It sounds like a obvious question but hear me out. Yes, I understand why stock price and how a company performs have a direct correlation. I do also understand that a company’s performance affects its stock price. However, I do not understand the other way around, especially when the shares crashes.
This is my understanding how stock works: when a company goes public, the company raises money from the public in exchange to the ownership of the company. Stock price going up doesn’t mean the company gains more money as the investment is already made. Stock price going down doesn’t mean it looses money as they do not have to pay back for the investment. So why do companies go bankrupt due to its stock price crashing (and possibly get delisted)?
In: Economics
The company itself is a major shareholder of its own stock.
The company can its ownership stake as an asset; that asset is now worth less causing loss on balance sheet
Stock price crash is a symptom, not a cause. That being said, if majority of employees have stock options, it can cause a lot of discontent which can affect company health.
Also the opposite is true as well , stock price can go up but company’s performance hasn’t changed. The whole GameStop stock saga during the pandemic is a perfect example of that
The current stock price represents what investors think the future profits of the company will be.
If the stock price is crashing, that means investors think the company isn’t going to be profitable in the future.
This can start a vicious spiral. If the stock is crashing, potential employees are less likely to join. Why join a company that may go bankrupt? What’s the point of getting stock options if they will be worthless one day? Without good employees, the company will suffer.
It also makes it harder for a company to raise more money by selling more shares. Who wants to buy more stock of a company that may not exist? Without the ability to sell shares, how do you shore up your balance sheet? You could borrow money, but who wants to lend money to a company in a downward spiral?
In some ways, the stock price is like a measure of the markets view of a company. When the view is positive, meaning the market expects the company to make more money in the future, the stock usually goes up. When the view is negative, meaning the market expects the company to make less money in the future, the stock goes down. This is because the money the company earns (or loses) is passed on to shareholders through dividends, stock, buybacks, or reinvestment into the company. The stock movement in price reflects the view on the company”s future earnings and future value to the shareholder. Now…. the stock may go down, meaning the market believes the company will make less money in the future, for reasons that have nothing to do with the company itself. Look at any one of a number of companies, say Apple, that have been through several drawdowns in the market (the housing crisis, the Covid crisis, the recent interest rate, hikes), and you can see the stock decline significantly. This reflected the markets view that people would buy less Apple products, not that the company was in financial trouble. The stock went down, however Apple did not go bankrupt. When the stock price goes down to the point it is below what many people think is a fair value for its future earnings potential, you will hear people say it is a “value” or “on sale” and buy more, reflecting their confidence in the company.
In your example of Fisker, the stock declined because the market perceived the company would make less money in the future because the company itself was struggling. But the stock decline did not cause the bankruptcy, it was the other way around.
For those not EL5, this is a very simplified explanation, and I’m aware I have not considered other issues, like macro themes, crowding, sentiment, catalysts, etc.
Mostly it is correlation vs causation. Generally speaking stock price crashing will not directly result in bankruptcy.
But companies don’t live in isolation. Stock market falling rapidly is usually an indication that the company is either already or soon to be in some financial difficulty. Lots of smart, competitive people analyze companies for investment opportunities or to give advice to clients – they figure things out and sell if they think the situation is bad. Companies also have suppliers, bankers and customers. Once they see a company share price fall, they might rethink doing business, offering credit/loans or making long term purchase contracts because they see this as a sign of possible future issues. So these things interact with each other – falling share prices make it more difficult for a company to operate as others may do less business with them and this leads to poorer results which results in falling share prices – a kind of death spiral.
Delisting is another matter. A company is listed on an exchange if it follows the regulations of the exchange. This privilege can be rescinded for a variety of reasons. If there is insufficient shares to trade, market capitalization goes too low, the company fails to provide audited statements and all sorts of other infractions may result in the exchange no longer allowing the company shares to be traded ie it is delisted. Delisting is a pretty serious and final outcome but exchanges can suspend trading in company shares for a period if it believes that something has gone wrong. (insider trading, market manipulation, lack of disclosure etc) Suffice to say that companies in financial trouble can also find it difficult to follow exchange regulations because most exchanges REQUIRE companies to disclose material events to the public promptly.
Stock price crashing reflects a poor outlook for the company.
Imagine you’re a pharmaceutical company and you’ve invested billions into a new miracle weight loss drug.
Investors are excited and buy up your stock, raising your stock price
A drug trial discovers the drug doesn’t work, and worse causes patients to smell terrible and turn their skin green.
As a company you’re now out of all the money you’ve spent. Maybe you’re even low on cash. You have nothing to show for it. The company is in a possible death spiral.
In this case the stock price is likely to decline sharply since the future for the company is poor.
Often companies keep their stock as collateral with banks. When the price crashes, the banks may ask for more collateral or ask for early repayment.
Adds to the woes.
Oh boy lots of stuff happens depending on size of a crash. A lot of companies have borrowed money against value in the company, when that value drops debts can become due. Institutional holders of the stock apply rules for fund like company must be worth more than x or have revenue more than y or stock price itself above x dollars. A big enough crash could trigger an automatic sell for these holders which happens in huge crashes, the company can end up being delisted from the exchange and bankrupt. Then this could impact the revenue streams so it’s complete whammy losing customers, debts being due, and the company stock selling at discounted prices is too much for companies to recover from.
Let’s say you set up a lemonade stand and tell me that if I give you $10 for supplies you’ll give me part of your lemonade stand and even 2 cents of every cup you sell. Sadly, it winds up few people want to buy your lemonade and you sold only a couple of cups.,
But you need more lemons, sugar etc. to make a new batch, and want to spend money on paper glue and sparkles to make a couple of posters to get people to buy your lemonade.
You ask me for another $10 to do so.
But at that point I no longer think you’re really going to sell much lemonade and decide I don’t want to give you another $10 to carry on your lemonade stand. Nor will anyone else.
Now you’re stuck what do you do?
You can try to switch it up and instead of telling me you’ll give my part of your stand and profit, you’ll pay me back the $11 if I give you $10, but we’ll cover bonds another time.
No-no, it works the other way around. Stock price crashes because the investors find out the company is screwed and not worth much anymore. Stock price doesn’t crash if there is nothing wrong with the company, and if it did, it would be very temporary with other investors simply buy up the cheap stock and become new owners, the price would recover quickly.
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