Why companies care about share price at bourse

By Odhiambo Ocholla

It is often hard wondering 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.

What happens in the secondary market, when investors buy and sell to each other on the Nairobi Stock Exchange (NSE), cannot take away the gains the company has already made. There has been some perception in market that some listed companies support their share prices.

However, like with most things, the story is a lot more complex than that. First, most senior management would generally have a vested interest in the company; therefore their own personal wealth could be dramatically affected by a fall in the company’s share price.

Secondly, many employees receive performance related bonuses in the form of shares in their company. This effectively serves 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.

It’s not unusual for the founder of a public company to own a significant number of shares. It is also not unusual for the management of a company to have salary incentives or employees stock options tied to the company’s share prices. 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.

Cheaper credit

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 share is ignored, it can have serious repercussions on the fate of the company and its management. Share price is often an indicator of a company’s financial health and can influence analysts’ and lenders’ evaluations.

Stock performance directly affects a company’s borrowing power, which has a significant and direct effect on financial health. However, share price is a poor metric because it has more to do with emotion and perception than whether a company is taking care of the business.

It’s understandable how our system encourages the range of behaviours we are seeing. Here’s the irony of the situation: companies live and die by their share price, yet for the most part they don’t actively participate in trading their shares within the market.

Wrath of Shareholders

Although a manager has little or no control of share price in the short run, poor share performance could, over the long run, be attributed to mismanagement of the company. If the share price consistently underperforms, the shareholders’ expectations, the shareholders are going to be unhappy with the management and look for changes.

To what extent shareholders can control management is debatable. Nevertheless, executives must always factor in the desires of shareholders since these shareholders are part owners of the company. Companies would want their share price to remain relatively stable, so that they remain strong and deter interested companies from taking them.

On the other side of the takeover equation, a company with a hot stock has a great advantage when looking to buy other companies. Instead of having to buy with cash, a company will simply issue more shares through the right issues to fund the takeover.

Further a company may aim to increase share simply to increase their prestige and exposure to the public. The larger the market capitalisation of a company, the more analyst coverage the company will receive. Analyst coverage is a form of free publicity advertising and allows both senior managers and the company itself to introduce themselves to a wider audience.

— The writer is an investment banker