Can Irrational Exuberance Serve as a Theoretical Explanation for the Boom and Bust of Dot com Companies in the U.S. in the late 20th Century
1.1 Background
Irrational exuberance is a state of overoptimistic speculation of asset values in the stock market. First used by former Federal Reserve Chairman Alan Greenspan, irrational exuberance is referred to as the unjustified market excitement towards the rapid proliferation of information technology throughout the economy, which prompted businesses to pour in billions of dollars into IT leaving little imprint on the overall economy (Tabb et. al, 2001). A stocks intrinsic value is based on its real-world potential to make money in the long run. However, the market value of a stock is fixed based on what the market expects of it, rather than what it is actually worth. Thus, if market forces decide that a stock is very valuable, then its price begins to sky rocket. After a certain point, this irrational price of the stock becomes almost meaningless since its value is based purely on mass speculation backed up by hype.
The term irrational exuberance was coined while describing the state of the stock market in 1996, where Greenspan suggested that there might be irrationality in the divergence of market prices (Garber, 2001, p. 7). The undue escalation of asset values could have long-term consequences such as the prolonged contractions in the stock market in Japan. The sudden collapse of a financial bubble created by irrational exuberance also has the ability to impair the economy by stifling jobs and affecting price stability. It has become apparent that undue overestimation of stock prices is one of the main drawbacks of an unregulated free market. The phrase irrational exuberance caught up with investors and it was significantly associated with the analysis of the stock market trends in the United States, especially while referring to assets that were overvalued (Kulpmann. 2004, p. 1).
Kulpmann (2004, p. 2) points out that people had initially invalidated the advantages of incumbents, as they perceived dot com technology to be completely new. Whereas, the truth was, the Internet did not invalidate the importance of the product, the brand, the distribution system or even physical locations like stores and warehouses. The irrationality in the exuberance of stock prices of dot com companies was less pronounced, as Porter and other experts had popularized the view that exuberance was valid to some extent since the Internet is a very powerful and important technology. While one looks into the failure stories of dot com companies, it becomes apparent that the main shortcoming was the failure of firms to uniquely tailor their strategy to utilize the power of the Internet. The irrational exuberance framework was analysed in this research for understanding the boom and bust phenomenon of dot com businesses and determine whether it would theoretically explain the direction of the phenomenon.
The dot com era took a stronghold on e-commerce, a domain that deals with buying, selling and promoting goods or services through the Internet. A huge number of people make online transactions through the World Wide Web in which they give out personal and financial details including credit card information. The Internet does not only deal with money, but also with enormous databases, full of vital and sometimes top secret information that corporations and governments have, within their own close and secure environments. These everyday transactions can sum up to hundreds of thousands of dollars per day and companies undertake this in order to create a competitive advantage over other organisations. Competition is the cause of the success or failure of firms and this leads them to take defensive actions and thereby increase their performance (Clark 2001). In addition to gaining competitive advantage by exploiting new resources such as low labour costs, cheap raw materials, improvement in infrastructure and legislation, the judicious use of the latest communication channels is one of the most powerful ways to establish competitive advantage (ibid).
There are two competing explanations on the boom and bust of dot com companies. The first takes into account the economic aspect, and this argues that what transpired in the late 1990s in the U.S. was a natural industry evolution, a classic financial bubble that happens in the normal business cycle. The other explanation involves the management aspect, and scholars argue that the dot com companies collapse was largely due to its weak business model. Both these perspectives are explained next, including a detailed discussion of the irrational exuberance hypothesis.
The dot com era and its proliferation in the last few years ago have led to the creation of cyber space. The cyberspace created, through the development of IT, has established a new market for trade, work, commerce, and consumer confidence. Cyberspace has gradually developed along with the Internet and the interconnection of computers around the world. It has been described as a parallel universe and a multi-media skin of digital networks, which infused rapidly into social, cultural, and economic life of people (Clark, 2001, p. 9).
Modern technology powered by the Internet has not only had implications on the dot com era, but gradually reshaped the economic, social, political, and cultural spheres under which business is conducted. It has created new avenues for businesses to develop by facilitating faster, more efficient modes of work, through better software, hardware and methods of communication. For instance, video conferencing has eliminated the need for people to travel to conduct meetings, while email powered by the Internet has enabled employees to get more work done just by staying at their desk.
Through the late 1980s and early 1990s, the dot com and IT era had been developing at a steady rate, becoming ever more popular in the business world due to its ability to enhance profits and speed up business. During this era, only the relatively affluent population could afford to own a home computer system, while computers had not captured the general publics imagination as they certainly did later on. As technology developed, so did the number of people looking to purchase home computer systems and use them for a wider range of activities including several budding entrepreneurs that thought of starting up a dot com company. In 1991 alone, almost 55 million Americans operated a full-time or part-time business at home, and this number had increased by 40 million in 1996. It must be noted that the late 1980s and early 1990s were the early periods of the dot com era (Nevaer, 2008).
The dot com phenomenon, despite the slowdown, experienced continuous development and growth due to the services, convenience, ease, efficiency and compatibility with the day-to-day fast-paced life of society. E-commerce had started moulding and answering the needs and demands of consumers and businesses, while offering them alternatives to time-wasting exercises involved in store product services and conventional business management (Munroe, 2008). Dot com is crucial to the research and development sector of businesses as it allows efficient extraction of valuable information without unnecessary and insignificant data being produced. This structure allows businesses to establish more flexible storage mechanisms thus, significantly lowering the excessive costs and time-wastage associated with mass paperwork and filing systems. Inventory control is also assisted by the increasing technological advances of e-commerce, in which stock re-ordering can now be done progressively in an uncomplicated and speedy manner.
The significance of the Internet reaped strong opinions during the advent of the dot com era, as the media predicted that information technology in general and the internet in particular, would soon create a new mode of economy (Litan and Rivlin, 2003, p. 2). It was said that income would grow even more rapidly in this new economy, alongside the soaring of stock values, among infrequent and mild recessions. An explosion of new companies, particularly of the dot coms, placed strong confidence in the future of electronic commerce, which attracted optimistic investors and entrepreneurs into hope of becoming instant millionaires. Although there was some scepticism on the new trend, confidence in the Internets future still ran high, which for a time, was reinforced by the soaring high stocks of dot com companies.
By 2001, however, the dot com explosion had collapsed, with approximately 384 companies crashing down as the technology bubble burst. The term bubble here refers to the process by which investors purchase an asset (e.g., equity shares in this case) for the purpose of selling them at a higher value in the future, where established norms of estimating intrinsic and future valuations are greatly ignored (Mcginn et. al., 2002). Even before the crash of the dot com market in as early as 1997, economists were already talking about its impending collapse based on the behaviour of market fundamentals. However, the seemingly boundless possibilities that the Internet could contribute to wealth creation had already sent investors, old and new, into an investing frenzy. The shares had indeed yielded high return rates, but only for a short while. As this frenzy was based on irrational thinking and overenthusiastic predictions, the term irrational exuberance rightly defines the phenomenon. Halfway through 2001, the dot com market plummeted, sending investors money down the drain.
When the bubble burst signaled by plummeting dot com stocks, investors lost confidence in dot coms with vague prospects but no profits. Along with many dot coms that went bankrupt, the stocks of Internet technology suppliers likewise went through a plummeting trend (Litan and Rivlin, 2003, p. 2). An Internet depression was predicted by sceptics alongside a prolonged distress in the world economy resulting from the bursting of the Internet bubble in the United States.
1.2 Rationale
As todays world economy has experienced severe economic setbacks caused by the crisis of capitalism, the discussion concerning the decline of dot com companies is a relevant topic, particularly linking it to the irrational exuberance framework as its theoretical basis. Looking at irrational exuberance concept as a theoretical explanation for the boom and bust phenomenon of dot com companies in the U.S. in the late 20th century would contribute to deconstructing such boom-and-bust trends and their potential linkage to other cases of economic declines.
1.3 Research Problem
This research aims to determine if irrational exuberance can be attributed to the rise and fall of early IT companies in the late 90s in the America. Specifically, it aims to answer the following questions
How can the irrational exuberance framework be characterised and be utilised as a theoretical framework for the boom and bust phenomenon of dot com companies
How can the nature of dot com companies be theoretically analysed in relation to changing capitalist markets and the emerging software industry
What model(s) of analysis does the irrational exuberance concept possess that may serve in explaining the boom-and-bust phenomenon of the dot com era
1.4 Aims and Objectives of the Study
1.4.1 Aim of the Study
This research aims to review the literature on the boom and bust phenomenon of dot com companies, in its pursuit to solicit insights on irrational exuberance and ascertain if it could theoretically and systematically explain this occurrence. In reviewing the literature, the study shall strive to provide support for and analysis on whether irrational exuberance can serve as a theoretical explanation for the boom and bust phenomenon of dot com companies in the U.S. in the late 20th century.
1.4.2 Objectives of the Study
This study has the following objectives
To review the literature on irrational exuberance theory and boom-bustic phenomenon of dot com companies in the United States
To carry out a primary research on the nature of dot com companies and how this may be relevant to the irrational exuberance framework and
Identify discrepancies in existing knowledge.
It was hypothesised that there exists a relationship between irrational exuberance as a theoretical framework and the boom-and-bust phenomenon of American dot com companies in the late 20th century.
1.5 Structure of the Study
Chapter One discusses the background, rationale, research problem, and aims and objectives of the study. These aspects are included to establish the importance of the research topic at an early stage and provide a holistic scenario of its direction.
Chapter Two discusses previous investigations on related literature and presents how these past efforts relate or differ from the present study alongside how the latter would fit in with the body of works on the subject. This chapter provides analytical assessments of theories and models in relation to how they are carried out in actual practice and serves as an important component in the preparation of the research report (Bautista, 1999).
Chapter Three describes the kind of research methodology utilised in this study and justifies the reason(s) behind the adoption of such methodology. This chapter shall guide the reader towards understanding the methodology considered appropriate for this study.
Chapter Four contains the presentation and analysis of data obtained for addressing the research problems aims and objectives. This chapter outlines the analysis based on the collected data and is directed towards understanding how the data substantiates the relationship between irrational exuberance and boom-bustic phenomenon of dot com companies.
Finally, Chapter Five presents the conclusion and recommendations thus drawn from the preceding chapters, especially from the analysis of data in Chapter Four, made in reference to secondary research.
