Why do companies care about their stock prices?

June 4, 2007 8:44 AM

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. . .

1. A company might want to guard against hostile takeover, and a high stock prices makes such a takeover more difficult.

2. 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).

3. 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?

posted by sherlockt to work & money (18 answers total)

Very simply, because the company cannot be separated from its owners, the way you have done in your question.
posted by found missing at 8:48 AM on June 4, 2007

Don't forget stock options/ownership, especially of the high executives.
posted by iurodivii at 8:51 AM on June 4, 2007

The Board represents the shareholders. The Board appoints the CEO/President. The job of the CEO/President is to make the board happy as the proxy for the shareholders. He does that by making the stock price go up.How he makes the stock price go up is his business, but if it doesn't go up, he's fired and another CEO/President is appointed. ad infinitum.
posted by GuyZero at 8:51 AM on June 4, 2007

The value of a company's stock should be a good representation of the market's perceived value of the company. As the stock goes up, the company is thought to be worth more, and as the stock goes down, the company is thought to be worth less.
posted by debit at 9:04 AM on June 4, 2007

seconding iurodivii, top guys are paid via stock in a large part. If they make it go up, they are giving themselves pay raises. Screw the market and the good of the company, they want money!
posted by cschneid at 9:05 AM on June 4, 2007

you would make me very unhappy if you gave me my employee stock options and then I'd find out they tanked. me and a lot of other employees.

you would make the owners of a company very unhappy if you mismanaged the stock so much that investors lost confidence in your abilities and began selling your stock galore. (see home depot)

you would make it very convenient for a competitor or individual to gobble you up on the cheap if your stocks tank singnificantly (see icahn, carl or cerberus). making an offer for dow jones at $60/share was a lot tougher for murdoch than it would have been at $20/share. (an offer is only hostile if the company itself declares it unwelcome. there are fascinating cases - see mannesman/vodafone)
posted by krautland at 9:05 AM on June 4, 2007

The people who own the company are the people who own the stock. Their number one priority is to make money on their investment. Thus the owners of the company care about stock prices. Therefore, the company must also care, because it must do what its owners want.
posted by croutonsupafreak at 9:09 AM on June 4, 2007

GuyZero has it. Stock price actually does nothing at all for the company as an operating entity. But if the stockholders are unhappy with the stock price, they can fire the management.
posted by treepour at 9:17 AM on June 4, 2007

I can give you a practical example. I work for a company that was part of a large corporation. Company turned out a nice profit margin, say, 15-20%. But other companies in the corporation, doing the exact same thing in other cities, we're doing 20-25%. The large shareholders demanded we match that. Corporation, not wanting to be sold, started cost-cutting their way to bolster the stock price. No one cared that we were wildly profitable. They cared that we couldn't match other even more profitable places and thus were depressing the stock price. People lost their jobs. Lots of people. Friends. There was despair on a wide level. It got down to the point they were taking the plants and the water cooler out of our department to save money. In the end, it didn't work. The coporation, their hand forced by major stockholders, sold us to another corporation who cut even more people all over the country. Luckily, they didn't want our crummy 15% margin and sold us to a private local group.

But I lived through harrowing day-to-day environment directly affected by a stock price and demands of Wall Street analysts. I was surprised how real it was.
posted by lpsguy at 9:17 AM on June 4, 2007

Thanks - I was stuck in my perspective as "Mr. Littleguy investor" and wasn't thinking of those who own massive amounts of share and concentrated voting power. I also didn't consider the issues of employee stock options.
posted by sherlockt at 9:19 AM on June 4, 2007

To elaborate on what others have said, the concept is called fiduciary duty. The directors of a corporation have a fiduciary duty to increase shareholder value -- if that is not their #1 goal, they are not acting in good faith and can be held personally liable. Increased shareholder value is reflected either by payment of dividends or by equity appreciation. (Some companies do in fact pay fat dividends and don't care much about their share price, by the way -- usually these are the more mature companies that have already grown as much as they can.)
posted by kindall at 9:22 AM on June 4, 2007

So you're saying that stock prices going up or down don't effect the operation of the company, just the operation of the stockholders?

Is there a difference between the long-term stockholders (say, board members who have huge blocks of stock and a presumed interest in the company) and short-term stockholders (who maybe own the stock for an hour or two hoping to make .001% profit before buying something else)?

The fiduciary duty link just confuses me (but then, I suffer from law anxiety). It says the fiduciary must not profit from his role as fiduciary. How could that apply to board members who have stock in the company?

