Why Do Corporations Care About Their Stock Prices?
First, watch this short video:
Mostly summarized from Investopedia:
Corporations receive investment money only when they first sell stock shares (ownership shares of the corporation) 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 shares directly gain/suffer the monetary benefits/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.
Terms are the new executive cannot cash in (sell) the stock options until the stock price reaches $120.
When the stock price reaches $120 the executive can sell 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 shares 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 stock value and dividends gains for the shareholders = the owners of the corporation.
Over the long run poor stock performance is usually attributed to poor management.
If the stock price consistently underperforms the shareholders will be unhappy with management and want change of management.
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3- A higher stock price helps a corporation borrow money through sale of bonds to the public.
A high stock price is an indication the corporation will be able to pay off borrowing interest and principal of the bonds.
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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If the stock price falls to zero and the corporation goes bankrupt, the zero stock price reflects this business failure and is not the cause of it.
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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 a 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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Why do current shareholders of a corporation allow the corporation to sell more shares since this will cause a value drop in their shares?
ChatGPT:
When a corporation decides to issue more shares, it's often a move that can dilute the existing shareholders' ownership percentage.
However, shareholders generally allow this for several key reasons:
-Raising Capital:
One of the primary reasons a company issues new shares is to raise capital.
This influx of funds can be used for various growth initiatives like research and development, expanding operations, reducing debt, or acquiring other businesses.
The expectation is these investments will lead to greater profits and increase the company’s share price in the long run, offsetting the initial dilutive effect of share issuance.
-Financial Health:
Issuing shares can be a way to improve the company's balance sheet, particularly by reducing debt.
A stronger balance sheet can lead to better credit ratings and reduced interest costs on existing debts, which is beneficial for shareholder value.
-Market Conditions:
Sometimes, market conditions are favorable for issuing shares, such as when share prices are particularly high.
Companies might capitalize on these conditions to raise funds more cheaply than through debt (sale of bonds).
-Strategic Acquisitions:
Companies often issue new shares as a means to finance acquisitions without the need to spend cash reserves or increase debt.
This can be a strategic move to enhance the company’s market position and future earnings potential.
-Avoiding Over-leverage:
By issuing equity rather than taking on more debt, a company avoids the risks associated with high debt levels, such as vulnerability (not being able to pay off the debt) during economic downturns.
Typically, significant new share issuances need approval from current shareholders.
Shareholders will weigh the potential benefits against the dilutive effects.
If they believe the management's strategy will enhance the value of the company in the long run, they are likely to approve the issuance.
Overall, while issuing additional shares can dilute existing shareholders, the broader strategic reasons often align with long-term value creation, prompting shareholders to support such decisions.
So, there is a good chance the current shareholders’ share prices will immediately go up not down as a result of the sale of new, additional shares.
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