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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A big portion of most C-level employees’ salary is actually held in stocks and stock options. If they have low stock value, they’ve lost their own money.
The stock price can make it more expensive for the company to borrow money if it is too low, it also matters for executives since part of their bonus may be in discounted company shares.
At many companies, a significant portion of the executive’s pay comes in the form of options that increase in value as the stock price rises. The company might give the CEO the right to buy 100,000 shares at the current price at any point in time in the next 3 years. So, each dollar the price rises, means the CEO can exercise to gain another $100,000.
Some companies make option grants a form of pay for all employees, but it’s getting rare to see a company that doesn’t pay executives in this way. Because paying with options aligns executive interests with shareholder interests.
The owners are entitled to the earnings of the company. Everything the executives do is supposed to increase the value of the company
The company is owned by the shareholders, and the shareholders want to see their earnings per share go up every period. That is why they decided to buy shares, after all – to make money.
“Stock price” is just what the investment community feels the company is worth, and what a company is “worth” is really just the present value of all future earnings. So, if EPS goes up, dividends and/or share price goes up too.
The CEO is selected by the Board of Directors, who is in turn selected by the shareholders. So if the shareholders want earnings to go up, the CEO is going to make earnings go up else they be replaced by another CEO.
The executives work for the owners of the stock, often are compensated with stock, and get bonuses based on the price of the stock. It’s a crap system for both employees and consumers, but it has made a few well connected people many billions of dollars
For one, the stock price is like a report card on the executives’ job managing the company, it’s past performance and roadmap for future. Secondly, many executives have shares granted to them, stock option grants, etc. that mean a higher share price increases their personal wealth. And often those equity based compensation components are tied to the stock price/performance. Such plans are put into place by boards to align the goals of the executives with the shareholders.
If you are a publicly traded company, than if you turn a large profit every shareholder gets a cut of that profit (in theory). Now rather than pay out all that profit, usually a company will keep the money and reinvest it. But now the company is worth more money (because they made more profit and have more money than the market expected), and therefore owning a share of that company is more valuable, so the stock price goes up.
Investors want to keep the executives’ goals aligned with their own, so a large part of executives’ compensation is in company stock.
Put more simply – The market isn’t stupid. Your business’ performance and the stock price will be very highly correlated.
> 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.)
Imagine you and your friends were given 1 round metal disc today – if you go to the candy shop, you can buy 50 today but you’re also told, that it may also get you 100 on certain days and just 10 on other.
You’d naturally expect that the disc should get you more than 50 candies at any day in future. So is the case with Company Execs.
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