Why Do Companies Care About Their Stock Prices?

Investing News

Publicly traded companies place great importance on their stock share price, which broadly reflects the corporation’s overall financial health. As a general rule, the higher a stock price is, the rosier a company’s prospects become.

Financial Health

Analysts evaluate the trajectory of a company’s stock price in order to gauge its general health. They also rely on its earning history and price-to-earnings (P/E) ratio, which signal whether a company’s share price adequately reflects its earnings.

All of this data aids analysts and investors in determining a company’s long-term viability.

Key Takeaways

  • A company’s stock price reflects investor perception of its ability to earn and grow its profits in the future.
  • If shareholders are happy and the company is doing well, as reflected by its share price, its executives are likely to keep their jobs and receive increases in compensation.
  • A high stock price also tends to discourage a potential takeover.
  • If a company’s stock price is performing well, the company is likely to receive more favorable media and analyst commentary.

Financing

Most companies receive an infusion of capital during their initial public offering (IPO) stages. But down the line, a company may rely on subsequent funding to finance expanded operations, acquire other companies, or pay off debt.

This can be achieved with equity financing, which is the process of raising capital through the sale of new shares. But for this to happen, the company must demonstrate a healthy share price.

A company must be careful not to over-issue new shares because an overabundance can diminish demand. There are simply not enough buyers to gobble up the shares, which can ultimately depress the stock price.

Furthermore, creditors favor companies with higher-priced shares, which typically correlate with a company’s earnings. Healthy companies are better able to pay off long-term debt, which means they’ll attract lower-interest-rate loans, which consequently strengthens their balance sheets.

A Performance Indicator of Executive Management 

Investment analysts ritually track a publicly-traded company’s stock price in order to gauge a company’s fiscal health, market performance, and general viability. A steadily rising share price signals that a company’s top brass is steering operations toward profitability.

If shareholders are pleased, and the company is tilting towards success, as indicated by a rising share price, C-level executives are likely to retain their positions with the company. They are also likely to enjoy salary raises and yearly bonuses.

If a company is struggling, as reflected in a dwindling share price, a company’s board may decide to fire its top operatives. Simply put, falling share prices do not bode well for a company’s higher-ups.

Compensation

Compensation is a critical motivator for a company’s decision-makers to do everything in their power to make sure a corporation’s share price thrives. Many of those occupying senior management positions derive portions of their overall earnings from stock options. These perks afford management personnel the ability to acquire shares of the corporation at a determined price, on a future set date.

But for the option to increase in worth, the underlying stock price must flourish. For this reason, the existence of stock options is vitally important to stimulating a company’s health. Executives stand to personally gain when they make strategic decisions that benefit a company’s bottom line, which ultimately helps stockholders grow the value of their portfolios.

Risk of Takeover 

The prevention of a takeover is another reason a corporation might be concerned with its stock price. When a company’s stock price falls, the likelihood of a takeover increases, simply because its market value is cheaper.

Shares in publicly traded companies are typically owned by a huge number of investors. Bidders who seek to take over a company by obtaining a majority of shares can more easily afford to do so when the stock is trading at a lower price.

Consequently, management strives to keep the share price high in order to discourage this activity. Conversely, a company whose shares trade at high prices is better positioned to take over a competitive interest. 

Positive Press

Companies with high share prices tend to attract positive attention from the media and from equity analysts. The larger a company’s market capitalization, the wider the coverage it receives.

This has a chain effect of attracting more investors to the company, which infuses it with the cash it relies on to flourish over the long haul.

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