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This was somebody else's question, but since it was unanswered, I am copying it.

This is what I understood: if a company is listed on the stock exchange, it issues shares, for example 100 shares at a value of 1 euro each. If I buy a share I "own" 1% of the company and the dividends will be proportional to the number of shares I own (I assume).

Problem # 1: If the value of the stock I own increases due to demand, what benefit does the company get? After all, it made 1 euro from my initial purchase and it is not affected by the fact that I can sell my share to someone else at a higher price.

Problem n2: a possible answer to my question is that the company can place new shares on the market that will be purchased at a higher price than the initial 1 euro given the higher demand. In this case, however, I would "own" less than 1% of the company as more people have bought it. Consequently my dividends could be lower, forcing me to sell the shares to maximize the profit. And this does not really make sense to me to be honest, as it would generate negative feedback.

Would anyone be kind enough to explain to me what am I wrong with my reasoning?

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    The unasked question; why should it get anything out of it? It is simply the boards job (and from them everyone else's job) to make the share holders money. So they do it Commented May 19 at 21:13
  • Issuing new shares to the public would cause the share price to drop because you are diluting the shares. Commented May 20 at 16:50

6 Answers 6

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The company doesn't care about what happens to the stock price after the IPO. The people running the company care. The people who own the shares of the company care.

The initial owners sell part of the company via the stock exchanges to fund expansion; or to turn their paper value into real money. They usually do this while retaining most of the control of the company.

Over time that changes. The control of the company switches to the largest shareholders who may not be related to the founders. They want return on their investment. They want to be able to sell shares in the future for a profit. The average shareholder wants the price to go up.

Sometimes the focus on the price of the shares hurts the long term performance of the company. Instead of using the profits of the company to grow the company by investing in people, facilities, and research and development; the shareholders want the profits to fund dividends. That can cause the company to miss opportunities or abandon ideas that are slow to turn profitable.

The people running the company generally own shares in the company. They may have bought them, inherited them, or been awarded them. The value of those shares are used as an incentive to make decisions that will make those shares more valuable.

There are a few situations where the company cares about the value of the shares. They sometimes sell more of the company after the IPO to bring in more money to fund expansion, or when they need funds to purchase other companies. A strong share price also helps when they want to borrow money. Sometimes the company will buy some of their own shares back. It takes some of their excess cash, and then buys shares. They do this because they believe in the future they can resell those shares for a higher price.

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    The defining job of the company's management is to ensure that shareholders' value grows. Commented May 19 at 17:41
  • Okay but then, why is the company's performance whether good or bad, affecting the share price, since stocks are in the secondary market where people are just trading shares, the people are actually deciding the share price and not the company itself. Then why do we say that if the company does well, the share price will increase, because isn't the price of the share actually getting decided by us and not the people of the company. Why do people want to buy shares so much of the company that does well, because after all we decide the price, not the company's staff or anything Commented May 20 at 4:27
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    @SwaritKachroo: A company that has more money than it knows what to do with will generally provide dividends and/or buybacks, which are economically equivalent to a transfer of wealth from the company to the shareholders. Companies don't end up with excess cash by doing poorly, so the time-discounted expected value of future dividends/buybacks is an effective floor on the stock price. As for the ceiling, (some) shareholders need to cash out their investment eventually, and it makes more sense to cash out when you think the stock is overpriced.
    – Kevin
    Commented May 20 at 5:49
  • Typo: "retraining" should be "retaining"
    – Barmar
    Commented May 20 at 14:34
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    @PhilFreedenberg That's an overly simplistic view. Management's job is to manage the company on behalf of the owners. For a publicly traded company, the owners are the shareholders (what they hold is a share of the company ownership). -- If it's a conventional company and shareholders are investment firms and hedge funds, then, yeah, all the owners care about is making the share price go up. Other companies might have more complex philosophies, and management is there to execute those philosophies on behalf of the owners. Again, it's "act on the owners behalf", not just "grow share value".
    – R.M.
    Commented May 20 at 14:42
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A corporation is just a way of organizing people. It is a piece of paper in some lawyer's filing cabinet. It doesn't care about anything, any more than a rock cares if you polish it. The people who own the corporation care, and so the people they elect to run the corporation care.

Problem n2: a possible answer to my question is that the company can place new shares on the market that will be purchased at a higher price than the initial 1 euro given the higher demand. In this case, however, I would "own" less than 1% of the company as more people have bought it.

Presumably "they" didn't pile up the proceeds of the secondary offering in the parking lot and set it on fire. They would instead use them to do something which would try to increase the profits enough to make the dilution worthwhile.

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There are two ways it matters. The simple one has been covered at length in various answers: the owners (shareholders) care and they control the corporation. Often management and other employees are compensated with shares or options. It should be obvious that (all else equal) shareholders and option-holders want the share price to increase.

The second reason is less obvious. When a company needs to raise capital for e.g., expanding their operations, they have two main options. It can take on debt (issuing bonds or, increasingly, private debt) or it can raise funds by issuing new share offerings. There are tradeoffs to both options. Debt payments can be deducted from taxes but requires making payments from cashflow. Issuing new shares is 'free' but dilutes the value of existing shares (which is bad for existing shareholders)

How a company navigates that depends on a lot of factors such as interest rates and the (to your question) the current share price. A higher share price means less dilution for a given amount of capital raised. And issuing new shares will have (in a rational market) an impact on share price. If a company with a weak share price were to say, make an issuance that doubled the number of shares, it could cause a sharp decline in the price and cause a downward spiral. That can lead to a number of problems such as delisting or being removed from indexes.

