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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> Bang, end of story, right?
No, not end of story. The profits go to the stockholders via dividends or buybacks (for “mature” companies, things work a little differently for “immature” companies). E.g. if a company makes $100 million a year, and you own a few shares, you might have 1/1000000 (one millionth) of the company. Meaning you get $100 per year. In other words, the stock is like a financial instrument that pays you “$100 per year, forever (Asterisk)”.
Where the Asterisk says that the “Forever” part is in no way guaranteed. If the company does poorly, you might be paid less than $100 a year, or nothing at all. If the company does well, you might be paid more than $100 a year.
> Where does stock price come in and why does it matter?
Ask yourself a couple basic questions:
– How much are you willing to pay right now to get $100 a year, forever? $500? $1000? $3000?
– Alternate form of the same question: Suppose you’re getting $100 a year, forever. But someone offers you money right now instead, how much would they have to offer for you to sell your $100 a year, forever income stream? $500? $1000? $3000?
If you hear the company’s doing poorly, and that $100 a year might turn into $70 a year, how would that change your answers to these questions? What if you hear the company’s doing well, and that $100 a year might turn into $150 a year?
The moral of the story is that stock price, dividends and company performance are all related (at least in theory).
> for company executives
CEO’s and other company executives are professional managers hired to *run* the company. They don’t *own* the company. The CEO’s boss is the shareholders. The shareholders can hire or fire the CEO and other top-level executives and raise / cut their pay. (For a big company, say Microsoft, it might have like 100,000 shareholders so it’s hard to get them all to do *anything*, and if you own stocks in like 30 different companies it’s hard for you to keep in the loop for the decision making of all of them, so usually the shareholders elect a small committee of representatives called the “Board of Directors” to act for them. BoD can vote to hire / fire the CEO, and shareholders can vote for the BoD members with a simple majority, or even vote to change the “constitution” of whether / how many / how they .)
What this means is that the shareholders directly benefit from the stock price, so they will generally be happy with the company and want to keep the same CEO in place when the stock price is going up. But they will be unhappy and possibly want to replace the CEO and other top executives when the stock price is going down, especially if the reason for the decline seems to be that the company is poorly managed.
Also as many other posters have noted, it’s common practice for CEO’s and other high level executives to have a significant number of shares. (Commonly referred to as “Aligning incentives” or “Skin in the game.”) If the CEO owns a lot of shares then they will make a lot of money if the company does well, and will lose a lot of money if the company does poorly. So the CEO has reasons to run the company well.
(In theory. In practice, CEO’s too often try to create short-term boosts of share price for long-term viability. BoD / shareholders can try to prevent this by “locking up” the CEO’s shares so they can’t sell for a period of time, but it’s considered unreasonable to have a lockup period of more than a few years.)
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