Why do companies care when their share price falls?

Written on the 26th of February 2009 by Matt Comyn, General Manager, CommSec

Why do companies care when their share price falls? How is a company affected by a falling share price?

From a transparent point of view it can be confusing to wonder why companies care when their share price falls. After all, listed companies have already received money from investors, when they first sell shares through an Initial Public Offering (IPO). What happens in the secondary market, when investors buy and sell to each other on the ASX, cannot take away from the gains the company has already made.

However, like with most things, the story is a lot more complex than that. Firstly most senior management would generally have a vested interest in the company; therefore their own personal wealth could be dramatically affected by falls in the company's share price. Secondly, many employees receive performance related bonuses in the form of shares in their company, so effectively act as stockholders of the company and therefore pay strong attention to its share price.

Another pertinent reason is that a falling share price can impact on the reputation of a company, and therefore reflect on its management. If the share price of a company continually underperforms the overall market, shareholders are going to look for someone to blame. From a career perspective and egotistical point of view, management would not want to be heading up a company which is continually receiving bad press, lest it impacts on their own professional futures. Shareholders are part owners of the company and in extreme cases can band together to try and oust management through a proxy vote.

Publicly traded companies which are underperforming also often become takeover targets. If the share price of a company falls substantially, it makes it much easier and much more affordable for a wealthy shareholder or a rival company to move in and buy up a significant amount of stock or launch a takeover offer that shareholders cannot afford to refuse. This is a very big incentive for companies to ensure their stock price remains relatively stable, so that they remain strong and deter interested parties from forcing them into a takeover deal.

The rate and ease at which companies borrow money can also be affected by a falling share price. Creditors tend to look favourably upon companies which are performing well, and may offer them cheaper financing through a lower interest rate.

For all of these reasons, a company's share price is a serious matter of concern. If performance of a company's stock is ignored, it can have serious repercussions on the fate of the company and its management.

Disclaimers: The views expressed in this article are those of Matt Comyn, a representative of Commonwealth Securities Limited (CommSec) ABN 60 067 254 399 AFSL 238814. Commonwealth Securities Limited (CommSec) ABN 60 067 254 399 AFSL 238814 is a wholly owned but non-guaranteed subsidiary of the Commonwealth Bank of Australia ABN 48 123 123 124 and a Participant of the ASX Group and the Sydney Futures Exchange. As this information has been prepared without considering your objectives, financial situation or needs, you should, before acting on this information, consider its appropriateness to your circumstances and if necessary, seek appropriate professional advice.