Chapter 1: The role of capital market intermediaries in the dot-com crash of 2000
1. What is the intended role of each of the institutions and intermediaries discussed in the case for the effective functioning of capital markets?
i. Venture Capitalist: provides capital for the company in the early stage of development and ensures company to have a good management team and sustainable business. VC demand high return on investment and sells stock usually to public through IPO.
ii. Investment Bank underwriters: provide advisory financial services, make offerings to companies, underwrites the shares and introduce firm to the investors normally in the form of road shows. They help entrepreneurs in the actual process of doing IPO
iii. Sell-side analysts: work at the investment bank and brokerage houses. They monitor ...view middle of the document...
If this is satisfied, unqualified opinion statement will be issued.
vi. Regulator-FASB: establish and improve standards of financial accounting and reporting for the guidance of public
2. Are their incentives aligned properly with their intended role? Whose incentives are most misaligned?
The incentives and the intended roles were substantially misaligned thus causing breakdown in capital market. The most misaligned incentives and role were by venture capitalists as they had invested in many public companies with questionable business model: had not yet proven themselves operationally yet had gone public too early. Furthermore, due to expectation of high stock market valuation, VC firm greatly invested in companies and cause the availability of money to affect the business strategies and the attitudes of internet companies. The main compensation was a large share of profit (20%), hence this might also lead to misalign of incentives and role.
3. Who, if anyone was primarily responsible for the Internet stock bubble?
VC could be blamed as they are the ones who bring the companies public. Moreover, they have the expertise to analyze and guide the company and this has definitely cause the companies to rely on them.
4. What are the costs of such a stock market bubble? As a future business professional, what lessons do you draw from the bubble?
Stock market bubble has caused many new economy companies to collapse. Investors have also loss confidence to invest in these companies. It is estimated that $5 trillion costs were related to dot com crash.
From the bubble, successful investment should be based on deep market analysis and solid business plan. If ever a new company is to be started, we need to ensure that experienced VCs are available to guide the company along the way. Last but not least, rapid growth is not the best way for a long term prospects of the company.