I get the impression here and elsewhere that many people underestimate how much new stock is issued, and how frequently it is issued post IPO. A long period of unusually low interest rates also made issuing debt more attractive in recent decades.   If you really want to dig into it, you can research the finance concept called 'cost of capital'. Specifically, the 'cost of equity' is how the stock price fits in. If you are interested in how this plays out in practice, here's an article from a few years ago about a rise in new stock issuances. Another example is that AMC has responded to its meme stock status by issuing new shares. It's using the proceeds from that to help pay off its substantial debt.

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  • Imho, this is the correct answer. A company benefits from high stock prices because it can issue additional shares. Essentially when a company has an inflated stock price relative to its true value, the market is telling that company's board/executives to issue shares to raise capital. AMC and Gamestop both issued shares when their meme status took the stocks parabolic. Conversely, if the stock is well-below its intrinsic value it is a signal that the market wants the company to buyback shares, if it can do so, like Apple does.
    – Ryan
    Commented May 20 at 17:20
  • @Ryan A little off-topic but I was just listening to something about how the 'roaring kitty' account post of a cartoon caused the price of Gamestop and AMC to shoot up and how AMC is taking more advantage of that than Gamestop. AMC has billions is scary debt. Going to the casino seems like a more entertaining way to lose your money, IMO.
    – JimmyJames
    Commented May 20 at 17:43
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Compensation

Large companies often compensate executive officers with shares, and at a certain point, the majority of their compensation will be equity rather than cash. Highly skilled non-executive workers are also often compensated with equity, and this again becomes an important part of their compensation.

Compensating with stock has two major benefits. Firstly, it aligns the goals of the company with the goals of the internal shareholders. Sometimes executives want to drive pet projects to improve their own standing, possibly at the expense of other groups. Sometimes engineers decide that some personal project is more important than what the larger organization has decided to work on. By tying all these people to the company stock price, their compensation helps ensure that they tend to work on the "right" projects, as defined by consensus in the larger organization. This is, of course, not a perfect effect, but it is certainly stronger than using 0 equity in compensation.

The second benefit is that equity compensation can increase in value without the company itself spending its own cash. Essentially, external shareholders can increase the value of distributed equity compensation, which is much cheaper for the corporation than paying an equivalent in cash bonuses or salary. For companies in which a substantial amount of the workforce is compensated in equity, this can be a significant portion of employee costs. And, of course, equity compensation helps lure better talent (assuming the stock is doing well, of course). If the share price is not going up, potential talent will discount the value of working for that company. Conversely, insiders may use share price performance as an indicator of whether they should stick with the company or look for greener pastures. So prices going up can have a non-trivial effect on retention.

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  • "This is, of course, not a perfect effect, but it is certainly stronger than using 0 equity in compensation" - I'm curious as to whether anyone has actually measured this. Commented May 20 at 9:52
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Others have mentioned that many employees, particularly executives, receive compensation in the form of shares. So when share value increases, their personal (paper) wealth increases. So the people running the company have incentive to do things that increase share value (which should mean running the company well).

Banks and credit reporting adjencies may use the company's share price as one of its indicators of credit worthiness. So a company with an increasing share price will be viewed as a healthy company, which is worth extending credit to.

Finally, since share price is based on future expectations by the investor community, it's essentially a simple indicator of the company's reputation. If another company is looking for a company to form a partnership with, this will factor into their assessment of the company. A company with regularly falling share price is not considered to have good prospects, so it would be risky to start working with them on a long-term project. If they're a manufacturer, you wouldn't want to purchase from them if they won't be around in a few years to provide technical support or repairs (assuming there are competitors who could do better).

Finally, a company with a low share value is an attractive takeover target because the acquiring company can get it cheaply.

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You have the causation backwards. Companies do not (directly) benefit by an increase in share price -- the increase in share price is a reflection of the performance of the company (both realized and expected). So when a company does well, or is expected to do well in the future, its share price goes up as the value of the company is expected to go up.

since stocks are in the secondary market where people are just trading shares, the people are actually deciding the share price and not the company itself

Yes but this trading is not arbitrary. Owning shares in a company is owning a percentage of the assets of the company in liquidation, merger, etc. as well as any dividends that the company pays. So as the company earns more, it either invests more in itself (causing its value to go up) or returns some of it to its owners (making ownership more valuable). So shares trading on the secondary market should be tied to the current and future performance of the company, not just popularity or gambling. Certainly, many do trade purely on speculation, but there should be enough "smart money" to guide the share price beyond pure guessing.

In this case, however, I would "own" less than 1% of the company as more people have bought it. Consequently my dividends could be lower, forcing me to sell the shares to maximize the profit.

It's also possible that the company uses the proceeds from the equity offering to grow faster than it could without it, resulting in you getting more dividends despite a smaller ownership percentage. In other words, you own a smaller percentage of a larger pie.

If you own 1% of a $100 company, and it sells another $100 in equity, the company is now worth $200 and you own 0.5% of that. So your ownership percentage has gone down but your total worth has not changed. If the company then doubles its dividend payout (because its value has doubled), you get the same dividend amount that you did before.

I'm not saying that dilution is always good, or even neutral, but it's not always bad, either.

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  • That's nice in theory, but in reality companies often optimize their performance for short term stock price gain.
    – littleadv
    Commented May 20 at 20:30
  • That goes more to my point - that stock price is affected by company performance (and management decisions), not the other way around.
    – D Stanley
    Commented May 20 at 20:36
  • it's more of a circular dependency. One feeds into the other.
    – littleadv
    Commented May 20 at 21:11

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