1.6 Usage of Data Flow Diagram
In structuring the discussion, the study uses a data flow diagram (DFD) that explains the relationship and logical flows between the various sections in the literature review and the introduction. This diagram thus explains the relationships between various sections of the research, while the various arrow marks imply their links.
The Data Flow Diagram (DFD) is shown below
1.7 Summary
The background to the research problem, the rationale behind conducting the research, the aims, objectives and the structure of the research were discussed briefly, to provide the preliminary information on what the research is all about and how it will be carried out. The background to the research problem includes necessary information on irrational exuberance and an overview of the dot com phenomenon, allowing initial cognizance of the subject, which is critical to gaining a comprehensive understanding of the research problem. The research problem embodies the questions that need to be addressed in its entirety, while the structure of the research provides an outline of areas in which research is to be carried out.
LITERATURE REVIEW
2.1 Introduction
This chapter presents previous works on the dot com bubble burst and irrational exuberance, while investigating its pertinence to the topic under study. Through the analyses provided, the entire study is made to fit to the body of works and verifies inferences thus undertaken. As the chapter also strives to outline how the research topic is related to or different from past efforts, it serves as an important component in the preparation of the research and thus helps in shaping the studys conceptual framework (Bautista, 1999, p. 117).
2.2 Exploring the Irrational Exuberance Concept
As the concept of irrational exuberance was taken out from the analysis of the stock market trends in the United States described as overvalued, understanding the state of the stock market in 1996 is critical. According to Garber (2001), a study on the stock market concluded that there might be irrationality in the divergence of market prices. This study attempts to further that discussion by analyzing how irrational exuberance started from the stock market occurrence and proceeded towards the IT industry as a whole.
As the public has become increasingly impatient over the recent past and began to irrationally expect immediate returns, the stock prices started to fluctuate based on public sentiment (Evans, 2003, p. 26). According to Keynes (1964, p. 152), the market price of a stock is determined by an uncertain probabilistic equation based on the average public opinion of the stock. Galbraith (1998, p.169) held a similar view as he professed that the stock prices would rise if the public was in an optimistic mood and trusted in the benevolence of the market players, while the prices would fall when people are sceptical.
The value of stocks fluctuates based on the masses portfolio preferences and market sentiment. A bearish markets sentiments are dominated by the need for liquidity, while a bullish market does not crave for liquidation of assets. When the market is bullish, the price of securities rises and the contrary happens in a bearish market thus, the market establishes equilibrium in stock prices based on popular opinion. While the traditional rule of thumb assessment of a company and its prospects is the logical indicator of a stocks intrinsic value, it becomes a huge risk to bet against popular opinion, and therefore the majority investors become mere puppets of the bear and bull market dynamics. As stock prices began to be set based on public emotions, Keynes (1964, p. 229) warned that it would become increasing difficult to keep equity prices under check. Therefore, when the majority opinion of a stocks worth is illogical, it eventually leads the drastic change in opinion as the stocks yield would not hold up to expectations this crash in stock value is referred to as the speculation bubble burst. While it is commonly agreed that market speculation is based on public opinion of stocks, the intrinsic value of a stock determines its future value on the long run.
Kindleberger (1989) emphasises that deeply rooted psychological dynamics influence changes in asset prices, since propensities such as greed and jealousy perpetuate pervasive positive feedback loops that lead to overtrading and speculative frenzy. He also feels that such elated behaviour encourages corporations to indulge in fraudulent activity fuelled by their own greed. Classic examples of corporate greed can be seen in Enron, WorldCom and Adelphia, wherein financial cons were largely driven by unreasonable adaptive expectations that adhere to the Minsky cycle. Kindleberger also reiterates the importance of having a lender of last resort to intervene at the right time, reassure investors and prevent catastrophe (Kindleberger, 1989, p. 162).
The fluctuation in stock market prices encountered in 1989 was attributed to Galbraith and Keynes speculative theories of market behaviour (Kulpmann, 2004, p. 1). According to these theories, the absence of an accepted theory of asset price determination as well as the ambiguity of stock values allows prices to become relatively vulnerable to purely social movements (Shiller, 1989). It has also been observed that the stock market works in cycles, as a period wherein stock prices based on intrinsic value is followed by a period of overoptimistic pricing of stocks. While buoyant pricing of healthy stocks can be attributed to psychological phenomena, it is completely different from irrational exuberance wherein the speculative price of a stock is purely based on the future earning potential of a stock.
According to Shiller (2000), equity prices are greatly influenced by social dynamics such as fads, fashion, and social movements, thus making stock market investing as a social activity. During the dot com frenzy of the early 1990s, Americans were continuously told by the media and financial experts to invest in stocks. While the stock market gradually started to see a decline since 2000, most experts failed to question if it was wise for investors to continue investing a large portion of their wealth into stocks, which was perpetuated by herd mentality. The conscientious use of investor surveys and complex quantitative methods to analyse the survey data can help investigate forces driving equity price movements. An unconventional and behavioural approach to economics made Shiller one of the early pioneers of the behavioural financial school of thought (Kulpmann, 2004, p. 33). The approach followed by Shiller goes well beyond the typical economic analysis of quantitative data, as it employs cultural and psychological analyses to explain the reasons behind creation of financial bubbles.
Literature in the field of social psychology had been used to justify the argument that individuals respond to popular opinion and societal pressures when making portfolio allocation decision alongside invoking the theory of epidemics pushed through by mathematical sociologists to show how fads can affect the behaviour of investors, culminating in asset bubbles or irrational exuberance (Kulpmann, 2004, p. 33). In reference to wide-scale social movements, it is argued that the increased media reporting of stock market news and the corresponding societal preoccupation with it resulted in a growing demand for stock and intense upward pressure on prices during the period of 1990s.
Shillers conceptual framework claims that the behaviour of investors yielding irrational high equity prices is attributed to social dynamics, wherein a conclusion related to the Keynesian general theory maintains that daily stock prices fluctuate since the investing public capriciously changes its mind. Similarly, mass psychology or social conventions may cause undervaluation in equity prices that are biased towards market retreat (Kulpmann, 2004, p. 34). It is clear that the above literature provides important insight on the essence of irrational exuberance, albeit not addressed directly and rather mentioned as an embodiment of the stock behaviour. This literature provides an initial enquiry on the similar nature of the dot com phenomenon, which when analysed from a social psychology point of view, would illustrate similar inferences that can contribute to establishing an unconventional theory of irrational exuberance.
In determining whether irrational exuberance serves as a theoretical framework to explain such phenomenon, Galbraith and Keynes speculative theories of market behaviour are important domains. These speculative theories state that an underlying cycle of actions, attributions, and regulatory reactions of participants in the market environment are related to the emotional phases accompanying market crisis (Abolafia and Kilduff, 1988, p. 177). There is a so-called action-attribution-regulation process occurring in such environment, which enables participants to create the environment that meddles with their activity (ibid). The speculative theory of market behaviour is exemplified in a case study of the 1980 crisis in the silver futures market whereby prices increased from 10 per ounce to 50 per once, which in seven months, was made to go back to 10 per ounce. There occurred a traditional maniadistress model of speculative bubbles which is analysed as a cycle of organising that focuses on the strategic actions of buyers, sellers, bankers, government agencies, and the private sector. This case study looks at how the crisis was resolved through the cooperation of powerful organisations seeking to protect the integrity of the market. Such crisis was in the first place enacted by market participants that created speculative opportunities, and this view of market process in which potential crises may occur at anytime, is indicative of action and institutional constraint that frames the structure of market environments (Abolafia and Kilduff, 1988, p. 177).
It should be noted that the silver crisis of 1980 was a speculative bubble that was socially constructed. Such a bubble is characterised by traditional phase structure as mania, distress, and panic which is reframed as a process of organising involving the strategic actions of speculators, bankers, brokers, regulators, and mass media. These actors are said to be involved in overlapping and interdependent realms and are engaged in a conflict over the norms of transactions (Abolafia and Kilduff, 1988, p. 178). It must be emphasised that such crisis an outcome of a struggle between competing groups or coalitions who each seek to promote its own competing parochial interest, and not merely produced by disorganised behaviour of an atomized mass of speculators (ibid). A carefully orchestrated action of institutional actors resolves such crisis, out of a concern to prevent further damage to specific participants in this market and related markets. This market model is reflective of economic behaviour that is strategic and political, which is likewise entrenched in institutional structure. This literature is relevant to be used in this chapter since it provides significant insights on market behaviour characterising emotional phases and cycles of actions, attributions, and regulatory reactions of participants in the market environment which irrational exuberance is often an occurrence.
In line with the definition of irrational exuberance, it is worth-mentioning that the stock market in Tokyo fell sharply and closed down while Hong Kong fell at 3 percent, London at 4 percent, and the United States at 2 percent. The concept of irrational exuberance could be held responsible for these stocks occurrences and the global economics in general, with its notion serving as a theoretical explanation for the boom and bust of dot com companies. The framework of irrational exuberance gives way to a heightened state of speculative fervor in lieu of logical return-on-investment analysis. This involves irrational markets, speculative market excess, stock market crash, and speculative bubbles (Shiller, 2000, p. 282). This speculative fervor, albeit being irrational, is repeatedly reinforced by mass media and sustained by wishful thinking. The dropping of the stock prices, eclipsed by more significant subsequent events, led the phrase irrational exuberance catching the public attention (Shiller, 2000, p. 283). The author calls out the alluring yet deceptive nature of Wall Street he explains how so many experts have been wrong about stock prices and how they have been able to get away with utterly wrong predictions. In essence, Shillers book challenges the basic working of Efficient Markets Theory, especially in times when euphoria takes over common sense. Below is a graph showing how stock prices, earnings, dividends, and interest rates rise up since 1871
Figure 1 On Stock Prices, Earnings, Dividends, and interest Rates
The above figure shows a heightening increase in stock prices and a likewise increase in the earnings although not much as compared to stock prices. The latter end of the period in the graph that is, 2000 - shows a bust, which Greenspan, in his speech before the Federal Reserve Board in Washington in 1996, describes as irrational exuberance.
Nevaers (2008) research data points out retail financial products are closely linked to the dot com era and are particularly applicable to the irrational exuberance theory, because financial retail determines cash flow and irrational exuberance directly influences the resources available. Reliability is vital for online success and understanding the retailing aspect is important to plan a successful dot com business, since financial management is a pivotal aspect of Howcrofts irrational exuberance framework.
