Understanding Stock Prices and Values

It doesn't make a lot of sense to the casual observer why a company would be concerned about its stock price. After all, unless the company is currently issuing stock, it would appear that the stock price would be irrelevant to the company. Consider that when you buy or sell a stock, you're usually conducting transactions with other investors.

So why would the company care about the price? It would seem that the rise or fall of a company's stock price would be inconsequential. The fact is, however, that the company cares a tremendous amount! Here are the reasons why.

1The Shareholders' Value

You'll commonly hear CEOs of public companies claim that their primary responsibility is to increase shareholder value. The CEO and the board of directors don't want to make the shareholders unhappy. They can try to make changes in the current management.

Shareholders usually do this when they are losing money. They can make these changes because they do get to vote on things. In many cases, they can vote to send the executives packing.

2Prevent Hostile Takeover

While private companies can only be bought out if the owners choose to sell, public companies can be taken over if enough of the stock is owned by a single investor or group of investors. When companies are taken over, top-level people tend to lose their jobs, and no one likes to lose their job. Companies with a slumping stock price can be attractive takeover targets.

By keeping the stock price high, the assets of the company are more expensive for corporate raiders. On the other hand, if the stock price is high, it also makes it easier for companies to take over other companies. This is usually accomplished by issuing additional shares.

3Borrowing Money Is Cheaper

The stock price of a company is often used to gauge the financial health of the company. If the stock price has been dropping, analysts and creditors will tend to be wary of that company's future profitability. Over time, a company's earnings and stock price tend to be well correlated. A company with strong earnings is more likely to pay its debt obligations. As a result, with a strong stock price, the company is likely to get a better interest rate for loans.

A strong stock price also makes it more advantageous if the company wants to issue additional stock. When selling fewer shares, they can raise the same amount of money if the stock price is lower. The current shares are not diluted as much, and the damage to the current stockholders is minimized.

4The Executives Are Stockholders

Typically, the executives in a public company hold a significant amount of stock and receive stock options. The founder of the company usually owns a lot of stock. Those executives make a lot more money if the stock price is high.

5Pride Or Ego

All executives are aware of their next potential job. If they want to have the best opportunity to get ahead, they have to do a good job, and doing a good job is mainly dependent on raising the stock price. Everyone wants to be viewed in a positive light.

Companies have several reasons to be concerned about their company's stock prices. Some of the reasons are self-serving, but it is in the shareholders' best interests that the stock price does well. The management, company, and shareholders are all threatened when the stock price falls.

GET THE FREE MAGAZINE DELIVERED STRAIGHT TO YOU: