ACC 650
Dr. Ken Lorek
Some Additional Musings on the Dot Com Bubble Case
· Whenever one talks about the job responsibilities of sell-side analysts, it is important to not only discuss their buy/sell/hold recommendations with respect to securities, but also their involvement in EPS projections. At the time of the case, both activities were very biased with an excessive number of “buy” recommendations and lofty earnings projections that were never realized. If we were discussing these same analysts contemporaneously, I would add their involvement in cash flow projections.
· In discussing the auditing profession which was dominated by the “Big 5” international CPA firms during this time period, independence, or lack thereof, would be a critical concern. That is, such firms were allowed to engage in lucrative consulting arrangements with their clients which gradually replaced the audit as the primary revenue generator for such firms. In addition, auditors rendered a “going concern” opinion which was very biased in nature given the bankruptcy rate of the Dot Com firms.
· Empirical evidence suggests that investment bankers and venture capitalists, in collusion, brought many firms to the IPO altar not having ever earned a single dollar of net income. Moreover, the time period over which venture capitalists nurtured their clients was reduced significantly during this period.
· Sell-side analysts were fleeing brokerage houses and taking jobs at investment banks in growing numbers during the Dot Com Bubble phenomenon. One reason that they were doing so was the dramatic decrease in the trading fees that investors were charged. Close inspection of their compensation packages at investment banks revealed heavy reliance on commissions earned in the IPO process. This placed undue pressure on sell-side analysts to bias their earnings projections and buy/sell/hold recommendations. Finally, since many dot com IPO firms were not profitable, traditional fundamental financial analysis based on earnings and/or cash flows was largely supplanted by using revenue multiples.
· Agency theory suggests that well-functioning intermediaries are necessary to a well-functional and efficient capital market due to the information asymmetries that exist between investors and entrepreneurs.