Dot.Com Bubble
1) What is the intended role of each of the institutions and intermediaries discussed in the case for the effective functioning of capital markets?
Overall the role of intermediaries is to close the information gap between investors and companies. Investors usually do not have enough information or expertise to determine the good investments from the bad ones. And companies do not usually have the infrastructure and know-how to directly receive capital from investors. Therefore, both parties rely on intermediaries to help them make these decisions. Other institutions like regulatory or lawyers are entities to ensure that the parties play by the rule and also to build and develop a framework of rules.
Roles of important intermediaries in greater detail:
Venture Capitalists: Venture capitalists provide capital for companies in their early stages of development. Their role is to nurture the companies until they reached a point where they were ready to face the scrutiny of the public capital markets after an IPO.
Investment Bank underwriters: help start-ups or young entrepreneurs to “go public”. Their role is to plan and organise IPO’s.
Sell-side analysts: Their role is to collect information on public companies and then publish this information together with recommendations to the public/investors.
Buy-side analysts and portfolio managers: very similar role as the sell-side analysts with the slight difference that they do not publish their research to the public but have to convince their portfolio managers to follow their recommendations. Portfolio managers are in charge of buying and selling securities based on buy-side recommendations.
2) Are their incentives aligned properly with their intended role? Whose incentives are most misaligned?
To answer this question we will look at the incentives of the 4 intermediaries described in the case:
VC’s: Their main focus lies on supporting a start-up with knowledge and try to make it grow until it eventually my go
Overall the role of intermediaries is to close the information gap between investors and companies. Investors usually do not have enough information or expertise to determine the good investments from the bad ones. And companies do not usually have the infrastructure and know-how to directly receive capital from investors. Therefore, both parties rely on intermediaries to help them make these decisions. Other institutions like regulatory or lawyers are entities to ensure that the parties play by the rule and also to build and develop a framework of rules.
Roles of important intermediaries in greater detail:
Venture Capitalists: Venture capitalists provide capital for companies in their early stages of development. Their role is to nurture the companies until they reached a point where they were ready to face the scrutiny of the public capital markets after an IPO.
Investment Bank underwriters: help start-ups or young entrepreneurs to “go public”. Their role is to plan and organise IPO’s.
Sell-side analysts: Their role is to collect information on public companies and then publish this information together with recommendations to the public/investors.
Buy-side analysts and portfolio managers: very similar role as the sell-side analysts with the slight difference that they do not publish their research to the public but have to convince their portfolio managers to follow their recommendations. Portfolio managers are in charge of buying and selling securities based on buy-side recommendations.
2) Are their incentives aligned properly with their intended role? Whose incentives are most misaligned?
To answer this question we will look at the incentives of the 4 intermediaries described in the case:
VC’s: Their main focus lies on supporting a start-up with knowledge and try to make it grow until it eventually my go