The theory of irrational exuberance in theory is pragmatic and is fully normalized which deeply focuses on entity types in the conceptual model. The theory, as proposed by Howcroft is directly applicable to the nature of this dissertation, as the key attributes linked to the dot com boom began to fizzle out even before the companies realized that their businesses models were collapsing. Although the theory does not directly guarantee business consistency and avoidance of practical problems, it does serves as a framework to analyse potential decline ahead of time and plan for it accordingly.
As the dot com companies were too optimistic for their own good, they failed to integrate this theoretical framework it into their own business models, which could have helped reduce the extent of damage done to them. As this model was not implemented, dot com boom began to decline severely which saw the closure of many websites and their business models.
When comparing both the graphs above, the 2001-2002 drop shows how the dot com bubble suffered much harsher consequences than the current economic crisis. The UK market shared the same expereince as that of the United States. Below is a graph showng how the dot com crash contributed to the overall decline of the economy.
Howcrofts theory is further linked to the dot com bust as irrational exuberance raised asset values of dot com companies beyond acceptable levels, making them became subject to unexpected and prolonged contractions. The theoretical model of irrational exuberance incorporates cryptic warning insisting that the industry is close to being overhauled. In close correspondence to the dissertation title, the dotcom companies did not see this cryptic warning as a serious warning and continued to trade with no regard for the social status and economic conditions of potential customers. The competitive and inflated dot com organizations were in serious jeopardy of folding since innovation had reached a saturation plateau (see appendix, Graph IV). In a similar sense, the theoretical framework of irrational exuberance had actually foretold the dotcom bust since tech stocks had also reached a plateau, while investors continued to work on the blind faith that stock prices would continue to increase on an unlimited basis. With this in mind, Howcrofts model points to the notion that a dangerously inflated bubble regarding dotcom organisations was close to bursting.
Howcrofts analogy and theoretical framework of irrational exuberance is indeed extremely useful in assessing the efficacy of dotcom organisations and the precise mechanisms of dilemma which followed in light of unexpected changes by investors. Dotcom decline did indeed ensue as investors started to convey the theory of irrational exuberance into their own business decisions. While this prompted businesses to appreciate the obscure risks that were involved in running dotcoms and incorporate them into their business models, it was far too late to save the dotcom boom from going into a downward spiral.
The graph below shows massive injection of money following the dot com bust
It is important to note that during the height of the dot com fever, investing in print magazines or newsletters was not an option, since investors believed the whole world would automatically move into the Internet (Woodard, 2006, p. 358). Again, the irrational exuberance framework applies here, as overenthusiastic assumptions led investors to believe in modern miracles. This even led print publishers to transform themselves into web-based enterprises. But today, since that the dot com mania is over, most print publishers have taken a step back and stopped investing a large share of their capital into web-based ventures (ibid). That being said, most print companies have adjusted their business strategies to reach out to the demographic that is already jumped on the electronic bandwagon, in order to adjust to the boom-and-bust phenomenon.
The fact that dot com companies having weak business models caused a bandwagon effect was later argued by Shiller (2000). According to him, people had the impression that online bookstores were to take over the field when Amazon.com began to sell books online. Buono (2004, p. 146) supports this literature in his discussion of ComCorp, in which rough revenues of 3 billion worldwide were reaped in 2001, with approximately 8,000 employees. The company was a pioneer in the computer networking industry but was challenged by the turmoil related to the deregulation of the telecommunications industry along with the dot com fever-turned-bust. Along with these events, there occurred reduced capital spending for computers and computer networking equipment that resulted in revenue decline of ComCorp, pushing the company to restructure and downsize its operations (Buono, 2004, p. 147).
From the perspective of the Keynesians, the dot com boom and bust can be interpreted as a phenomenon that occurred primarily due to the endogenous and exogenous factors affecting the US GDP. This notion thus implies that the dot com bubble can be interpreted through various economic models, not just exclusively through the irrational exuberance framework. The business fluctuation that took place in the dot com phenomenon was no longer new as it was expected to happen given the behaviour of each fundamental component of the economy. This is exemplified by the market boom that was in full swing in 1996, considered the year of Yahoos IPO during which investment banks busied themselves making 3 billion for underwriting internet IPOs worth 100 billion into the stock market mutual funds (Taylor, 2008). AOL had acquired Netscape for 4.2 billion in 1998 and Time Warner for 165 billion in 2000, considered the largest media deal widely heralded as the merger of old and new media companies, which was believed to pave the way for the future. It was hence assumed that AOLs internet business would rapidly transform Time Warners traditional print, film, and television businesses (Taylor, 2008, p. 220). The backlash of the dot com bubble includes rampant off-shoring, severe devaluation of the IT industry, and diminished salaries and opportunities. The graph below shows the flow of the dot com business.
It is important to note that the changes in economic fundamentals that began in mid 1990s have actually provided investors a reason to believe that the market was indeed growing. Stiglitz asserted that the US economy indeed experienced increase in productivity and GDP prior to the bursting of the dot com bubble. However, technology investments mysteriously kept failing, as it reflected in the data on the nations productivity (Stiglitz, 2002, p. 370). This was an eye-opener which made most of the common investor folks realise what they had gotten themselves into.
Similarly, Gibbs (2001) discusses the irrational exuberance that happened during the proliferation of the dot coms, in which rampant optimism trumped basic criteria such as intrinsic financial longevity. Venture capitalists generously funded young entrepreneurs merely based on the nature of their business without taking a second look into their strategy, which eventually crashed the course of the market from capricious optimism to deep gloom. Looking at the larger picture, these developments led to the creation of a communications framework for American culture to penetrate and change every culture it touched, in the same vein as the Levi Jeans Effect (Gibbs, 2001, p. 74). Gibbs work attempts to understand the far-reaching socio-cultural consequences of the dot com bubble. This literature is aligned to the argument posed by Kulpmann (2004) and Shiller (1989) concerning the nature of the financial economy in which the stock behaviour is vested in, in the same manner as irrational exuberance is a product of erratic market behaviour that has influenced the emergence of the computer and network industry.
Irrational exuberance has been a distinctive feature in the evolution of the new economy and electronic commerce has multiplied this effect by providing easy access to a broader range of investors (Ferris and Pecherot Petitt, 2002, p. 107). Therefore, even a company without prior history of operating earnings would had a chance to go public, thanks to the considerable enthusiasm of reputable investment bankers towards business entities with a .com in their corporate name. This posed a new challenge for valuation analysts particularly on how to value an entity that bears only profitability prospects in the foreseeable future but no history of earnings or cash flows. This condition required a period of considerable change and introspection, after which new valuation techniques were introduced as part of the new economy (Ferris and Pecherot Petitt, 2002, p. 109).
A new valuation technique was employed in the period of considerable change and introspection characterising dot com companies, foremost of which was the market price-to-sales (PSales) or the market price-to-revenue multiple approach. This approach is calculated as illustrated (Ferris and Pecherot Petitt, 2002, p. 109)
While Ferris and Pecherot Petitt attribute overvaluation of companies to sheer naivety, they also present several approaches to improve the valuation accuracy of companies. The book takes on a very practical approach by presenting actual data based on real-world case studies of corporations.
2.3 Understanding Irrational Exuberance in the IT Context
Nevaer (2008) discusses irrational exuberance in an IT context, by emphasizing the ability of new communication channels to connect a firm with the infrastructural entities of other organizations, bring down barriers and create a new business global village. Digital firms had to select the most suitable Internet technology that complied with their business processes and data structures, as there are different kinds of hardware and software tools for different business applications. Therefore, this raises a big question of whether choosing the right albeit expensive set of technologies for the firms IT infrastructure conforms to the model of irrational exuberance (Ritchie-Dunham and Rabbino, 2001, p. 29). It is very difficult to practically manage a firms IT infrastructure since e-commerce often requires firms to frequently reassess their IT infrastructure to remain competitive. Moreover, a company has to keep up with the technology in order to deliver quality goods and services. The ever-changing nature of technology and the associated unpredictability makes it harder to set stock prices based on the conventional irrational exuberance model (Ritchie, 2001, p. 31). Therefore, this required the reconstruction of information architectures and IT infrastructures.
From 1982 to the first quarter of 2000, the bull market in the United States dominated the markets in all other G15 countries. This phenomenon is explained by the three competing hypotheses, namely (1) the new economy concept, (2) the falling risk premium hypothesis, and (3) the theory of irrational exuberance. Evans (2003, p. 74) states that the theory of irrational exuberance is diametrically opposed to the first two hypotheses which are consistent with the theory of efficient capital markets. This position puts the research on a rather shaky ground, since the irrational exuberance seems to be an unlikely framework for explaining the boom-bust trend of the dot com companies. However, Evans (2003, p. 76) later goes on to state that the supply and demand theory associated with the stock market trend is consistent with the notion of irrational exuberance. The author states that all the three theories mentioned herein remain inadequate in themselves in explaining the equity dynamics of the United States in the 1990s.
The application of irrational exuberance framework in dot com companies first involves looking at the assailing trends in the business. Although new Internet companies had incurred major expenses, almost none of them could claim to have had legitimate revenue streams. As these companies did not pay dividends aside from not having many assets, conducting fundamental analysis was considered extremely difficult (Taylor, 2008, p. 216). This difficulty may be furthered as a cause for relying on economic indicators or a theoreticalconceptual construct governing an economic activity. Moreover, Taylor emphasises that the difficulty in determining market capitalization complicates the process of establishing a reasonable valuation for Internet companies. While several million shares of stocks may be issued by a company, only a small number are traded publicly. This is illustrated by Amazon.com, which traded only three million shares on the open market despite twenty billion shares issued in its IPO. A huge amount of capital chasing a limited number of shares of stock in the late 1990s prevailed with vast amounts of liquidity available and the media creating a huge buzz about the internet.
When the classical law of supply and demand is applied to this situation, scarcity drove share prices up to unreasonably high levels, which made the market cap to be disproportionately exaggerated (Taylor, 2008, p. 217). Taylor does not stop at viewing the stock market problem from an economic perspective as he believes that an economy cannot function in vacuum and needs a socio-cultural medium to evolve in. His views serve as the voice of dissent against speculators who hype and greed to their own ends. Taylors grasp of economics as well as socio-cultural issues shines through in this book, as the interweaving aspects of the stock market that bring about irrationality in investors are discussed in the book. The very nature and propensity of how dot com companies operate and manage their businesses thus need closer examination when looking for a model that best fits analysing their boom and bust. This literature exhibits the direction of the emergence of the dot com era along with the flourishing of the software and IT industry.
