Why Do Corporations Care About Their Stock Prices?
First, watch this short video:
Mostly summarized from Investopedia:
Corporations receive money for their stock only when they first sell stock shares to the public, the initial public offering (IPO).
In the subsequent trading of these shares on the stock market the buyers and sellers of the stock realize the monetary benefits or losses from the fluctuating share price, the corporation does not.
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Note, stock options are referred to below, to clarify in advance here’s an example:
Corporation A current stock price is $100.
A new executive is hired and is given 10,000 shares of stock options at target price of $120.
The executive cannot cash in the stock options until the stock price reaches $120.
When the stock price reaches $120 the executive can sell and cash in the options for total $1,200,000, or can wait and hope to sell later at a bigger gain.
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Why does the management of a corporation care about its stock performance when the corporation has already received its money in the IPO? Some reasons:
1- Management has a monetary interest in the corporation.
A corporation’s founder typically owns a large number of shares.
Usually the corporation's managers have salary incentives or stock options tied to the corporation's stock price.
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2- Management wants job security.
Management's primary job is to produce gains for the shareholders, the owners of the corporation.
Over the long run poor stock performance could be attributed to poor corporation management.
If the stock price consistently underperforms the shareholders will be unhappy with management and want changes.
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3- A higher stock price helps a corporation borrow money through sale of bonds to the public.
If managers believe they will make e.g. 4% or more profits on a new project it is good business practice to borrow at 3%.
A high stock price is an indication the corporation will be able to pay back bond debts, interest and principal.
A corporation with increasing stock price is a lower risk and can sell bonds with a lower interest rate.
A corporation with decreasing stock price is a higher risk and must sell bonds with a higher interest rate.
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4- Equity financing
A higher stock price helps when a corporation seeks additional equity financing.
To raise money a corporation can sell more shares to the public.
A high share price means a corporation can sell new shares with less resulting drop in price of current shares.
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5- Unlike private companies, publicly traded corporations are vulnerable to takeover by another corporation if their share price declines making them a bargain.
Private companies are usually managed by the owners themselves, and the shares are held within the company.
If private owners don't want to sell, the company cannot be taken over, there are no outside shareholders to demand changes.
Publicly traded corporations have shares distributed over many owners who can easily sell their shares at any time.
When a Corporation A with declining price shares is bought by another Corporation B, the managers of Corporation A stand to lose their jobs, money, and prestige.
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6- Conversely, Corporation A is better able to take over other corporations if it has a high share price.
Instead of having to buy Corporation C with cash, Corporation A can buy it with shares it holds within the corporation, or can sell more shares to the public to raise funds.
With a high share price fewer shares of Corporation A are needed to buy Corporation C.
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7- Corporations want a higher share price to increase its prestige with and exposure to the public.
Managers are always thinking about keeping their current job and looking ahead to another, better next job.
The better a corporation's share price is performing the more news coverage the corporation receives and status the top executives receive.
News coverage is free publicity helping the corporation and its managers to introduce themselves to a wider audience of customers, stock buyers, and next better employer.
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