Companies make money by selling products and services. If they sell well, they get profit. Bang, end of story, right? Where does stock price come in and why does it matter?
I do understand that during IPO the company basically sells stock, instead of product and services, and gets profit from that. But later on, when stock is just traded between people outside of company, why does its price matter **to the company?**
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Three main reasons:
1. **Aligning Incentives:** A large portion of executives’ pay is in stock. The reason for this is that you want to incentivize the executives to increase the value of the company for shareholders. If the stock price increases, the executive makes more money (as do the rest of the stockholders), so the executives obviously want the stock to go up. It is simply about aligning the incentives of the executives with that of stockholders.
2. **Raising Capital**: If a company needs money (for example, to build a new factory) there are various ways they can do that. They could go into debt (either get a loan from a bank or issue bonds/notes/debentures) or they could sell shares (equity). The best option will depend on a variety of factors, but the main benefit of raising money by issuing equity (i.e., selling more shares) is that you don’t have to pay it back! Because it’s not debt! The main drawback is that your existing shareholders will be “diluted,” meaning that whatever % of the company they owned before you sold new shares will be reduced. If a company wants to raise $100 million dollars by selling shares, it’s much better to have a high stock price because then you need to sell fewer shares in order to raise that $100 million (and therefore your shareholders will be less diluted).
3. **Debt Covenants**: Many loan agreements will have what are called “covenants” that the debtor (the company) has to abide by. A covenant basically says “you have to do this” or “you cannot do this” or else you are in default and the bank can demand that you pay back the ENTIRE loan RIGHT NOW. For a publicly traded company, a covenant might say “you can’t pay any dividends if your stock price is below $x” or “if your stock price falls below $x, you have to pay back 15% of your loan immediately.” In this case, the executives want the stock price to go up, but more importantly they DEFINITELY don’t want it to go down too much.
A more extreme example has to do with stock exchange rules. The New York Stock Exchange and Nasdaq (and probably every other major stock exchange in the world) have rules that say if your share price is too low for an extended period of time, you will be delisted. Delisting is a very, very bad outcome.
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