If shareholders are dissatisfied with the firm’s performance their likely reaction will be to sell their shares. If selling is widespread, this will result in a falling share price. This may act as a control upon management as the falling share price will be seen in financial markets as a loss of confidence. It may also affect the prospects for further share issues and, importantly, increase the likelihood of takeover with the inherent risk of existing management losing its position.
The risk of takeover increases due to the falling share price lowering the purchase price or market value of the firm relative to its asset value, the ratio of market value to asset value being the firm’s valuation ratio, i.e