the p le d g o rs kno w tha t the d o w nsid e risk is lim ite d . In the w o rst-c a se sc e na rio , the p le d g e d sha re s w o uld b e liq uid a te d to m e e t m a rg in c a lls. The unlim ite d up sid e p o te ntia l c o uld m o tiva te c o ntro lling sha re ho ld e rs to o ve rinve st b y und e rta king risky b ut p ro fita b le inve stm e nts to b o o st sha re p ric e s a t the e xp e nse o f m ino rity sha re ho ld e rs (Do u e t a l., 2019;