And one other question. Did something change in the last 30 years, like a stockholder rebellion, whereby companies used to act without seeming to care what the stockholders thought, and now they are much more sensitive to the stockholders?
posted by MtDewd at 10:34 AM on June 4, 2007

Stock price actually does nothing at all for the company as an operating entity

This is not strictly true. Consider the Mergers and Acquisitions department.

When big company G purchases smaller company YT, for $1.65 Billion, they don't (usually) cut a cashier's check and hand it to the YT investors/owners. Instead, they issue stock in the larger company to the former owners/investors in the smaller one (3,233,464 shares of it, in one recent, notable case).

When the buyout is negotiated, the players come to an agreement on a price, in dollars. That price is converted from dollars to shares in a number of different ways (which are also, subject to negotiation). One common way is to take the average closing price for the 30 days prior to the announcement of the acquisition, or the 30 days prior to the closing of the deal.

If the stock has been trading high, the acquiring company will use less of its stock when purchasing smaller companies -- which makes acquisitions somewhat cheaper.

Yahoo's stock rose significantly between 2003-2004, which allowed it to go on a buying spree in 04/05. To a certain extent, we're seeing the same thing with Google right now. Their stock is high (and desirable), and they're able to leverage that into an ability to acquire companies at astronomical dollar values.
posted by toxic at 10:47 AM on June 4, 2007

Blah... messed up the strikethrough joke. Should have been:

Their stock is high (and desirable), and they're able to leverage that into an ability to acquire companies competitors at astronomical dollar values.
posted by toxic at 10:49 AM on June 4, 2007

As people pointed out earlier, the stock price is the primary metric that the managers are judged on. Some people believe that the incentive for management to raise the stock price is so strong that managers have a perverse incentive to make decisions that boost stock price in the short term at the expense of strategically positioning the company for the long-term. Stock price also affects the ability of the company to borrow money at reasonable interest rates.

I would guess that short-term stockholders are far more skittish, and can raise the uncertainty of future estimates of the stock price. Raising risk and holding reward constant will make a given investment less attractive.

Fiduciary duty, like it was explained above, means that the managers of the company should act in the interests of the stockholders. Granting stock options makes the managers part-owners, and this is a way of bringing into alignment the interests of the management and owners (a good thing.) What the fiduciary should NOT do is, say, hire his wife at $250k per year to arrange flowers part-time, or force his underlings to buy supplies from his brother's company. It's profit at the expense of shareholders that is a big (illegal) no-no.

As far as rebellion, there is a situation sort of like the one that goes on in presidential elections in the US: not everybody's vote is equal. In the elections, because electoral votes of each state usually flip as a block, the most important states are large battleground states. Institutional investors, like mutual funds, hedge funds, and pension funds hold far more money than they have held historically, and those managers can make the time investment to closely follow the decisions of the management. They have greater power, greater expertise, and more information than your small Charles-Schwab investor, and can be far more mercenary in forcing management to hold up their end of the implicit bargain. According to neoclassical economics, this should almost always be a good thing. But, as lpsguy points out, institutional investors can be short-sighted idiots too.
posted by Maxwell_Smart at 11:28 AM on June 4, 2007

I agree with Maxwell Smart, with the caveat that fiduciary duty means more than that the managers of the company should act in the interests of the shareholders. It means that they are obligated to do so by law. Violations of the law are investigated in the US by the Securities and Exchange Commission.

Ultimately the shareholders of a company get to direct the way the company is managed, either directly (by sitting on the board) or indirectly (by electing the CEO and directors.) Even Mr Littleguy has some small voice in this - in the general case, you can vote in your company's elections - although generally even all the Littleguys' ownerships taken together don't amount to very much influence compared to that of the directors and corporate officers.
posted by ikkyu2 at 3:33 PM on June 4, 2007

The downside is that companies are much more concerned about short-term gains than long-term financial health due to this focus on the stock price. See any of the American car manufacturers for an example of an industry absolutely gutted by this short-sightedness.
posted by maxwelton at 5:35 PM on June 4, 2007

Max, I don't really see your point.

GM and Ford's focus on their stock price has not been the major factor that's leading them into default. Bizarre, byzantine, and unpredictably changing government regulations; foreign competition; and domestic unions that demand impossible benefits and pensions in order to produce work inferior to that done at a quarter of the cost overseas; have all taken their toll on that industry.
posted by ikkyu2 at 9:19 PM on June 4, 2007