This may sound naive…but why do most companies put so much value and such a strong focus on stock price and shareholder value, rather than societal value, sustainability, human capital, etc?
To me its irrational. I understand in situations where companies want to raise capital via stock issuance that they would want highest price per share, but how many established, already public, companies issue new stock? (it seems not many, because doing so would have a deflationary value on existing stock, and in theory the overall market capitalization of a company would remain).
Why would the board of directors of a company or the C-Suite executives even care (other than they may be invested heavily in their own stocks and stock options). Is it really for personal reasons rather than some broader economic reason that might actually impact the health or inherent value of an enterprise?
It seems so many companies are in a race to the bottom - every expense gets squeezed, often resulting in poor labor conditions, environmental impacts, quality and customer experience issues…the things most people care about and “value” real tangible ways. Some organizations have bucked this trend (think CostCo vs Wal Mart), but what is stopping most organizations from really practicing business in a more sustainable way?
A rationale argument would be to keep costs low for competitive purposes, or a need to invest in differentiating factors (R&D)… I get that. Does that make “shareholder value” an irrelevant concept?
Plenty of companies engage in subsequent public offerings, and these do not have a deflationary effect on stock price. If FriedoCorp has 100 shares outstanding at a price of $10 each, then it has a market capitalization of $1000. If it sells 100 more shares for $10 each, then it has a market capitalization of $2000, and now has increased the assets on its books, because it got $1000 in new capital. A higher price is obviously beneficial in a secondary offering because it indicates high demand for the shares, and allows the company to raise more capital.
Stock price is also important because many of the directors, senior executives, and in many cases mid-level employees may be invested heavily in the company stock, as you pointed out. Lower level employees may have stock options or retirement plans that are invested, at least in part, in the company.
Many companies have lines of credit which are secured by shares of stock. If the stock price drops, the banks will demand more shares as collateral. If the stock price increases, the company can borrow more.
As for humanitarian causes and societal value, as a company does better, it will hire more people, invent more stuff, and provide more services. Whether that’s valuable to society is certainly open for debate. But companies aren’t set up to be social benefactors; they’re there to make a profit for their investors.
In addition, if the stock price is very cheap, they are open to the threat of a hostile takeover, unless they have some kind of a workable “poison pill” in place. It becomes attractive for somebody to take over the company by buying up a controlling interest in it. Look up what Carl Icahn and other “corporate raider” / “activist shareholder” types do.
Stockholders elect the board. The board chooses the employees (including the executives). Stockholders typically want the value of their shares to go up.
Also, makes it easier to get investment money without having to borrow it and pay interest.
Besides the takeover threat already mentioned, many CEOs have their compensation based on changes in stock price. Further, the shareholders and business press care, so a company underperforming the market will attract lot of bad press and angry shareholders.
The stock prices is to some extent a report card on how a company has done and is expected to do, and most CEOs don’t want to get a “D”.
The BoD and C-level execs have a fiduciary duty to the shareholders.
On a smaller scale, let’s say someone owns a local shop, but is an absentee owner who cannot (for entirely legitimate reasons) manage the store directly. This owner hires a management team to handle the day to day business and strategic planning. The owner expects that team to safeguard the value he has stored in the company, and expand the value of the company, or provide him with the profits of doing business. If that team is more interested in societal ills than the value of the company, they are not doing their jobs.
Someone buys some company’s shares in what he thinks to be a cheap price,
and then sells them to the next guy, at a higher price.
The next guy thinks that he bought them at a cheap price,
and sells them at an even higher price to the next to the next guy.
The next to the next guy…
And so on it goes…
All’s fine, as long as you are not the last in the line.:smack:
Because all shareholders know that the stocks are overprised,
and that they are not going to make up for the money
each one of them payed for these damn stocks,
not even in 300 years,
by the pennies that the company pays them back each year,
as their fair share in the companies profits.
Bottom line… The only way shareholders can make a profit,
is by selling these shares at a higher price, than one they paid for.
And the only way that they can talk some s…r in buying them,
is by convincing him that these shares are gonna go much higher, soon,
and, so, he will have no problem finding a s…r to sell them to, in an even higher price.
