Role of Capital Market Intermediaries in Dot-Com Crash of 2000

Submitted by-Addagatla Sainath (188010)

Kanishk Rathore (188123)
Kashish (188128)
Sumit Kumar Singh (188250)
Vanvari Mohit (188269)

During the late 20th century, the Internet created a euphoric attitude toward business and
inspired many hopes for the future of online commerce. For this reason, many Internet
companies (known as “dot-coms”) were launched, and investors assumed that a company that
operated online was going to be worth millions. But, obviously, many dot-coms were not rip-
roaring successes, and most that were successful were highly overvalued. As a result, many
of these companies crashed, leaving investors with significant losses. In fact, the collapse of
these Internet stocks precipitated the 2001 stock market crash even more so than the
September 11, 2001 terrorist attacks. Consequently, the market crash cost investors a
whopping $5 trillion.

Factors That Led to the Dot-Com Bubble Burst: The 3 major factors that led to the burst
of dot-com bubble were:

Use of Metrics that ignored the cash flow: Many analysts were focused on the aspects of
individual businesses that had nothing to do with how they generated revenue. For example,
one theory is that the Internet bubble burst due to a preoccupation with the “network theory,”
which stated the value of a network increased exponentially as the series of nodes (computers
hosting the network) increased. Although this concept made sense, it neglected one of the
most important aspects of valuing the network: the ability of the company to use the network
to generate cash and produce profits for investors.

Responsible Market Intermediaries: Auditing/Accounting firms, Sell-side Analysts, Buy-side

Analysts and Portfolio managers

Significantly Overvalued Stocks: In addition to focusing on unnecessary metrics, analysts

used very high multipliers in their models and formulas for valuing Internet companies,
which resulted in unrealistic and overly optimistic values. Although more conservative
analysts disagreed, their recommendations were virtually drowned out by the overwhelming
hype in the financial community around Internet stocks.

Responsible Market Intermediaries: Venture Capitalists, Investment Banks (Underwriters),

Sell-side Analysts, Buy-side Analysts and Portfolio managers

Non-aligned interest with the intended role of each institution/intermediary: Some of the
incentives of the institutions and intermediaries are not properly aligned with their intended
role, such as IBs, Sell-side Analysts and Accountants. IBs and Sell-side Analysts are
motivated to price the IPO as high as possible as their compensation is based on the amount
the IPO is able to raise, so they could potentially over price the IPO intentionally and are also
subject to optimistic bias. Accountants are supposed to verify the accuracy of companies’
financial statements but they are also paid by those same companies. In order to keep their
clients, accountants may be motivated to audit the company in such a way that caters to the
companies’ expectations rather than according to established standards.

Responsible Market Intermediaries: Venture Capitalists, Investment Banks (Underwriters),

Sell-side Analysts, Buy-side Analysts and Portfolio managers, Auditing/Accounting firms