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Beatriz Mena- The Dot-Com Crash Case

How market works in general, we have two groups, the investors
(which have savings and wish to apply this money in a business and
get high return) and the companies (which need the money for
create new products and make profit). We have two problems:
(1)Information asymmetric: entrepreneurs know more the firm
value than the investors/ Information friction: what company
should I invest?
(2)Agency problems: they should maximize the share holds
wealth however managers can maximize their own utility
Two groups: financial intermediaries (VC/ IB/ Fund Managers)
getting money from investors + information: verify and
analyze the information provided by open companies (there is
risk of fraud).
Most of times they are working properly, however sometimes
they are in problem as in the dot-com crash of early 2000s.
1. What is the intended role of each of the institutions and
intermediaries in the case for the effective functioning of
capital markets?
In the economy, households and institutions seek good
investment opportunities for apply their savings. On the other
hand, there are several entrepreneurs and existing companies
that would like to attract these savings to fund their business
ideas. Once thaut the markets are not perfect, financial and
information intermediaries are crucial in order to connect
these two agents. In the case, the author highlights the role of
several intermediaries and institutions on the context of the
Dot-Com Crash:
a) Venture capitalists are responsible for provide capital to
the firms when they are still small, in other words, in their
early stages of development. Doing so, the VC can earn a
huge return if the business becomes a success, therefore a
good VC should be able to screen good ideas from bad
ones. On the bubble context, the VC invested in companies
in the late 1990s because of the high stock market
valuations, in ordinary circumstances they would not
invested as much as they did. Get capital from private
investors and make the company grow and then sail to the
market sell the company, make a success IPO not a long
term perform of the business. People intend to buy as
company as they can (don’t miss the “new microssoft”)
b) Investment bank underwriters are the agents who are
in charge of doing an Initial Public Offer (IPO), as part of the
process, the investment banks help the firm calculate the
price of their offering, introduce them to investors etc. As
the bank receive a commission based on the amount of

many analysts knew that several Internet companies were overvaluated. The analyst has also to convince the portfolio managers within their company to follow their recommendation. they listen to the analyst recommendation and then take the decision. As they worked for the IB. it has incentive to overprice once that the market was buying this shares anyway. so they were magnifying the bubble. c) Sell side analysts publish research on public companies which consider trends of the industry and specific practices of the firm. hedge funds and insurance companies. They are pressured to be accurate (you have to have some relationship with the mangers. Usually those reports contain a by or sell recommendation as well. so you have to focus in good companies because the share price should be stable. but they felt pressure to invest (they new that in the short time the prices are going up). The portfolio managers as the name say. if there is something wrong. A buy-side analyst is responsible for doing an industry research and then decide whether buy the stock or not. so they could get commission. so they couldn’t have a underperformance over and over and its impossible get the same profit as the dot-com firms. In early 2000. Financial Analysts: forecast earnings. manage the money. In dot-com they were buying and selling because the general buyers were always pushing the price up. Fund Managers take the money in order to invest n good projects and then can make profit. Sell shares to the general market. What their incentives? Work hard and make sure you recommendation will make money to your customers. buy recommendation would help their brokers for buying. They did that because they performance is measured by comparison. they can warn . so they were helping their friends) e) Accounting Profession. several analysts were target of criticism as they give a buy recommendation for companies whose stocks had dropped steeply a few months after. d) Buy side analysis is performed by institutions which do the actual buying and selling of the securities as mutual fund companies. their job is audit financial information provided by public companies in order to prevent fraud.money that the company raised with the offering. Sometimes they work for brokers. they can have positive bias because their bank is underwriting shares of these companies. But now they were getting as much company as possible because they earn fees as they were gaining fees anyway. On the crash context.

3. has the mission to “establish and improve standards of financial accounting and reporting for the guidance and education of the public”. was a primarily responsible for the Internet Stock Bubble? I don’t think that there is a primary responsible for the Internet Stock Bubble. In fact. Make sure that the numbers are consistent with the accounting standards. Investors were pushing the prices so high that cause the distortion. f) Regulator. Moreover. is anyone. in the dot-com scenario the auditors didn’t gave “going concern” clauses to firms in poor conditions. Whoever. so you have to be independent. For example. only a firm easy to sell later with high profits. the stock price would valorize. because as described on the case. Investment Banks don’t have incentive to offer a stock at a faire price. but the one that will maximize their own revenue. In my opinion the most misaligned agent is the Venture Capitalists because in the late 1990s they were giving money to firms that were going public too fast. Are their incentives aligned properly with their intended roles? Whose are most misaligned? The incentives are not aligned properly why their intended roles. which is the Financial Accounting Standards Boards (FASB) in the USA. as their suggestion were always optimists. The venture capitalists were investing in firms that were going public right away. Small companies did the audition not the five big ones. so as the investors were waiting for the “next big thing”. so they didn’t need to bet in a sustainable business. . several agents had incentives misaligned and didn’t play their roles properly.investors about the financial position of some firms. 2. Also the sell-side analysts didn’t give proper recommendations. Who. as the main incentive is earn profit while the role is to become an information channel in which people can rely on in order to take investment decisions. with the emerging of “new economy firms” (firms that deals with Internet as consultants and dot-coms) some assets became difficult to measure as well as some accounting rules became obsolete. the buyside even knowing that the stock prices were overvaluated. The main problem is that sometimes making a good information role doesn’t guarantee a high profit.

what lessons do you draw from the bubble? Bubbles are harmful to the economy because they can destroy a large amount of wealth as they allocate resources in bad projects. we need to analyze if a business can generate income with its own activity or if the valorization is due only to speculation. Even the auditors aren’t exempt of fault.they invested on them anyway. . Moreover bubbles can lead negative impacts in the confidence in overall economy that can take a while to recover. 4. because probably this pace can’t be sustained in a long term and it’s an indicative of bubble behavior. because they didn’t warn the investor about the poor financial condition of the firms. I think that the main lesson that we can take from a bubble is to be aware with extremely rapid growth. Moreover. What are the costs of such a stock market bubble? As a future business professional.