With more linkage to the irrational exuberance model, the foundation behind the growing success of the dotcom era is concise. The Internet is still powerful as it offers ease and expediency, which appeals to consumers as it facilitates an alternative method of shopping and conducting business while saving valuable time, resources, and counteracting storage insufficiencies. E-commerce allows society and business to function collaboratively, resourcefully and competently in todays rapid paced society. As a direct result of global e-commerce awareness, communication methodology has changed dramatically within the business arena. Businesses now predominantly use the electronic medium to transfer information (Witham, 2006, p. 9).
Some examples of the difference in current business strategies to old methods which have been covered by the model of irrational exuberance are (1) Information acquisition businesses can now use web pages to gather information, which is easy compared to the traditional method that involved researching books, articles, brochures, catalogues and magazines (2) Sending and receiving payments Electronic Funds Transfer Point of Sale, EDI (online databases) and (3) Interstateinternational communication letters, mailings, printed forms are now replaced mostly by efficient email usage (Witham, 2006, p. 10).
Online businesses possess key benefits in retail as sales are conducted more speedily while business expansion and new product addition has become a simple proposition to the management. E-commerce is ideal for those who lack the time and ability to spend time searching for a particular product in a small quantity. The product range that consumers gain access to through one keystrokemouse click is immense as the introduction of search engines had allowed a variety of different businesses to be located in one spot. The cost of products bought through the e-commerce system can be generally less expensive than those bought at stores. This is due to the fact that many of the products purchased are sold directly from the manufacturers, thus, cutting out price mark ups and middle man costs. This also means that bulk purchasing of a product in an exact amount is hassle free. The irrational exuberance theory points out that bulk purchasing has inadvertently caused the dotcom bust due to ineffective use of resources. Overhead costs of online businesses are much lower than store based businesses as the only salesmarketing costs that the business must pay are those of website usage and design.
According to Nevaer (2008), the economic crisis faced by dotcom companies include challenges faced at microeconomic and macroeconomic levels. There is a common concept that when you sell online, you sell to the world. This concept is quite far from the truth and it underlines the irrational exuberance theory, since companies only estimate the resource availability without accurately analyzing the market. In order to deploy a good dotcom business, there were some strategic challenges that needed to be overcome, in addition to facing competition and adhering to government regulations.
Dot com businesses also required a complete change of the business structure. Firms that were planning on going digital needed to consider restructuring their entire business model or even creating a new one from scratch. They need to implement new management processes, changes in business culture and follow different procedures for managing their employees. Also, they need to create a new structure for information systems, networked processing functions and more importantly change their business strategy. As some companies try to launch dotcoms without changing any of the above, they are most certainly destined to fail. A firms business model will have be in line with the irrational exuberance framework in order to be successful on the long run without being adversely impacted by the highs and lows of the stock market. Digital companies also need to be prepared to face strategy-related issues, since the same strategies will yield different results in the real world and the online world (Nevaer, 2008).
New strategies are required for customer service, advertising and ordering. A digital firm has to consider building a well-structured and very secure paying system. Such systems are used for the payment of goods or services online. This is probably the most essential security action for doing online transactions. There are quite a few diverse systems developed for different purposes, and therefore a firm must consider all the options carefully before implementing one. Some of these payment systems include digital wallet, electronic cash, micro payment and smart card. Despite the fact the drivers of dotcom businesses suggest increased revenue and cost reduction, Nevaers (2008) research data does not seem to conclude with a similar inference. Many dotcom companies met failure due to the fact they could not generate enough revenue to actually cover their expensive marketing campaigns, labour costs and technology infrastructure. Dotcom companies may not have the costs of retail stores and front staff, but they have other costs such as call centers and large warehouses. Dot com marked a new era in business and therefore the business models that were created were new and mostly not tested for long-term success (Srinivasan, 2005). Therefore, several vital dotcom business processes must be redesigned in order to meet the expectations set forth by the proponents of e-commerce. The supply chain management along with the co-ordination of the firms other departments, production line and sales stores are more likely to undergo change. Looking at electronic infrastructure development from a broader perspective is also critical, since it is indispensible for coordinating online transactions, business activities as well as the potential linkage with other firms within its industry.
2.4 The Emergence of Dot com Phenomenon
In his 1994 book Peddling Prosperity Economic Sense and Nonsense in the Age of Diminished Expectations, Paul Krugman suggests that there is a relationship between technological innovation and fluctuations in the business cycle. The dot com phenomenon is an example in which the business cycle is driven by technology. With the rise of technology in the 1990s, economic growth has taken place and innovation has slowed down as current technology reached a tipping point, leading to decrease in productivity. His hypothesis states that long-term economic growth cannot be sustained in the absence of a continuous technological progress (Krugman, 1994, p. 91). This point is quite valid and investors will have to keep a tab on technological advancements to get a pulse on the Internets potential for growth. Based on his book, the dot com bust has similarities with the productivity slowdown of the early 1970s because the set of technologies that had driven the postwar boom had been pretty much fully exploited, while the technologies that will eventually power another boom were not yet ready for prime time (Krugman, 1994, p. 91). This point strikes a chord with the irrational exuberance framework, as it concedes the fact that all productive eras come to end before another one begins.
Krugmans literature is relevant in this study as it focuses on the significance of technology in the advancement of e-commerce. This discussion is aligned to that of Howcroft (2001) who argues that the development of the Internet and telecommunication industries represents significant potential for change, yet it appears that the response of the stock markets in the late 1990s concerning return on investment of Internet stocks was based on irrational exuberance rather than sound economics. Howcroft suggests that the assumption about the Internet and e-commerce as two major investments complimenting each other is underpinned by inherent determinism. This is because of the belief that innovations in technology drive changes in society, and that the population is ready for e-commerce. However, the author highlighted that there is a difference between having all the technological elements ready and having proactive marketing strategies for the implementation of e-commerce.
Central to Howcrofts analysis is the management failure that occurred within the frenzied buying of overvalued dot com shares, which concurs with the ideas presented in the literature of Ferris and Pecherot Petitt (2002), Shiller (1989), and Evans (2003). The notion of irrational exuberance was personified in the myths that prevailed during the glory days of the Dow Jones, and Howcroft attributes these attitudes as the elements that led to the dot com boom and bust during the late 1990s. Her literature signifies the importance of technological literacy among the public for them to appreciate online shopping, which is practically an addition to the earlier notion of the integration of commerce and technology in e-business. Without internet literacy, no consumer will shop online and prefer this mode to traditional shopping. It may be inferred based on this literature that unrealistic expectations led to the creation of myths, which for a long time had persisted in the dot com era, giving false hope to businesses and the economy. The continuity of the dot com businesses was thus an offshoot of technological advancement that saw mere potential in business and market modifications, but still continued to exist in the old realm of capitalism.
Nevaer (2008) also refers to the irrational exuberance theory and correlates it to the dot com era, while implying the theory was advantageous to the likes of Silicon Valley and Wall Street. There was an astronomical amount of economic activity stemming from new information technologies, the vast majority of which came from the Silicon Valley region. Huge stock was placed on software companies, development agencies and websites, which did not actually possess any real commodities or assets. Irrational exuberance theory precisely states that placing such a huge stake on such companies and inappropriate proliferation of those resources can be catastrophic. As their worth was set in the cyberspace, an unprecedented level of investment was put into Silicon Valley researchers. However, it was unusual that they were not subject to the social stigma of developmental failure and were simply expected to develop new ideas in the dotcom era. So, in essence, a lot of money was wasted even before identifying a successful formula, in hopes of clawing back their losses from future success. The irrational exuberance theory warns against this type of thinking as this fiscally irresponsible mentality was the catalyst for the dot com bust.
As Silicon Valley was perceived by investors to the centre-of-the-universe, it affected overall changes in society and resembled Wall Street in the 1980s (Suijker, 2003). Venture capitalists were investing vast sums of money because they believed that success was virtually guaranteed. As the ultimate predictor of downfall according to the irrational exuberance theory is market saturation, the least efficient websites and dotcom businesses were cut away and the Internet bubble burst precisely in line with the theory of irrational exuberance. All of the virtual money that was generated on the Dow Jones stock exchange was wiped off clean as the speculation market collapsed. Only the dotcom businesses that were running efficiently and offered the public something that it wanted, survived (the most competitive firms that could survive on their own). The question now was whether or not the new economy that was created by the dotcom boom, computer sales and new information technologies still existed. This question was addressed by Witham (2006, p. 9) as he mentions that a substantial fraction of the investment made during this period still has social value in spite of losing billions of dollars in the Internet bubble. This showed that there were some positive remnants left over from the new economy, although things could have been much better if it werent for the initial inappropriate use of resources.
Shiller (2000) best describes the inquiry behind irrational exuberance, particularly dwelling on the discussion of the stock market in the US in the late 20th century. His dissection of the phenomenon by understanding the structural aspects behind the formation of market bubbles and analysis of cultural aspects such as hype created by the media and herd mentality is unrivalled. Shillers prediction was spot on, as the burst of the housing bubble paved the way for the recession and this trend it more than likely to repeat itself, unless structural changes are made in the way market forces operate. Furthermore, savings deposits proportionally decline when people start investing more on securities, which again can be considered to be a clear indicator of things to follow.
Buonos research of IT companies also confirms the validity of the irrational exuberance framework, since companies management styles have started to swing to popular notions, much like the way the clothing, music and art works, thereby leading to a surge of success followed by decline. It should be reiterated that the boom and bust are not solely dependent on general economic operations of the larger economy andor asymmetric information earlier mentioned in the previous literatures of this research. Rather, the analysis needs to consider the manner in which dot com businesses undertake their capital spending and ascertain if it leads to equivalent results in their revenues. It is important to mention that dot coms also aimed at pursuing competitive advantage, a usual pursuit of a typical business in the globalised age (Goldfarb, et al., 2006).