“but why do most companies put so much value and such a strong focus on stock price and shareholder value, rather than societal value, sustainability, human capital, etc?”
As others have noted, shareholder value is the reason a public stock corporation exists. It’s interesting that constant repetition of the latter goals, including by corporations in their own PR, has led to the belief that those things have any intrinsic importance to a corporation or are its appropriate goals (as opposed to the people collectively, ie the govt, simply pursuing those goals).
But in fact if it weren’t for common incentives like stock options or restricted stock, managements of corporations might, and in some cases do, shift their goals to some of the others mentioned in the question or indeed, and more likely, to just advancing their own personal interests which do not coincide with a higher stock price. A common example of this is corporate charitable giving. Who gets the ‘reputational’ credit for this? ‘The corporation’ which tends to mean the corporation’s managers. But who’s money are the managers giving away? Not theirs, it’s the shareholders’ money. Why don’t they just give that money to the shareholders, and that which isn’t taxed (and taxes also go, at least theoretically, to advance the public good) could be donated by the shareholders, if they choose, and the shareholders take credit for it.
So I think the short practical answer to the question is actually: senior management compensation schemes keyed off the stock price keep management’s focus at least mainly on the stock price and therefore (approximately at least) on shareholder value. And the other goals become means toward the end of shareholder value (though their positive effect on the reputation of the company).
In a nutshell: Enron used their own stock as collateral for loans. When the stock value went down, the banks called in the loans. When the company couldn’t pay the loans, it died.
Other people have listed many other good reasons, but the Enron story is a particular interesting example of the importance of stock value.
Here and there, you have a fine understanding of how a stock market bubble works. Stocks may or may not have bubbles. It’s hard to prove even after the fact. But that’s not how the stock market works when its acting normally.
The whole point of a company is to make money. There are two basic ways that this money makes it to the ownership of the company:
Some companies take their profits and pay dividends- they’re divided up by the number of shares, and each shareholder gets a dividend check proportional to the number of shares they hold.
Other companies make money by reinvesting profits and hoping to raise the actual value of the shares of the company. This money is only realized when those shares are sold, so people with large ownership stocks have incentive to press the company to raise and keep that value high. They’ll shitcan the management and/or board if they don’t live up to expectations… which explains a lot of their paranoia about stock price.
It’s as easy as that. The problem comes in is when shareholders want short-term results- like quarterly. This often makes companies do stupid or short-sighted things to make short-term forecasts at the expense of long term profitability. I’d wager that’s what you see and hear that baffles the crap out of you.
Stock price usually doesn’t have a lot of bearing on day-to-day operations, except in situations where it’s used as part of getting lines of credit.
Generally speaking the combination of fiduciary duty and execs being personally invested is the reason you see them devolve into salt-mine like conditions. The perception is that every dollar they spend on say… cushier chairs or urinal cakes to de-stink the bathrooms is one less dollar that they make in profit, and since the workers don’t count, and the customers only count when they’re pushed to the point that they go to the competition, you see a lot of annoying as hell behaviors.
You also see a lot of behaviors in companies like phone and cable companies meant to deliberately obfuscate and make it difficult to switch providers without jumping through a lot of hoops. The idea is that if it’s hard to change, most people will put up with their bullshit rather than go through more bullshit to change.
It is interesting, but also pretty rare and an example of the most manipulative or foolish kinds of corporate transactions, depending which side somebody was one.
As a general rule to which Enron is a strange exception, no well run financial institution or investor will accept a company’s stock as collateral for a debt incurred by the company. The unfavorable correlation is too obvious: in almost any case where the company can’t pay the debt, its stock price will have already collapsed, and the collateral will no longer cover the debt either. Posting collateral is an everyday part of innumerable credit transactions but in 99.9% of cases the stock of the indebted entity is not allowed as collateral. The collateral has to be something whose value is at least somewhat independent of the ability of the borrower to pay (the borrower’s fixed assets like real estate, airplanes, etc, or better yet liquid collateral like high quality securities issued by somebody other than the borrower, or cash, the latter two being standard in collateralizing obligations with financial institutions on both sides).
