Mostly summarized from Gregory Mankiw’s Principles of Economics, 5th Ed.
PART 9 The Real Economy in the Long Run
Chapter 26 of 36 Saving, Investment, and the Financial System
Section 7 of 25
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Companies live and die by their stock price.
Yet mostly they don't actively participate in trading their shares on the securities market.
Companies receive money from the securities market only when they first sell a security to the public in the primary market, which is commonly referred to as an initial public offering (IPO).
In the subsequent trading of these shares on the secondary market, the stock market, it is public investors buying and selling the stock seeking to benefit from appreciation in stock price.
The original company that issues the stock does not participate in any profits or losses resulting from these transactions.
This confuses many people.
Why then does a company, or more specifically its management, care about a stock's performance in the secondary market when the company has already received its money in the IPO?
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One reason a corporation’s managers care about the stock market is they typically have a monetary interest in the company.
It's not unusual for a public company's founder to own a significant number of outstanding [publicly traded] shares.
Typically the managers hold a large amount of the corporation’s stock
Also manager usually have salary and bonus incentives tied to the company's stock prices.
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Management's primary job is to produce gains for the shareholders, who are the corporation’s owners.
Poor stock performance is over the long run is attributed to company mismanagement.
If the stock price consistently underperforms shareholders' expectations, the shareholders will be unhappy with management and look for changes.
Shareholders can band together and lead in ousting current management.
Corporation managers must always factor in shareholders' desires when making decisions.
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Another main role of the stock market is it measures financial health.
Analysts are constantly scrutinizing companies and this information affects the companies' traded shares.
Creditors [lenders including bond buyers and banks] tend to look favorably upon companies whose share price is rising, and will accept lower interest rate payments on bonds and loans.
Strong earnings and a high stock price are good indications the company will be able to make its interest payments and loan principal payback.
As a result, the company will pay a lower interest rate, which in turn increases the amount of value returned from a capital project.
Invested money received from a 3% interest bond issue needs only to generate a 4% profit.
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A rising stock price is helpful for a company seeking additional equity financing.
With a rising stock price a company is better able to sell new additional shares to the public to raise money rather than borrow.
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Publicly traded companies are vulnerable to takeover by another company if their share price falls.
A low stock price of corporation A means it’s easier for another corporation B to buy A.
Main method being B offers a share price above current market price to shareholders of A.
For this reason, managers of corporation A want the stock price to rise or at least not fall substantially.
Conversely, a company with a rising share price has a better ability to buy other companies.
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A company wants a rising share price because it increases its prestige and exposure to the public.
Publicity, essentially free advertising, is generated, leading to increased sales and profits.
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free advertising
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