This may be demonstrated by the supermarket Tesco, which launched a market-leading e-commerce service for customers and likewise used the Internet extensively for purchasing (Tipton and Krause, 2002, p. 98). Although many start-up companies that adopted innovative business models have now failed, some have however achieved profitability. For example, Last Minute (main focus travel www.lastminute.com) and Kelkoo (consumer retail www.kelkoo.com) have been operating profitability across many countries including the United States. It should be noted that the dot com era is now fast receding into the past, but managers throughout the world are still grappling about turning the e-business concept into a business reality (Goldfarb et al., 2006). The authors state that a critical moment for entrepreneurial capitalism was witnessed in the closing years of the twentieth century, which saw unprecedented levels of technology entrepreneurship that began in the mid-1990s and lasted through the peak of stock market in 2000.
The study focuses on examples of dot com companies such as WrestingGear.com, Scient, and Amazon.com, which were typical dot com startups. Scient alone earned back several billions of dollars spent by investors, while Amazon stood as one of the few firms that were able to successfully pursue profitability and obscure several small internet businesses (Goldfarb, et al., 2006). Companies in some sectors have demonstrated success but failed, as inappropriate allocation of resources occurred with no anticipation of the future. However, it has not been all doom and gloom in America as the low cost airlines such as North American airlines and Spirit airlines have succeeded in transferring the majority of their customers to online booking within a span of few years, while acquiring many new customers. These examples outline why e-commerce still prevails at present after the historical bust in the late 20th century and still serves as a precursor to the new economy.
This new economy was only an extension of the capitalist market in its changing phase, and that it is not really a new economy after all. As exemplified by the literatures in the Literature Review section (Stiglitz, 2002 Trajkovski, 2007), this new economy unveiled its real face when the speculative bubble accompanying the dot coms finally burst, giving away the idea that what took place (bubble burst) was a capitalist crisis that assumed the form of a boom and bust. The bubble that burst after this phenomenon has however proved that only technological advancement and acceptance from the masses will make it a winner in a capitalist market. The rapid expansion of the bewildering growth of e-commerce markets described by Preisel, et al. (2004, p. 210) and Taylor (2004, p.312) is primarily due to the advances in PC-based communications. It was predicted that market opportunities for equipment and infrastructure providers would grow rapidly along with opportunities for well-positioned software firms, services companies and contentaggregation companies.
During the transitory period following the bust, the inadequacies of dot com companies started to surface in spite of internet technology growing swiftly (Taylor, 2004, p. 215).
2.5 The Nature of Dot com Companies
In some traditional industries, the impact of the Internet has been immense as shown by the banking industry. Banking shows that in a seven and half-year period (May 1999 to December 2007), the number of households using online banking increased to 100 million worldwide and around 6,000 different financial institutions offered web-based banking. Meanwhile, many business-to-business companies and governments have encouraged their customers to use their online services in order to speed up operations. In this post-dot com era, managers are looking to learn from the experiences and study the irrational exuberance theoretical model and subsequently identify success factors and incorporate best practices while trying to avoid the costly mistakes made by others (Navaer, 2008). Goldfarb, et al. (2006) suggests business creation during the dot com era was characterized by irrational beliefs such (1) a Get Big Fast business strategy was an appropriate mode for internet businesses (2) the rise and fall of VC investment sizes and total investment is considered as the most dominant event in the Internet (3) exit rates of dot com firms are comparable to those of entrants in other industries during their formative years, and (4) survival is not related to the amount of private equity financing. This study delineates the relevance of irrational exuberance in the emergence of the dot com era in the United States. The above literature lists out the aspects that form the basic foundation of the theoretical construct of irrational exuberance. A brief review of factors underlying dot com failures is presented through the concept of irrational exuberance.
It is significant to note that alongside the rapid growth of e-commerce and the internet, several managed security service provider (MSSPs) were formed during the height of the dot com boom of the mid-1990s. These businesses initially preferred to focus on their core businesses but later decided to cash in on the opportunity to provide computer security services to other similar technology companies (Tipton and Krause, 2002, p. 367). The authors point out that dot com companies eventually took their expertise in security with new technology as the and evolved themselves into managed security service providers, as the boom turned into bust. However, a rapid consolidation and fallout among MSSPs occurred, as they were not able to achieve financial stability. It is important to note that outsourcing frequently appears to occur in these circles, contrary to the ancient tenet of not making information available to those who do not need to know. It is said that exposing the corporate business model to an outside entity would seem inimical to good security practice, which is shocking since technology-companies based are supposed to know better and yet succumb to irrational exuberance (Tipton and Krause, 2002, p. 368). The authors bring up certain key computer-related security issues that are seldom discussed.
Taylor and Francis Group (2006) agree with Tipton and Krauses assertion that several MSSPs were formed during the dot com boom of the mid 1990s in synergy with the rapid growth of e-commerce and the Internet. The group articulates that rarely would one encounter reading a discussion of the growth of the Internet without having to associate the word exponential to describe the rate of such expansion. However, businesses have started to move more slowly to protect the information made available to others, thereby leading to rapid integration between Internet and corporate business models (Taylor and Francis Group, 2006, p. 367). It is interesting to note that the Internet itself has developed a personality of being open, yet being filled with companies are characterised by a closed corporate attitude. This literature presents a deeper view of how world economics have slowly transformed through the dot com era after the introduction of the outsourcing business, which is mainly powered by information technology and the Internet. This is essential in analysing the extent to which the boom-bust trend of dot-com companies has modified old economic and organisational structures of businesses.
Taylor (2008, p. 216) states that financial markets had never seen such tremendous growth, and thus new ways to evaluate Internet and web-based companies were conjured up by several analysts and investors as they faced a rapidly changing business situation. This tremendous growth can be interpreted as the basis on which analysts and critics have declared that a new economy has been created they have also started to urge other aspects of life to work in partnership with the dot com businesses. As dot com businesses are yet to find it an ideal analytical framework to analyse its existence, the end of the dot com era marked the beginning of a period in human history technology transformed every aspect of business, government, society, and life in general (Roberts and Bellone Hite, 2007, p. 251).
It is worth mentioning that dot com businesses exist in a virtual world, and thus it differs in its day-to-day operation. Buono (2004) states that there are two primary characteristics that distinguish virtual teams from conventional teams spatial distance and technological mediation. Virtual teams vary from each other on several dimensions, such as the proportion of time spent working virtually as compared to conventional employees, the proportion of team members at any one location, the proportion of time spent on virtual team compared to those spent to other tasks, and the relationships between team members. On studying ComCorp, it was understood that their teams were highly virtual as they had experience in working on a dot com business and relied heavily on a variety of communication technologies and a web-based groupware application (Buono, 2004, p. 149). It should be noted that task complexity poses constraints on how virtual teams were designed, which directly influences how leadership functions are carried out in the organisation. This literature is significant in that it elaborates how leadership and human resource functions are characterised in a dot com environment. Buono supports the assertion of Howcroft (2001, p. 197) and Kaplan (2004, p. 21), by concluding that the atypical setting of the dot com business have contributed to creation of various myths regarding its existence. It may be furthered that looking at its operations might provide a good data grounding for analysing the internal mechanisms of a dot com business and understand why a business of this nature captured the imagination of investors. However, the authors do not make any link to competitive strategies or advantages.
The dot com era is not an extremely new phenomenon since the first introduction of an e-commerce strategy came in the early 1960s and 1970s with the introduction of Electronic Data Interchange (EDI) (Kaplan, 2002, p. 21). More recently, companies have moved from the idea that simply having a website for an online presence was adequate to fully implementing e-commerce strategies. This has had a number of impacts on businesses, as companies have had to reassess their business models to be in line with contemporary leaders in the dot com game. Employees no longer have to work from an office as they can do it from home. Market and channel strategies have also changed, as e-commerce has expanded the common marketplace to international markets, reflecting the importance of segmentation and customization. Relationships with suppliers have now been greatly improved due to advancements in communication. The ones to provide a proper infrastructure for this implementation are felt by nearly all businesses (Kaplan, 2002, p. 22).
Security for e-commerce businesses is constantly being improved, as top priority is given to protecting consumers from previous concerns such as possibility of credit-card theft, computer hackers, and the wrongly processed orders. To overcome difficulties associated with the inability of consumers to physically see, smell, touch, taste or hear their purchases, businesses are increasingly offering a money-back guarantee, free trial periods, and many other interactive features to make online commerce resemble conventional store purchases (Kaplan, 2002, p. 23).
2.6 The Boom and Bust as a Result of the Bubble Burst
It is important to discuss the nature of the economic bubble that hit the dot com business in the late 20th century. Palgraves Dictionary of Political Economy (1926, in Garber 2001, p. 7) cites a pre-modern definition of a bubble, which is any unsound undertaking accompanied by a high degree of speculation, which exactly describes a bubble from an irrational exuberance framework. It suggests that existence of a bubble cannot be known unless the bubble bursts, since commercial undertakings that have a high degree of speculation may very well turn out to be quite successful. Therefore, only the long-term results of the investment will determine if it an undertaking was unsound. (Garber, 2001, p. 142). A speculative bubble is typically characterised by high prices are temporarily sustained largely by investor enthusiasm rather than by consistent estimation of real value (Shiller, 2000, p. 35). Shillers work agrees with Stiglitzs in the sense that both explained the dot com bubble by exposing the failure of investment bankers to exercise caution and failure of dot com CEOs to provide credible information to investors. It may be posited that such a bubble encountered by dot com companies is no different from the bubble encountered by typical businesses operating within the capitalist and open-market framework, and can thus be analysed by employing the same framework used to analyse similar bubbles.
The dot com boom and bust is similar to unreasonable individual and corporate speculations that occurred in other episodes in history (Kaplan, et al., 2004, p. 21). A period of rapid economic growth characterised the dot com bubble, which is similar to other speculation bubbles experienced by industrialized societies as they encounter an economic recession (Ibid). It must however be considered that with the dot com phenomenon, individuals and corporations took boundless risks while ignoring traditional business practices and social values. The authors express that the dot com bubble witnessed a loss of traditional human resource intelligence, regulations, fast rates of change, and massive early investments exerting heavy pressures to produce goods quickly in exchange of a positive cash flow. They argue that several myths affecting human behaviour have transpired as a result of the social environment created by the dot com bubble, which is a testament to the far-reaching impact of the dot com phenomenon. This scenario points out to the massive and drawn-out results of the dot com bubble that some critics have viewed as a product of the irrational exuberance framework.
