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 intended role of each of the institutions and intermediaries are shown in Exhibit 10, with the idea that the overall structure and individual roles are working as a whole to facilitate the capital flow from the investors to the companies.
2. Are their incentives aligned properly with their intended role? Whose incentives are most misaligned?
No. As indicated in Exhibit 10, the overall structure and individual roles are working as a whole to facilitate the capital flow from the investors to the companies. If we need to have this market operation in a “clean” way, the incentives of the intermediaries should not be directly related to the short term gains from this capital flow.
However, in real life, that is not the case. The one intermediary whose incentives are most misaligned can be the money managers. Though it is true sometimes they are under pressure from “greedy” investors, it can be true that, in most of the cases, they are the one who build up the bubble (willingly or unwillingly), due to the fact that, the incentives they received are directly from their short term (e.g. quarter or annual) performance, against the market benchmark or other money managers.
3. Who, if anyone, was primarily responsible for the Internet stock bubble? My view is that, economic bubbles are part of the capitalist market cycles, it is very difficult to say who was primarily responsible for a economic bubble. There is this old saying that, “when market is going crazy, no one can really do anything about it”.
But take the 2000 Dot-Com bubble case, if we really have to identify someone who was more responsible than others, it seems it may be the sell-side analysts. This was mainly due to the fact that, the analysis they put up were to certain extend biased, with unrealistic assumptions that the growth rate was very high and would remain that way. It is not convincing that they really did not see any sign of risk, but it is more convincing that they may be intentionally ignore some of the obvious risks.
4. What are the costs of such a stock market bubble? As a future business professional, what lessons do you draw from the bubble?
My view is that, economic bubbles are part of the capitalist market, as the market is always going through cycles. When the market is going up and down, bubbles are built up and then go bust. The costs of such a stock market bubble are very bad to some of the investors, especially individual investors. But in general, it is not bad to the market as a whole. Only by going through the cycles, the market is further developed through self-corrections.
As a future business professional, what we need to learn from the bubbles are that, we need to build up our knowledge and insight of the market, and need to do enough due diligence in business and investment. Warren Buffett can be a good example for us. When the economy is going through cycles, with enough insight, we will need to make decisions such as “buy when everyone sell, and sell when everyone buy”.