The Insanity of Caring About Stock Prices

“Oh my God Johnson, our stock has dropped to nothing. We’re ruined!.” Not the greatest quote from TV, I grant you, but when I watched Robocop 3 a decade ago, it struck my little mind that the share price of a company can make it or break it. And not just the firm, but the employees as well. In “Fun with Dick and Jane,” Jim Carrey convincingly pulls off the image that if your share price falls, it spells doom for the employees too.

Image Credit: artemuestra

Share Prices

But when I studied Finance in my MBA, I never quite understood why companies cared so much about their stock price. After all, haven’t they already sold the shares in the IPO? And how can they control what the public thinks about their company anyway? It always seemed to me that people bought and sold stock based on their reputation, not on detailed analysis of their books. How can companies care so damn much about what people think about them?

Recently when there was a rumor that Steve Jobs had a heart attack, Apple’s share price dropped. There are two issues here. First of all, I’m not sure that the loss of Steve Jobs would have that great an impact on the performance of Apple. One doesn’t consistently produce great products for decades due to the genius of one man no matter how great. So there’s no reason to believe that the performance of Apple is going down if Jobs goes.

Second, I’m sure that everyone believed that it was just a rumor. But the funny thing about the stock market is that it doesn’t matter what you believe or don’t. And it doesn’t matter what everyone else believes or doesn’t either – what matters, is whether or not you believe whether or not others believe! If you believe that others believe that Steve Jobs had a heart attack, you must sell. If you thought that others were smart not to run at the sound of rumors, you would not sell either.

How in heaven’s name can companies seriously believe for one single moment that such whimsical things as the highly unstable temperaments of day traders mean anything at all?

I have read several reasons why companies have good reason to care about their stock price. Some reasons that I’ve heard are:

  1. The management owns a huge percentage of shares. Their personal wealth depends on the share price.
  2. The employees receive bonuses based on the share price
  3. Financing companies look favorably on companies with a good share price. Lower debt deals
  4. Hostile takeovers
  5. Prestige

Out of these, only the first and fourth reasons seem good ones. I can sympathise with the management if their personal wealth is inextricably linked to the company. Though if I were in their place, I wouldn’t place all my eggs in one basket. Who the hell would do something like that?

And of course, the threat of having your company taken over is a very real danger. A good reason to keep your price high.

However, I don’t understand why number 3 should exist. Don’t financiers look at the real performance of the company based on the accounts and other concrete information? How can they get any idea of the performance of a company solely based on the share price? Or is this one of those “Collective wisdom of the crowd” mantras?

Lots of questions.

I’m not a stud corporate worker and I probably don’t understand harsh realities of the corporate world. Maybe these guys have many more reasons to keep their share prices in the public market high. But I can’t see them.

5 comments to The Insanity of Caring About Stock Prices

  • Unless your blog is a poor attempt at satire, it is evident that you’re neither an economist nor a savvy Wall Street investor.

    You are, however, getting close to the heart of the matter, namely that established financial facts as well as personal opinion and convictions make the wheels go ’round.

    That, coupled with innate investor greed and the willingness to gamble, makes the stock market one of the most perfect examples of supply and demand.

    What makes the market go up, whether in New York or London, Hong Kong or Mumbai ? More buyers than sellers, as well as the reverse.

    It is the reluctance to factually assess risk that is more responsible than actualy illiquidity that is at the heart of the current financial crisis.

  • Raymond

    BJ Park,

    It’s true stock prices of publicly traded firms are more subject to traders daily actions and news, and that is what you see.

    To help you put stock prices in perspective, look at privately held companies such as Mars,Inc. Their stock do not trade in the stock exchanges so there is no daily quotation for the company’s market value.

    Absent the stock market and despite current volatility—

    If you were interested in making an offer to buy the company whole or in part to it’s current owners, you would go trough what M & A teams do to value the company before making a bid:

    Determine its net worth, assess its management, market position and future prospects, etc. This is where your MBA in finance will help you.

  • Dirk

    If only we were all multibillionaires. Or, that the multibillionaires had all the good ideas, and used them to the betterment of everyone in society. Then, the investment required to create production assets- factories, software, sales staff, or solar power farms- could come from an individual, and corporate ownership wouldn’t be necessary.

    However, in the real world, good ideas come to people of modest means, and groups of people of modest means can be interested in creating capacity in an industry. Corporations were created for this reason- to allow people to pool interests. Once pooled, as people die, etc., there needs to be a method to unpool- to pull out one’s investment. This is where the stock market came in.

    Think of this as an investor- you want liquidity for your investment, right? So, a good market is required. Like a good food market, you want your stock market to be clean, easy to get to, honest- the cleaner, the higher the price.

    You then want people to manage the company so it makes money, and the value increases. The better managed, the more the value. And you want economic conditions such that the value increases. If you sell potatoes or soup, perhaps a bad economy would be best for you, but for most companies this means a vibrant and growing economy. And as their stock wealth increases, their borrowing capacity increases, their family’s livng standard can increase, and they can have more to give away. It should be obvious why shareholders want a higher stock market.

    So, why do non-shareholders care about a stock price? Because, they may have a good idea sometime, and want it financed. And the better the market (cleaner, accessible, honest), the better their odds of higher prices, which translates to higher prices today. So they should want a good market, too.

    Who wants lower markets? People without good ideas they need to finance, but with money who want to get ownership cheaper. Or short sellers, who buy high and hope to sell low. Or the few who want to constrain/fix the money supply and see lower prices as more affordable. The problem is that human psychology and culture doesn’t reward those whose claim to fame is “I’ll do the least worst”- we equate growth and progress with larger numbers, not smaller.

  • Raymond

    That is interesting. And I thought the Limited Liability law
    of the state of New York in the 1800s opened the way for large corporations to be created. But large as they are, they are collectively owned by individual investors large and small.

    And as a shareholder you want more cheese per slice, or more earnings per share instead of just sales growth funded by debt. Like the economy, you do not want some harebrained
    CEO telling its owners to focus on sales growth and never mind the companys liabilities.

  • Edward Powe

    This is fantastic! How did you learn about this when you were getting started?

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