The rapid expansion of the astonishing growth of e-commerce markets in terms of suppliers and turnover came to an abrupt hold in the year 2000, marked by the failure of several promising Internet-only firms popularly known as dot coms (Preisel, et al., 2004, p. 260). While this came as a shock to many, people who were well-versed in the functioning principles of the stock market saw it coming all the way. Therefore, assuming that the dot com bubble would last forever would be naive to say the least. When viewed from a larger social perspective, it becomes apparent that the human need for never-ending progress and failure to be contented are some of the psychological aspects behind this phenomenon.
A re-evaluation of dot coms and other Internet-related firms performed by stock markets brought back indices to normal values, thereby ending the hype of a new economy. The continuing growth regime, increased productivity and high employment levels are all now considered just another peak in a continuing cycle and brief event in business history (Preisel, et al., 2004, p. 261). This literature supports the inferences posed by Kaplan (2004, p. 212), Shiller (1989, p. 195), and Evans (2003, p. 198) where it has been argued that the socio-economic environment of the dot com bubble was unsustainable. Preisel calls for a more realistic analysis of past events and future perspectives in the dot com arena, given the rocket-like upward movement of market valuation and their subsequent lack of sustainability.
Furthermore, it is also not sufficient to merely look at the relevance of the developments in the IT industry as the sole basis for analysing the boom and bust of dot coms. Looking at the economic theoretical framework as a whole would guide the analysis is a more meaningful, positive direction. This line of thought synergizes with the literature of Trajkovski (2007, p. 108) who notes that the business cycle of boom and bust has become an integral part of capitalism, which is likely to get smoothened out eventually. The literature points out that the new economy poses another example of unsurprising surprise, a kind of surprise that confirms certain predictions. This is in synch with the enquiry, how far would contemporary economies go in the absence of economic regulation and management (Trajkovski, 2007, p. 109). New economic theorists state that the proliferation of the dot com businesses can only be construed as a biologically isomorphic, multi-agent system subject to emergence, in which the field of possible emergences is delimited. This field includes new means of production, state intervention, and labor politics, in an attempt to vouch for safe creative developments (Trajkovski, 2007, p. 109). Trajkovski also concludes that this is not new economy by any means and concurring with most authors reviewed in this research. This again reemphasises that the nature of a speculation bubble, as the dot com eras true nature was not understood until it failed.
It should also be pointed out that diversifying a portfolio across countries helps in effectively reducing risks in the midst of a bubble (Stiglitz, 2002, p. 370). The author mentions that deregulations on many segments of the economy including telecommunications, utilities, and banking led to its downturn, which can be further correlated to the direction of Keynes framework, the monetarist concept, and Schumpeters literature. In relating the activities that preceded the dot com burst, Stiglitz implies that asymmetric information i.e. an information failure in the stock market resulted in overvaluation of dot com stocks. This could result due to either the buyer or seller having incomplete or inaccurate information about the other, or when the cost of obtaining better information is prohibitive. It could also result when both parties possess unequal knowledge about a market transaction (McConnell and Brue, 2003, p. 420). Relating Stiglitzs work to that of early theoretical economists cited above, one can comprehend the importance of sharing information pertaining to market transactions.
It should further be understood that information can cause either favourable or unfavourable outcomes, depending on the usage of marketing. Based on Stiglitzs account, it is clear that investment bankers and CEOs collaborate in keeping the market information asymmetric because of the profit that it could reap from investors. In their desire to boost profits, investment bankers and dot com firms chose to create an investment hype anchored on technology, which is understandable for Stiglitz, because every business wants profit and high returns. However, citing the case of Enron, Xerox and WorldCom, it is important for the credibility of the stock markets that the profits booked be real and not based on phony accounting (Stiglitz, 2002, p. 371). The author also noted that executives at that time were rewarded based on stock prices, and not on companies performance, which also contributed to the over-valuation of shares. As the he states
Corporate CEOs had other accomplices, especially within the investment-banking community. Investment banks disseminated poor information that led to mispricing and high volatility, as their misdeeds gradually became apparent and, finally, to a lack of confidence in the markets.
Thus, the above discussion makes it apparent that that the dot com phenomenon was characterised by an atypical presentation of overvalued stocks and profits that led to the mistakable general perception that dot com companies were earning well. This is a clear-cut divergence from the common notion of stock markets which conventionally deal only with actual profits and amount of stocks, and a regrettable step into the territory of financial schemes.
2.7 Summary
The literature review provided in this study involves discussion of the emergence of the dot com phenomenon, which was considered in its initial phase as a new economic trend, dubbed as the new economy. The collection of literature discussed agree that such a trend is unsustainable and temporary, as earnings of the dot com companies and the value of their stocks plummeted, an event called bust. The general consensus is that the dot coms which lacked the necessary strategies of catering the market have not been successful in creating the speculated new economy, while their functioning and potential were in fact within the tenets of traditional capitalism. The literature review serves as the groundwork for gathering sufficient viewpoints and deciding on what kind of data needs to be collected to further the research. Furthermore, it outlines the analysis of the research pertaining to irrational exuberance as a theoretical explanation for the boom and bust dot com companies in the US during the late 20th century.
The capitalist market due to the emergence of technological advancement and in hopes of creating an indefinitely sustainable economy produced a bubble that paved the way for a short-lived economic boom merely based on speculation the reasons behind the dot com bubble burst were also discussed. The characteristics of an irrational exuberance model were discussed and it was employed to explain the boom-bust trend in the stock markets during the dot com era.
Apart from the fact that almost none of dot coms had legitimate revenue streams, they also do not pay dividends and were not backed by strong assets. They were yet to prove their potential to the investors and their laurels thus were purely based on speculation. Moreover, the media hype surrounding dot coms, glamorised atypical working environments, and herd mentality made thousands of investors to buy high-priced stocks of dot-com companies that had no intrinsic value in the real world. Due to these aspects, fundamental analysis of this phenomenon was hard to conceive. This worsened the problem as it the assessment of the stocks solely depended upon speculation and frenzy, rather than economic indicators or sound theoreticalconceptual constructs. Therefore, it became nearly impossible to accurately determine the reasonable valuation of Internet companies. This research could shed further light on these problems by scrutinizing the characteristics of the irrational exuberance framework and determine if it is suitable to analyse rise and fall of the dot com economy.
RESEARCH METHODOLOGY
3.1 Introduction
The methodology used for this research is a combination of primary and secondary data analysis. This section of the paper discusses how the research shall be carried out and outlines how analysis would be done in the study. The rationale behind the choice of research design is initially outlined alongside the construction of the method used.
3.2 Research Philosophy and Approach
The approach adopted in this research is a combination of collecting primary data with respect to gauging market mood, and further researching secondary data pertaining to the to irrational exuberance framework. Primary data was collected using a questionnaire that was designed to determine average opinion of the stock market. Secondary data was accumulated to structure a basic framework for irrational exuberance so as to determine if the boom-bust of the dot com era adheres to this formulated framework.
The primary research involves administering a questionnaire designed to understand the psyche of regular investors and determine the extent to which impulsive, random choices of those investors affect the bigger picture. To accomplish this, four simple yet straightforward questions were picked in order to concentrate on different aspects pertaining to irrational exuberance of the stock market. These multiple-choice questions were posed to a sample size of twenty-five subjects.
The sampling group consisted of fellow students pursuing different courses. As the population used for the survey belonged to a specific demographic, it may not seem to be an exactly representation of real-world stock market investors. That being said, since most of these students have some background knowledge of finance and economics, it would not be an exaggeration to consider them equivalent to casual investors who comprise a large segment of the stock market and whose mood swings affect the market. The sampling size was kept small to ensure that adequate time was spent on administering the survey properly, thereby making sure survey data obtained was accurate.
The questions were open-ended and three discrete options were provided for each question to evoke response. The questions focused on determining the average investors perception and understanding of the stock market based on their value system, media hype and peer pressure. The participants were also asked to comment on the reason behind the burst of the IT bubble, which also happens to be closely related to this research. The questionnaire was administered personally and each participant was clearly told about the nature of the survey and its implications. Each question was explained clearly with background information to ensure that the data obtained truly reflected the average opinion of a typical stock-market investor.
As far as secondary research is concerned, a positivist approach was adopted to focus only on observable facts and not on subjective speculations. Therefore, the analyses and inferences drawn are based on the aforementioned research philosophy. The drawing of conclusions and their verification is the major analytical task of this research and generally follows the data collection phase. The corresponding thrust here is on display finding methods which present the data in such a form that valid conclusions can be formed (Robson, 1999, p. 476). Yin (2003, p. 52) identifies three general strategies that can be used when analysing case evidence. Of the three, he identifies relying on theoretical propositions as the most preferred. In many cases, a study is based on a particular set of theoretical propositions. This theoretical stance helped frame the research questions, and through them, the design of the study. This strategy can be a powerful aid in guiding the analysis, indicating where, and on what, attention should be focused (Robson, 1999, p. 476). The research propositions also help to organise the entire research (Yin, 2003, p. 53).
The positivist principles emphasise that the aim of research is to identify causal explanations and fundamental laws whose approach involves preoccupations with internal validity, external validity, reliability, and practical operability while phenomenological approach attempts to understand a particular phenomenon, such as the dot com phenomenon. As this understanding is unearthed, the inquiry concerning the suitability of irrational exuberance framework to the phenomenon shall be likewise established.
This was done by generating models that governed the manner in which early dot com organisations operated. Johnson and Duberley (2000, p. 40) point out that the realm of management becomes more scientific when managers are able to predict and control their environment through the generation of causal relationships governing the phenomenon. Therefore, the idea behind this exercise was to determine if this framework could be used to predict future trends in the stock market. The framework was modelled to reflect objective reality with respect to the rise and fall of the dot com era.
3.3 Research Design
As it was very hard to gather primary data for a study of this nature, more effort has been directed towards collecting and analysing secondary data. Nonetheless, primary data was collected from students by using a simple anonymous questionnaire. This instrument was used to gauge the participants perception of the stock market, its functioning, the boom-bust trend of the dot com era and healthy stocks in the current market (refer to appendix A). The idea behind this study was to determine average opinion of specific demographic, which plays a critical role in the stock market according to Keynes (1964, p. 152). This data was later grouped and synthesized to determine average opinion. If the results matched the real-world stock market, it would reinforce the importance of Keynesian theory and its role in explaining stock market behaviour.
