How do companies benefit from an increase in the share price of the company

Question

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?

Answer 1

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.

Answer 2

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.

Answer 3

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.

Answer 4

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.

Answer 5

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.

Answer 6

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.