Why should a company care about their stock prices?
I'm sure this question will betray my utter lack of understanding of the stock market, but I have a hard time understanding why companies are so obsessed with their stock prices. My understanding of stock is that a company sells little pieces of ownership of the company in exchange for cash today. Once the stock leaves the hands of the company (and the company gets the cash it wanted), why should it care what the stock is worth?
I can think of a few possible reasons, but none of them totally satisfy me. . .
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A company might want to guard against hostile takeover, and a high stock prices makes such a takeover more difficult.
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A company has a pool of stock not yet issued, and high prices for current stock might bode well for future issues of stock (though the new stock would dilute the pool and bring the price down).
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Stock price is an indicator of goodwill toward the company, so higher stock prices might mean better rates for loans and other types of investment.
None of these reasons, though, completely satisfy me. What am I missing?
High stock price = stronger currency for making stock-based acquisitions
a high stock price also generally is a company morale-booster, as a higher and higher portion each year of compensation for employees is stock-based comp. High stock = happy employees
High stock prices also signals general market sentiment that you are performing above market expectations. Poor stock price performance should be an indicator that A) your company is doing something fundamentally wrong or B) your company is not properly displaying to the market its value. Either way, a poor stock price can explain to a company what they have to change to improve (whether that is better marketing of their value-add/growth or improving the business model).
two that strike me immediately:
compensation of management is often comprised of stock options so it is in their best interest to have the stock price as high as possible
also
if you want financing on your operations you better be not be worthless (ie can make good on your obligations)...low stock price means earnings are nonexistent which means you have no money to pay interest on the loans which means you don't get the loot -- times interest earned ratio
hmmm....I get the impression he's asking the much more fundamental question of what exactly stock means for the company, not what you use it for.
To answer the question, the people who at the end of the day are supposed to control the company are its owners. People who run and manage the company may be employees and executives, but people who actually own the company and theoretically control it through a board of directors are the shareholders who own the equity. As an owner, you care about the stock price because that represents your money.
The executives care because 1) (theoretically at least) they will be fired if the stock performs badly by their true bosses, the owners and 2) they are often receive some form of stock-based compensation.
I suppose this questions comes from the point of view of "why did banks have a lot of issues when they stock prices dropped"........ For this issue, banks often needed short term financing in the overnight markets and as their stock price dropped their cost to borrow continued to rise. Without that borrowing (if the cost became too hight) the company would go bankrupt.....
This however brings us to the general basis for why a companies stock price matters..... because it will be the major determining factor for funding. Which often we forget that cash is essential for the day-to-day operations of any company. Unlike the retarded nonsense youve been hearing from the media (Lou Dobbs being one of them) a Credit crisis and a liquidity crisis are mainly the same thing. It would be absurd for a company to float shares for short term capital needs, so most of a companies short term liquidity will be met by debt (typically a revolver)
As the company's stock price declines....... future equity raises become less and less valuable and the amount of company sold to bring in the necessary amount of cash will be larger... At some point you cannot go to the general market for cash funding. At the same time as the debt markets view your likelihood to collapse as higher and so charge a higher rate of interest on your loans. Since banks must borrow much more frequently, this became a downward spiral fast.
Meanwhile if we assume rational markets....... declines in stock prices mean also declines in business profitability... it the stock is rationally priced based on an asset cash flow basis.... so declining stocks would indicate general problems for the company from both a financing and business perspective.
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