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?**
In: 37
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.
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.
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
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 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.
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.
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