When the stock market drops, most people wonder: why does the price of a company's stock really matter? If stock values and prices are dependent merely on the whim of investors and don't really reflect the value of anything, then why care when the prices dip?

Theoretically, a company's stock price should reflect the performance of the company. When it makes more profit or increases its market share, the company's stock price should rise. In the real world, however, that's not necessarily true. For example, Amazon.com has never made a profit, yet its stock is currently hovering around $100 per share. In contrast, when Boeing added more workers to ramp up production, its stock price fell. Only when Boeing announced that it would lay off workers by the end of the year did its stock price recover. Clearly, stock price reflects what investors think about a company's potential profits but, more importantly, it also influences the overall health of the company. Here's how:

First of all, companies are typically valued not just on their annual sales and assets, but also on the price of their stock. When stock prices sink, the overall value of the company decreases, and this effects the credit-worthiness of the company (its ability to borrow money). Companies that need to borrow or issue bonds to finance expansion have a problem when their stock price sinks: they have to pay higher interest rates, because their creditor now views them as a higher risk. For a recent, public-sector example, the government of Brazil's credit-worthiness suffered when investors began to sell off Brazilian bonds. Moody's Investors Service downgraded the Brazilian government debt (similar to a sinking stock price), and Brazil's creditors upped short-term interest rates to as high as 50%. This meant that suddenly Brazil's interest payments on debt jumped from 1% of the country's gross national product to an insane high of 7% of GNP. Without interest payments on its debts, the government's budget would balance; it's debt service payments that have forced the country to run up ever higher deficits to the point where it's now begging the IMF for a $30 billion bailout package. The same thing can happen to businesses.

Secondly, in the past two decades, more companies attract upper level management and high-tech or high-skilled employees by offering stock options as part of their compensation package. This causes two major problems for companies. First, major management decisions will be directly linked to the performance of the company's stock--a good thing for investors who want short-term, stratospheric growth, but not conducive to making long-term, strategic decisions--which often demand investment in new equipment or small wage raises for lower level workers in the near term.

Secondly, in a "tight labor market," companies compete with one another to attract and retain highly-skilled workers. When a company offers stock options, it suddenly becomes enormously important for the company's stock to do well. If the price falls, the company risks losing a large number of employees. The company would have to pay for recruitment, training, and replacement of those employees. Lost productivity, training costs, loss of morale, and the loss of experience that occurs when a company has high turnover rate can propel it into a downward spiral. In a sense, this alone proves how inefficient the system really is: companies hobble themselves by overvaluing some employees--thereby creating an "upper class" of employees who can easily afford to move from one company to the next.

Finally, when the stock price decreases, so does the ability of a company to finance mergers. Much of the economic growth of the 1980s and 1990s has been fueled by massive mergers. In the distant past, mergers were financed by heavy borrowing, usually through the issue of corporate bonds or through bank loans. Today, it's more common for large companies to finance mergers through direct stock swaps. For example, Company A wants to buy their competitor, Company B. Company A offers the shareholders of Company B a chance to trade in 2 share of Company B's stock for 3 shares of Company A's. The shareholders vote and, if they approve, the deal is finalized. If, however, Company A's stock price falls drastically in the interim, Company B's shareholders may decide to pull out of the deal. In recent months, several large mergers have been put on hold or cancelled for this very reason.

If stock prices really had no impact on companies, large companies wouldn't spend enormous amounts of cash to buy up their stock when the price falls, yet many do. Boeing, for example, recently spent a chunk of its cash reserves buying up its own stock.

Stock prices reflect an enormous instability in the system; global investors can literally drive a company out of business or force it to sell to competitors, regardless of the overall health of the company. It doesn't matter if the company makes a necessary product or performs a vital service, or if it employs a lot of people. Waste is endemic to capitalism (as any chronically unemployed or under-employed person can tell you). The fact that companies can be scrapped in the pursuit of profit--just as workers, the elderly, children, and the environment get tossed aside--should surprise nobody.