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

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1. Intended role of each institution/intermediary:
Venture Capitalists – They screen companies with good business ideas from bad ones and provide capital to the start-ups with good business ideas. The required return on capital for VCs is very high to compensate the shareholders for the higher risk in investing in new businesses, and this is achieved when VCs sell their stake in the business through IPOs or trade sale. Thus, VCs will work to ensure the business is sound so that it will fetch the highest possible price when going public.

Investment Banks – They provide advisory financial services, price the IPO, underwrite the shares as well as introduce the company to the public. They are then paid a commission fee based on the amount the company manages to raise in the IPO. Thus to maximize their fees, IBs are motivated to pick the best companies which the public will pay the most for.

Sell-side Analysts – They provide support during IPO process by providing research to the buy-side before the company goes public. They also publish research on public companies and make recommendations on the stock, which could be very influential on investors. They are compensated based on amount of trading fees and IB revenue generated through their research.

Buy-side Analysts/Portfolio Managers – These are institutions that actually buy or sell public stocks. The analysts research the companies and provide recommendations to the portfolio managers. Compensation for the analysts is based on how good are their recommendations. Portfolio managers act on behalf of investors and will buy the actual stocks based on the analysts’ recommendations and their own judgment. Their compensation is determined by the performance of their portfolio compared to the benchmark return.

Accountants – They audit the financial statements of companies, ensuring that companies’ financials reflect the true state of the firm and are also in compliance with established standards. Investors...
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