Why public companies prioritize stock price

When a public company lays off 5 percent of its staff and its stock goes up the same afternoon, people ask how that makes sense. It does, once you see that the company is doing what it's built to do and the stock price is the scoreboard.

Here is where that comes from.

The legal part

A corporation's directors owe their duties to the corporation and its shareholders. Courts have been saying this for a century. The famous case is Dodge v. Ford Motor Company, decided in Michigan in 1919. Henry Ford wanted to cut car prices and raise wages instead of paying a special dividend. The Dodge brothers, who were shareholders, sued. The court ordered Ford to pay the dividend, and wrote that a business corporation "is organized and carried on primarily for the profit of the stockholders."

The modern version is eBay v. Newmark, a 2010 Delaware case. Craigslist's founders wanted to keep running it as a community service rather than for profit. The court said they couldn't, at least not with a for-profit corporation: "promoting, protecting, or pursuing non-stockholder considerations must lead at some point to value for stockholders."

Courts give boards enormous room on how to pursue value, under what's called the business judgment rule. A board can raise wages or keep a money-losing plant open if it can say with a straight face that this serves shareholders long term. What it cannot do is decide that shareholders come second.

Benefit corporations exist because of this. They are a separate legal form, available in most states since around 2010, that changes the duty to include other stakeholders. Patagonia is one; almost no large public company is. Our post on benefit corporations covers the difference.

The pay part

The CEO of a public company is paid mostly in stock, and the stock is worth more when the price is high. At an average S&P 500 company, something like 70 to 80 percent of the CEO's package moves with the share price. So does the pay of everyone in the top few layers.

This was done on purpose, starting in the 1980s, to make executives think like owners, and it worked: an executive deciding whether to cut 2,000 jobs is looking at a spreadsheet where the cut raises earnings per share, and earnings per share is most of their pay.

The market part

Public companies report results every three months, and analysts publish estimates beforehand. Miss the estimate and the stock drops, sometimes 10 or 20 percent in a day. Beat it and the stock rises. This creates a strong pull toward decisions that look good in the next 90 days.

Activist investors reinforce it: a hedge fund buys a few percent of a company it thinks is underperforming, demands cost cuts or a sale and threatens a fight for board seats. Boards usually settle, and the cuts happen.

Buybacks are the other lever: when a company has cash, it can invest it, raise pay, pay dividends or buy back its own shares. Buybacks raise earnings per share and support the stock price. S&P 500 companies spent close to a trillion dollars on them in 2024.

What the "stakeholder" statements mean

In 2019 the Business Roundtable, a group of about 180 large company CEOs, put out a statement saying corporations should serve customers, employees, suppliers and communities as well as shareholders. It got a lot of coverage.

Two Harvard law professors, Lucian Bebchuk and Roberto Tallarita, then checked what the signing companies did. Almost none had the statement approved by their boards. Almost none changed their charters or their pay plans. The researchers concluded it was mostly for show. The legal duty didn't move because the statement didn't touch it.

What this means for a worker

If you work at a public company, your job exists because it currently serves shareholders more than it costs. When that math changes, the job changes. That's a description of the arrangement, and it's worth knowing before a restructuring rather than after.

The next post in this track is about exactly that: what happens to employees when the company goes public or gets sold.