As this study is particularly interested in uncovering the relationship between the dot com crash and irrational exuberance, the questions have been structured to gauge current average opinion of the stock market and check its validity. Furthermore, the sampling size was limited to have control over the environment, as loss of control could affect the researchs validity. In a survey of this nature, the accuracy of the results depend upon the honesty of the respondent, which is why only a few students that were serious about the study were considered while administering the questionnaire.
Secondary data for the study was acquired through library research. Analysis was conducted on secondary data to draw inferences on the subject of irrational exuberance as a theoretical framework. This method of data collection was deemed relevant in successfully fulfilling the task of establishing whether irrational exuberance can serve as a theoretical construct for explain the boom-and-bust phenomenon of dot com companies in the late 1990s.
This study uses a qualitative design methodology to conduct secondary research. In order to analyse the boom-bust phenomenon of dot com stocks using the irrational exuberance framework, the various trends and developments that took place during that era needs to be understood in a logically deductible manner (Bautista, 1999). The analytical technique that was used for the interpretation and analysis of data is called thematic analysis. By employing this technique, all the data which was gathered from secondary research was analysed to relate them to already classified patterns. This made it easier to identify and observe patterns in the collected data, which became a critical step towards making sense of seemingly unrelated data (Constas, 1992, p. 70).
The usage of secondary research data was ideal for this study since the research problem aims to theoretically prove that irrational exuberance framework can be used to explain the unusual trends in the American dot com era. Therefore, one would be required to focus on irrational exuberance as a theoretical construct, which in turns needs the backing of secondary data as well as analysis of the following aspects
Investigation of the irrational exuberance construct and linking it to the bubble burst experienced by dot com companies
Economic investigation of the entire phenomenon using theoretical frameworks that prompted its boom and bust.
Moreover, secondary research enabled the research problem to be brought to light and addressed, which would brought about new solutions to such problems and revalidated prior solutions (Davis, 2000, p. 212). By utilising secondary research data, findings of prior studies were drawn together in order to determine if irrational exuberance can serve as a theoretical framework for the problem at hand. The secondary research carried out for data analysis shall be analysed according to the criteria outlined in the matrix below
Evaluation CriteriaEvaluation AreasElaborationMotivationIrrational exuberance as a theoretical frameworkExplained through a phenomenological approach that is linked to the stock market trends in the United States, drawing possibilities to be used as a theory to explain dot com boom-bust phenomenon.How can irrational exuberance construct be used as a theoretical framework for understanding the boom-bust phenomenon of dot com companiesIrrational exuberance as a capitalist model of analysisLinking dot com phenomenon to boom and bust thus encountered and using irrational exuberance as a capitalist construct that may systematically explain it. What systematic body of knowledge supports irrational exuberance as a theoretical framework to explain the dot com boom-bust phenomenon
How does the development of capitalism give way to a dot com boom-bust phenomenon that can be explained by the irrational exuberance framework
DATA ANALYSIS
4.1 Introduction
This chapter presents what was obtained after carrying out analysis of primary and secondary research. The primary research data was acquired by administering an earnest questionnaire to twenty-five students questions pertaining to the stock market were put forward to understand average opinion, which is a critical aspect in gauging the mood of the stock market according to Keynesian theory. Secondary research data was acquired by employing of library-based research method and relates them to the findings and analysis in the Literature Review section.
This research looks at the concept of irrational exuberance as a theoretical framework that may explain the boom-and-bust phenomenon of the dot coms in the United States during the latter part of 20th century. Apparently, the irrational exuberance construct is not yet a theory neither was there a wide range of literature using this construct to explain such phenomenological events. This research is thus an attempt to investigate whether such construct can be used as a viable theoretical framework to explain the dot com boom-bust phenomenon.
4.2 Primary Research on Irrational Exuberance as a Theoretical Construct
Primary research data was collected by distributing a questionnaire to twenty-five students to record their take on the stock market. According to Keynesian theory, the market price of a stock fluctuates based on the average public opinion of the stock (Keynes, 1964, p. 152). Therefore, the objective of this study is to get behind the psyche of a typical investor, in order to understand their perception of the stock market.
Going by Keynesian principles, average opinion about the stock market among average investors should be an accurate way to assess the mood of the stock market.
The questionnaire employed laid down four multiple-choice questions to get a pulse on what the average investor (i.e. student) feels about the stock market. This research would serve as an indicator of what the average investor presently senses of the stock market. If the results of the data analysis indeed match the opinions of market experts, then it would reiterate the validity of the Keynesian theory of market unpredictability fuelled by irrational behaviour. This, in turn, would validate the use of such principles as a framework for explaining the dot com boom-bust phenomenon.
Analysis
The raw data obtained from the study was consolidated by tabulating the answers of the questionnaires (refer to Appendix A). The option that was chosen by the majority of the participants for each question was considered to be an indicator of average opinion. When analysing the results of the survey, it became apparent that participants have quite a fair grasp of the stock market. As the stock market is greatly influenced by the sentiments of the investing public, their opinions and impulsive decisions could very well influence the overall performance of stocks. In the conversations that involved explaining survey questions to the participants, it was clear that their decision to buy or sell a stock was greatly influenced by the general mood of the market, which in turn was controlled by the media and other psychological factors. Therefore, if the media and experts irrationally expect returns out of a company or business sector, they are bound to mislead investors and eventually pave the way for a bubble burst phenomenon.
The following table indicates the survey results and is a direct indicator of participants perception of the current stock market. Each cell in the table enlists an option for the corresponding question and also indicates the number of participants that chose that particular option. The responses that are selected more often would serve as a measure of popularity and as a faithful indicator of average opinion. The following table indicates the number of times a particular option was chosen by the respondents in the study, which would serve as an indicator of average opinion.
1) General perception of stock marketa) Healthy investment opportunityb) Socially accepted form of gambling
c) Structured to reap money of the naive15642) Reasons for IT bubble bursta) Irrational speculationb) Poor management of early IT firmsc) Bit of both32203) Healthy stocks in current marketa) Financial servicesb) Real estatec) Information technology44174) Current mood of stock marketa) Bullishb) Bearishc) Neutral21112For instance, when asked about their general perception of the stock market in the questionnaire, fifteen out of the twenty five respondents had expressed that it was a healthy investment opportunity (refer to appendix A). Since this opinion is shared by the majority of respondents in the study, it can be considered as the average opinion. In spite of its unpredictable nature and instability, the average opinion about the stock market was still positive as a majority of the participants expressed trust in the stock market. As the common public still views the stock market as an honest and healthy place to invest money, the mood is generally positive. This again reiterates the fact that irrational feelings rather than rational thought reigns stronger in the stock market.
In spite of good faith in the market in general, the current mood of the market was perceived to be mostly bearish i.e. general mood directed towards liquidating assets and investing in less volatile investment venues this trend can be attributed to the recent economic recession and budget deficits. This observation coincides with Galbraiths idea the stock market can function successfully only when people are optimistic and believe in the goodness of other market players to share wealth. Similarly, average opinion indicated that Information Technology stocks were currently healthier compared to real estate and financial services stocks, indicating the high-low pattern in the stock market. It was also expressed that the spate of the dot coms in late 90s was a combined result of irrational speculation and poor management strategies.
4.3 Secondary Research on Irrational Exuberance as a Theoretical Construct
4.3.1 Deconstructing Irrational Exuberance
To understand the reasons behind stock market crashes, one has to intricately understand the dynamics of the stock market and the contemporary principles behind stock pricing. In an ideal world, a stocks price in the market would be proportional to the expected income that it would fetch a stock holder, which also happened to be the mainstream paradigm until recently. The stock market has tended to function quite differently in the past three decades owing to the human need for instant gratification.
Analysis
The concept of irrational exuberance is characteristic of a socially constructed speculative bubble whose basis of preoccupation by participants are emerging market opportunities. The literature by Abolafia and Kilduff (1988) provides a substantial insight that supports the speculative theory of market behaviour embodying the dot com phenomenon. The study concludes the institutional factors that cause this phenomenon will prove to be a recurring motif in capitalism. As mentioned in the Literature Review section (Kulpmann, 2004 Shiller, 1989 Evans, 2003), equity prices governing speculative bubbles are greatly influenced by social dynamics such as fads, fashion, and social movements, thus making stock market investing a social activity (in the case of irrational exuberance vis--vis stock market prices in the US), which can also be applied to the boom-bust phenomenon of dot coms in the late 20th century in the United States, with the emergence of and engagement in dot com companies as a social activity. In the same manner as the soaring stock market prices were analysed as lacking any accepted theory of asset price determination and having the ambiguity of stock value allowing prices to become relatively vulnerable to purely social movements (Shiller, 1989 Kulpmann, 2004), the dot com phenomenon, lacking an accepted theory of price determination (Ritchie, 2001) had also been relatively vulnerable to purely social movements. Hence, as the soaring stock market prices in the US in which the term irrational exuberance was first coined was analysed along the framework of speculative theory of economic markets, the same may be undertaken for the dot com companies which encountered boom and bust as a rumination of a similar speculative bubble.
It may thus be inferred that the dot com phenomenon alongside its boom-bust speculative bubble is not only within the domain of economic principles but also lies in social psychology as it is strongly influenced by group behaviour (buyers, sellers, mass media, government agencies, private sector, etc.) in explaining the elements of price dynamics often ignored by conventional theorists. Thus, the concept of irrational exuberance that proceeds to the boom-bust phenomenon of dot coms is a non-conventional and behavioural approach to economics. Rather, the boom-bust phenomenon is characteristic of responding to societal pressures and popular opinions as basis for making portfolio allocation decisions. The dot com phenomenon is considered a fad a social phenomenon and how it was regarded as the new economy due to the promising prospects it offered shows how fads can affect the behaviour of investors, which culminates in asset bubbles of irrational exuberance.
Below is a structure of how the dot com boom-bust phenomenon may be understood based on the Irrational Exuberance theoretical framework
In the framework above, it is seen that social psychology and economics are two fields governing the irrational exuberance framework. Socio-economic phenomena like dot coms are socially constructed based on the participants such as buyers, sellers, brokers, mass media, government agencies, and individuals, whose actions and decisions affect the speculation. The Keynesian model and the speculative theory of economic markets are theories that explain why such a phenomenon emerges and how the associated social dynamics affect market behaviour. The whole gamut is the theoretical framework of irrational exuberance which in itself is linked to the two models just mentioned.
