I was reading an article at Bloomberg.com yesterday, If Only Everybody Was Paid More. Okay article, mostly even-handed, then I looked at the comments section, and a writer was kvetching about companies didn’t care about their stock price because management had more than enough money to do what they wanted. The stock price did not matter, because secondary trading puts no money into the hands of the company.
I started to write a comment, “You don’t understand the stock market…” but after ten minutes, I realized that I had a blog post, and so I copied it to a file, and am completing it now for my readers, who are far larger, and more intelligent than the comment stream at Bloomberg.com.
The price generated by secondary trading does the following to help a company:
If the price is low relative to net assets or potential earnings, it will attract new shareholders that will angle for change. Those investors will aim for control, or for certain value-enhancing actions like a special dividend, a spin-off, etc.
If management/board thinks the price of the stock is undervalued, they will be among those buying shares in the secondary market, improving the value of the shares for the remaining shareholders.
If management/board thinks the price of the stock is overvalued, they may look at other companies to buy that are reasonably priced or cheap that will make their firm more useful. At that point, their stock is a useful currency for acquisitions.
The stock price also serves as a guide to dividends, as it goes higher, often the dividend will go higher. As the stock price goes lower, the dividend will stay the same, until it is unsustainable. When it is unsustainable, the dividend will drop precipitously or be eliminated. When that happens, the stock price will drop more, but the company’s bonds will rally.
A company with a high valuation and excess cash may pay a special dividend to enhance the value, as Microsoft did in the last decade.
Companies with a high valuation may decide to do a secondary offering if they run across an idea that they want to try internally that will require a great degree of investment.
Corporate bond and loan pricing is affected by the stock price. Typically companies with high valuations get lower rates than those with low valuations.
Note that if stock valuations get too low, investors start to distrust the preferred stock, corporate bonds, and bank debt, in that order.
Also consider the stock options, profit-sharing plans, and any 401(k) match that happens in the corporation. They have a significant effect in motivating employees to do better. As the price rises, so does morale. Vice-versa when the price falls.
To summarize: the price that a stock trades at is very important to a corporation, even if it is not receiving any money directly as a result. In general, the higher the stock price in the secondary markets, the greater the number of financial options that management has, and vice-versa.
The stock price matters to defined benefit pension plans, endowments, etc., because it affects solvency and ability to spend. It affects fund managers, because a high market capitalization makes it more painful for them not to own your stock, if they benchmark against an index that the company in question in it.
And, if you get big enough, index inclusion means you get a dedicated bunch of shareholders that aren’t leaving anytime soon. The rewards get bigger until you get into the Holy Grail, the S&P 500.
So, yes, it does matter what the stock price is to a corporation, even if the company does not receive any money as a result of the trading.
By David Merkel, CFA of alephblog