Dot-Com Bubble

Market Bubbles

In general, market bubbles are characterized by an overmagnification of a particular market due to inflated confidence of its value by current buyers. This creates a hyperbolic disparity between the value at which companies are traded and their intrinsic worth. In the case of the dot-com bubble, company values were driven by investor interpretations of market sentiment, rather than traditional valuation techniques. For this reason, [Page 307]market bubbles are generally not detected until market sentiment dramatically drops. The result of the impact of investor expectations, compounded with the fact that it is often difficult to place a hard numerical value on technology companies, was that Internet companies received valuations that far surpassed their true value. When the rising expectations turned downward in the spring of 2000, the dot-com bubble fell in line with the typical “bursting” trait of stock bubbles.

Investor Fraud

Investors were frequently misled regarding alleged positive prospects of a company. Investors, eager to reap the potential rewards of high-growth equity investments, convinced themselves that these prospects would eventually come to fruition.

One example of investor deception was InfoSpace. At its height, InfoSpace was worth $31 billion. Once the company deteriorated, an investigation attributed much of the company's success to fraud and deception. The investigation sifted through company e-mails and confidential documents and discovered that revenue came from nonexistent transactions and accounting tricks. The higher-than-actual advertised revenue fooled everyone, from Wall Street traders to private investors.

A second example was Think Tools AG, a giant in the European dot-com space. In March 2000, Think Tools AG had a market valuation of CHF 2.5 billion. Founded as a consultancy company, Think Tools AG expanded to include a suite of product tools that ultimately was not capable of its promised and marketed features. Ad campaigns went as far as falsely citing Nelson Mandela for successfully using the tools. Consequently, the stock soared. Once misleading information was revealed, such as the fact that reference clients at the time of the company's initial public offering did not even use the Think Tools Suite, the stock price plummeted.

Self-Deception and Stock Options

Self-deception was also prevalent during the dotcom bubble. An important example of this self-deception was the operation of stock options. Because cash is not always available in Internet companies, stock options are offered as a form of payment. In some cases, stock options can convert into a fortune. In many cases during the bubble, however, these options were meaningless.

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