Abstract: Stock options and tricky financial instruments are dividing the interests of insiders from the performance of the Internet companies they dominate. In a market as volatile as the present one, suspicion of skyrocketing initial public offerings should be the order of the day. More than $14 billion of shareholders' money, nearly $11 billion in venture capital, and a sizable percentage of Harvard's newest MBAs headed for Silicon Valley and its counterparts elsewhere in the first three quarters of 1999. Record numbers of people and amounts of money are flocking to the new economy's Pied Piper: the Internet start-up, with its promise of innovation and wealth. But crackling behind the song, you can hear the distortions of a market that has primarily rewarded insiders and short-term investors instead of aligning the interests of executives, employees, and shareholders around the long-term performance of these companies. And when the time comes for the piper to be paid, as it inevitably must, the least informed and most starry-eyed of the participants--retail investors--will probably pay the highest price. The story of this misalignment begins with the first-day IPO pop, for which Internet companies are now famous. On average, the share prices of the 175 such companies that went public in the first nine months of 1999 closed on their first trading days at levels 77 percent higher than their IPO prices. Events of this sort are immediately and massively celebrated in the communications media as evidence of the extraordinary robustness of Internet offerings. What these stories really mean is that about 40 percent of the immediate value of the publicly traded shares was handed to investors rather than to companies that need working capital. In extreme cases--such as Calico Communications, whose first-day closing was 300 percent above the offer price--companies may leave up to three-quarters of the new capital on the table. What is going on? Investment banks can't be chronically underestimating the demand for these stocks. Even in markets as volatile as the present one, bankers are skilled at gauging demand for an IPO; their fees and reputations depend on this. Instead, those bankers and their clients, accustomed to an almost insatiable demand for pieces of Internet companies, have apparently been structuring deals to ensure that demand greatly outweighs supply. Often, the total amount floated is less than the top executives' share. Thus, these deals are guaranteeing not only a surge in market prices but also an extremely large profit potential for insiders and employees laden with stock and options. For in the world of the present, people are scarce and capital isn't; Silicon Valley is overrun with money, but the shortage of skilled software developers is so severe that the high-tech industry has lobbied the US government to increase the number of visas it issues. Extraordinary stock incentives have emerged as the solution to this labor shortage. If the incentives are to work, companies can't afford the kind of moderate stock performance that would disappoint the precious high-tech talent they have recruited with large blocks of stock options and the right to purchase discounted shares. Structuring an IPO to produce large first-day returns and the appearance of market momentum is a good start. Keeping prices aloft through press coverage and meetings with analysts--rather than making money--becomes the main goal, since a surging stock price creates an aura of success around a company, however lacking in profits. There are two major problems here. First, this stock-based profit potential is actually a destabilizing force for companies and markets. Second, the market's nonchalance about the huge profits going to insiders bespeaks an indifference to the interests of the people picking up the tab: unwary retail investors. …
Publication Year: 2000
Publication Date: 2000-01-01
Language: en
Type: article
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Cited By Count: 2
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