However one other important advantage of a high stock price has only been indirectly mentioned: corporate takeovers. If the management of Company A can get their stock price from $50>$100 and the shareholders of Company B will accept a $50 takeover offer for their shares in either case (and assume for simplicity the number of shares is the same), they can do the deal at 1 share of A for 2 of B, rather than 1:1. That makes it much easier for managers of A to get their board’s approval of the deal under the board’s fiduciary duty to maximize value for shareholders (of Company A). And thus the managers of A can build a larger empire, and larger corporate empires pay their top managers more than smaller ones do, as a rule. Personal ambition of senior managers definitely plays a role in Mergers and Acquisitions. And the stock of the managers’ company is often the ‘currency’ they use to buy other companies. This is a reason, separate from compensation packages directly tied to stock price which is the main reason, why top managers want a higher share price.
I like this approach. I think scaling down large corporations is one of the best ways to understand for people who find it unnatural. Sure we tie executive compensation to stock performance and blah blah blah.
The fundamentals of it though are that the people who manage the company get paid to make money for the people who own the company. I think pretty much anyone can imagine being hired by the owner of a small store and paid a good salary to run his company for him.
Say he meets with you annually each January to discuss your performance running his store. How do you think he’ll react if you tell him net profit is way down because instead of pursuing aggressive cost reduction, you gave all the employees raises and let poor people have free stuff?
He’d fire you and hire someone else to manage his store. So why would tens of thousands of owners be any different?
While it’s not really a planned thing, corporations end up serving the role that people generally think of Social Security as fulfilling. They provide the people of the nation with food and shelter, through the majority of their life. Beside that, they also provide services and products to the masses. But the difference between a business and Social Security is that businesses are self-sustaining and require the people they are helping to give something in return (labor).
Since a company is self-sustaining, it has to be able to survive from year to year. Laborers will come and go, products will come and go, but if the institution fails, whoever is currently employed and whatever is currently being provided goes out the window.
The stock market is a financial metric of the total value of the company to society as a whole and as compared to its competitors. A company which can’t keep pace with the growth of the economy is going to collapse, so keeping their stock growing is a fairly important thing.
There is some argument to be made that the stock market doesn’t accurately reflect the value of a business to the people of the world, since if you asked people whether they would rather have 1000 iPods or to be able to afford the medical treatment to allow their grandma to live another 2 years, they would always say that they’d rather have grandma. Yet, the total dollar value of those two things might be exactly the same – and that’s decided by how people decide to allocate their money through their lives. Humanity is fairly shortsided in its wants and needs, which distorts the value of all the services and products it asks for, thus distorting the stock market. But I don’t know that there’s any good way to correct for that, which wouldn’t be horribly up to the politics of the person making the test.
I’d say the converse, that that’s a good argument why asking people stuff in polls is often a bunch of nonsense. They say in the poll they’d rather help grandma (or say whatever other thing they think makes them look virtuous), which is often BS, but where people really put their money in the market (for goods and investments) is reality.
It might seem crazy but the original purpose of a PUBLIC company was to further the PUBLIC good. It was recognized that common needs such as road, infrastructure, etc. could not be individually financed, hence an entity was created that permitted these things to be funded via a corporation. There was an expectation of course that capital would be preserved and not lost… perhaps even increased. But the main purpose of incorporation was to create an organ to allocate capital for the common good in ways that individuals had insufficient incentive to do so.
What ??? Well you are stretching it to refer to public infrastructure such as roads and other civil engineering.
Early examples of the distinct companies are the Dutch East India Company and the Hudson Company.
See Corporation - Wikipedia
They exist to prevent their operation being seen as GOVERNMENT FROM AFAR, and to avoid them being seen as the authority challenging the actual Governor of the place. So they serve the public good (if installing a western materialist society into the area at any cost is “good” … ) but yet work as if private…
Of course they are meant to be a work like a real business, produce goods (grain, beef, milk, gold,whatever), develop and sell land, etc, and are meant to pay dividends back to their share holders owners… but of course the law would have to protect the investor from liability…
The government may have created these entitities with some other formula for liability, but I think the issue of liability is very important here… the investor was well aware of the potential for death, rape, torture and theft, etc, that their company would be sued for… and needed complete protection before they could invest.
So it seems no coincidence that these invade and settle companies were the first to provide absolute protection to investors.