[ale] OT: corporate finance 101

[David Corbin]

James P. Kinney III wrote:

>Why do companies panic when their stock price falls? They are not the
>ones selling it. Unless they are in IPO, or have a new release. The
>stock buyer pays the stock seller. The only time the company gets the
>money is when they are selling. Someone please enlighten me as it makes
>no sense.
>
>I've been reading on the Enron mess and it stinks.
>
You've had number of different  answers, none of which are wrong, but I 
thought I'd tried to a clear summary.  Stock prices reflect the value of 
the company.  This is used for a lot of things, including securing loans 
and making acquisitions.  But a reason that motivates management 
(companies in effect) more, is personal wealth.  They often have a lot 
of their personal wealth tied up in stock or options.   When I used to 
work for McAfee (mid-90's), they had an incredible growth spurt.  The 
CEO had million or so shares of stock and options.  A one dollar drop in 
price cost him a million dollars in value.  Nothing to sneeze at, but 
nothing to panic over.  However, many investors invest on a "momentum 
strategy'.  For quarter after quarter McAfee show growth and profit, 
meeting numbers each time.  The stock price grew accordingly  Then one 
quarter they missed.  Bam!  The price dropped. Over the next year, it 
lost 90% of it's value.  So, it wasn't just a a million dollars lost by 
the CEO, it was 40 million.  Fear of that happening is what make them 
panic when things the price drops.

Remember, fundamentally, companies don't act, only people do.

All that having been said, McAfee was also where I learned that a 
significant factor in the price of a company is the managements ability 
to "pitch Wall Street", and not how well it operates.  Despite positive 
growth and proftis, a 30-fold run in price over 3 years was not warranted.  

Enron is a different matter, because it was fraudulent behavior.





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