Case Study 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? The institutions and intermediates roles are: a) Venture capitalists: VC provides capital for companies in their early stages of development and screen good business ideas and entrepreneurial teams from bad ones. It employs savvy business people who worked closely with their portfolio companies to both monitor and guide them to a point where they have turned a business idea into a wellmanaged fully functional company that could stand on its own and nurture the companies until they reached a point where they were ready to face the scrutiny of the public capital markets after an IPO. b) Investment Bank Underwriters: It helps entrepreneurs in the actual process of doing initial public offerings, and provides advisory financial services, helped the companies price their offerings, underwrite the shares, and introduce them to investors. c) Sell-Side analysts: The main role of sell side analysts was to publish research on public companies and involved forming relationships with and talking to the managements of the companies, following trends in the industry, and ultimately making buy or sell recommendations on the stocks. d) Buy-Side Analysts and Portfolio Managers: They are usually assigned to a group of companies within a certain industry and are responsible for doing industry research, talking to the companies¶ management teams, coming up with earnings estimates, doing valuation analysis, and ultimately rating the stock prices of the companies as either µbuys µor sells and also need to convince the portfolio managers and portfolio managers are responsible for buying or selling securities. e) Accountants and Auditors: Independent accountants audit the financial statements of public companies to verify their accuracy and fair and auditors are responsible for making a report to the third parties based on the company µ financial statements. s

the stock price would soar upwards as soon as the company went public.f) The Regulator-FASB: It establishes of standards of financial accounting and reporting for the guidance and education of the public. Companies in VC were primarily financed by venture capital and IPO¶s (Initial Public Offerings) of stocks. including issuers. there is nothing wrong with doubling the company each year like Microsoft company did back in late eighties but. what lessons do you draw from the bubble? $5 trillion costs of such stock market bubble were related to dot com crash case. Lessons from the bubble: A If business model does not real money do not buy it. the partners in VC firm typically had a substantially percentage of their net worth tied in their funds. 4 What are the costs of such a stock market bubble? As a future business professional. 2.Venture capitalists provided capital to public companies with questionable business model and which were went to public very early without scrutinizing these companies by VCs savvy business people. Who. The novelty of the stocks and the difficulty of valuing the non-traditional firms meant the stocks were initially overvalued and. The most misaligned incentive associated with Venture capitalists . which aligned their interests with their investors and the main form of compensation was large share of profits (typically 20%). This was true even if the company had never made a profit or even a stream of revenues (Dot-com Bubble). B Rapid growth is not way to build a solid company. if anyone. D To make a huge profit in short time is not good all the time. and users. combined with enormous demand from investors wanting to get in on the ground floor of the ³next big thing´. Moreover. was primarily responsible for the Internet stock bubble? Venture Capitalists were the primary responsible for internet stock bubble. 3. Moreover. VC had an expertise people to analyse and guide the companies. Are their incentives aligned properly with their intended role? Whose incentives are most misaligned? Their incentives are not associated with their role. auditors. C Start a company with experience what a company is going to start. . doubling size within quickly is not well enough for the long term prospect.