1. What is the intended role of each of the institutions and intermediaries discussed in the case for the effective functioning of capital markets?
Broadly, the institutions and intermediaries’ primary role involves channeling investors’ savings and funds to new companies that require capital to finance and grow their businesses. Because there is an information gap between investors and companies, investors rely on intermediaries to act as the experts on these investments in which intermediaries provide advice and recommendations.
The specific role of each intermediary are as follows:
Venture capitalists: Provide capital for companies in early stages of development. VC firms source capital from institutions and high networth individuals.
Investment bank underwriters: Provide underwriting and IPO services for companies going public. They facilitate a company in gaining capital from the capital market
Sell-side analyst: Analysts for investment banks and brokerage houses that researches on stocks and makes recommendations on its value whether to buy or sell.
Portfolio managers and buy-side analysts: Analysts and managers that makes actual purchases on stocks on behalf of the mutual funds, hedge funds, or insurance companies that they are managing. The capital from these funds are sourced to buy stocks.
Accountants: Provides audit and assurance services on companies’ financial statement to satisfy the regulatory requirement.
2. Are their incentives aligned properly with their intended role? Whose incentives are most misaligned?
Not all intermediaries’ incentives are aligned properly with their intended role. Some intermediaries such as buy-side analysts and portfolio managers are pressured to buy an overvalued and increasing stock by its investors although knowing the fundamentals of the business are not strong and the stocks overvalued. Investment banker fees are usually paid based on a percentage of the funds raised from IPOs therefore