Distinctive characteristics of the irrational exuberance framework that were responsible for causing boom and bust of the dot com firms can be used to structure the model. These characteristics can be used to predict if such a trend occurs again, so as to act responsibly and avert disaster. Following is an irrational exuberance framework tailored to explain the unusual behaviour of dot com stocks.
The following framework, inspired by Kulpmanns model, helps counteract the effect of stock market behaviour characterized by investment frenzies and crashes (Kulpmann, 2004, p. 99). If one looks at the dot com crash and then the housing bubble burst that followed from a larger perspective, it can be observed that the period of stock market lows and highs tend to occur in repetitive patterns. There is something to be learnt from this knowledge, as it can serve as a framework for predicting future market trends.
While t denotes time period, the model represents alternating financial cycles of the stock market. This model calls for an elementary change in mindset, as it involves anticipating a weak financial cycle soon after a strong cycle. When a company starts expecting poor returns from the stock market, it pushes the company one step ahead of the game and enables it to adjust its operating strategy accordingly.
Since market behaviour is a principal focus of speculative bubble embodying irrational exuberance, social dynamics are relative to the occurrence of boom and bust, in which the Keynesian General Theory of economics may be used on the aspect that dot com companies revenues fluctuate since the public continuously changes its mind. It is conclusive of the idea that social conventions may cause undervaluation in equity prices in these dot com companies, which function on the side of market retreat, such as the bubble finally bursting or the dot com market finally taken into a bust.
4.3.2 Valuation and the Emergence of Dot com Companies
According to Ferris and Pecherot Petitt (2002, p. 109), the phase between the end of the 20th century and the beginning of a new one gave way to a period for valuation analysts and investors who were schooled in the traditional methods of firm valuation vis--vis the evolution of the new economy. This new economy with corresponding valuation in the absence of earnings and cash flows had an emphasis on e-commerce, along with widespread attitude of irrational exuberance among several market participants, in which a demand for equity investments took place.
The framework advocated by Ferris and Pecherot Petitt (2002, p. 109) to calculate the value of a firm is dependent on two variables namely, an appropriate PSales multiple and future sustainable operating revenues. An appropriate PSales is determined by calculating an adjusted industry average multiple after which it is multiplied with an analysts s best estimate of future sustainable revenues in order to arrive at an estimate of firm value. A forward price objective per share is yielded by dividing the estimated firm value by the number of actual (or expected) shares outstanding (Ferris and Pecherot Petitt, 2002). The belief that it is more important for companies to grow revenues than earnings is the basis for the acceptance of the PSales multiples as a valid valuation metric. The logic behind this belief is the idea that revenues are a good proxy for marketplace acceptance (which means growth in market share), alongside the idea that firms that are able to build market share quickly will likewise achieve profitability and positive free cash flows rapidly (ibid). However, the PSales multiple as a method for assessing intrinsic value or setting share targets is considered inherently flawed since it is a relative valuation approach only and bears no indication of whether a security is fairly priced and is limited only to whether it is relatively priced to some peer group. Hence, when valuation comparisons are made across industry groups or when entire industry groups are mispriced, the PSales earnings as a method for assessing intrinsic value is of limited value (Ferris and Pecherot Petitt, 2002, p. 111).
Similarly, the PSales multiple is the basis for estimating future operating revenues when used for valuing internet companies, whereby debates are centered on the selection of which measure for estimating future operating revenue or traffic is the best proxy for future revenues. Despite reliance on several Web usage proxies, analysts consider three most common of these, specifically the number of unique visitors to a Web site, the number of page views, and the number of minuteshours spent on a firms web site (Ferris and Pecherot Petitt, 2002, p. 111). It is indicated by some research that the traffic proxy most consistently related to future operating revenues and share price points out to the number of unique visitors to a firms Web site (ibid). This explains how irrational exuberance may have taken place at the onset of the dot com era, as heavy emphasis was placed on the PSales multiple for valuing a firm in the absence of earnings andor cash flows. This change in perception and evaluation are all part of the irrational exuberance framework.
Analysis
It is apparent that the valuation method used by dot com companies are not within the traditional methods of firm valuation, which was somehow accepted readily despite divergence in orientation since the dot com era was construed as an evolution of the new economy. This new economy is what may be termed herein as a social dynamics that occurred through speculative bubbles from being a social activity. The presence of frenzied speculation for the dot com phenomenon is shown by the new valuation techniques applied to the dot com companies in which an entity (a dot com company) that bears only profitability prospects in the foreseeable future but no history of earnings or cash flows is given valuation according to new techniques constructed to suit it. Thus, Ferris and Pecherot Petitt (2002) employ a new valuation technique, wherein the market price-to-sales (PSales) or the market price-to-revenue multiple approach is employed, in an attempt to obtain a price per share. It may be concluded that this approach for valuation does not take into account earnings or cash flows, which is something essential to a business in the traditional domain. Since the traditional domain was considered a pass to conduct a business in such emerging new economy, devising new valuation techniques to suit the need of the dot coms was considered essential.
A lesson to be learned from the dot com phenomenon is that technical expertise combined with the use of technology must not be mistaken as the advent of a new economy. Rather, the dot com phenomenon still belongs to the extensive system of capitalism, which sees its height through globalisation and adapts to the changing economic and technological modes. It may be furthered that the bust is a natural adjustment taking place to be followed by another expansion, and is thus, cyclical.
The dot com era of the late 20th century flourished along with software and IT development, which opened a new market for trade, employment, commerce, and consumer confidence. Some pundits perceived this to be a parallel universe and as something that would rapidly alter the social, cultural, and economic fabric of our lives. This type of ambitious language was also responsible for stock market experts to mistake the dot com era as a new economy. It must however be noted that the mistaken new economy created new avenues for the development of new businesses characterized by faster, more efficient modes of employment and the likewise faster, more efficient software, hardware and methods of communication.
This misconstrued new economy was also highlighted by the mass media with their impetuous hyperbole, predicting that information technology and e-commerce will eventually create a new mode of economy. Favourable speculations snowballed into strong confidence in the future of electronic commerce, which in turn attracted optimistic investors and entrepreneurs. This trend continued as long as the stocks of dot com companies continuously soared, and this bubble burst when investors lost confidence in dot com companies as they did not make any profits leading to an Internet depression This clearly explains the relationship between technological improvement and economic growth while productivity increase contributes to the economy, the failure of firms to accommodate technology into their strategy ultimately led to no value being created.
It can be inferred that the boom and bust of the dot com era was caused by a plethora of exogenous factors, and not just by the technology factor. The initial success of few dot com companies in the new dot com market made others jump in until the market crashed due to saturation and inability to fully comprehend the concept of irrational exuberance. Further, the existence of a bubble in the dot com era cannot be determined until the bubble actually bursts, and only after that can one conclude that such an undertaking was unsound.
The unpredictable nature of the bubble caused by technological unpredictability does not however hinder the use of the irrational exuberance framework for analysing the phenomenon. Although some commercial undertakings have become profitable even with a high degree of speculation, this was not the case with most of the dot com businesses as they were unable to earn even a small part of revenue streams that they had projected to investors. Apart from lacking dividends, publicly trading only a small part of the shares issued during the IPO offering worsened the situation. As far as business cycles and the economy are concerned, the boom and bust of dot com companies in the U.S. are no longer new, since they lie within the conventional capitalist system which is quite familiar with high and low investment cycles.
It was also understood that businesses can also stay ahead of the market and invest accordingly, by estimating potential declines ahead of time using the model to the flow and direction of their businesses. The immediate collapse of the dot com market can be sufficiently analysed on the irrational exuberance framework, since it is a conceptual model that dynamically explains the occurrence of boom and bust. Moreover, the loss of management control, connectivity and application integration, lack of organizational change, hidden costs of enterprise computing and scalability, reliability, and security, are all encompassed within the irrational exuberance framework.
CONCLUSION AND RECOMMENDATIONS
5.1 Conclusion
This primary as well as secondary research concludes that irrational exuberance can be used as a theoretical explanation for the boom and bust phenomenon of dot com companies in the US in the late 20th century.
This conclusion is prompted by the following analysis
The results of the primary research adhere to Keynesian theory as the answers picked by the students are in line with the actual mood of the stock market. It also indicates that the average opinion behind the IT boom and bust of the late 1990s was due to a combination of irrational speculation as well as bad management strategies of early IT firms. When looking at secondary research, it becomes clear that the dot com companies that emerged in the latter part of the 20th century in the United States were initially thought of as a precursor to the new economy, which promised wealth and financial accumulation to even the most ordinary people and small business owners. A belief system that reinforces the idea that ordinary people could get rich by investing in the right stocks at the right time. While this belief is central to the functioning of the stock market, Galbraiths views were essentially conventional as he emphasized more on the basic structure of the businesses and economy as a whole.
Dot com companies, on the contrary, were often characterised by lack in earnings and cash flows and heavily relied on stock market value, which slowly became the basis for analysing its business potential, instead of being the other way around. New valuation techniques were designed to suit the character of these dot com companies that could not use the existing valuation methods based on earnings and cash flows. This shift from the conventional way of functioning based on stability illustrates the frenzied mindset of dot com investors and regulating bodies, as the promise of unprecedented lured them to behave irrationally. Existing market and transaction norms were thus modified just so they may accommodate the dot com business. That being said, it is also remarkable to note that Galbraiths description of the gloom surrounding the stock market crash in the 1920s was very much similar to the mood of investors after the dot com bubble burst.
The dot com era and the boom-bust phenomenon that accompanied are characterised as social activities that were greatly influenced by the behaviour of people in a social and market environment. The boom and bust occurrences are thus prompted by the actions and decisions of agencies around the dot com phenomenon, allowing it to behave in a fluctuating manner as it lies in the social psychology domain as well as in the economic domain. The bubble that developed as a result of speculating that the new economy would come into force upon the onset of the dot coms finally burst to give an inference that such phenomenon was a kin to capitalist model, albeit an evolution of capitalism in the globalised market, and not at all a new economy. Dotcoms initially overspending by overestimating its resource availability and incorrectly understanding its target market were also reasons behind the IT bubble burst, and thus adding support to the irrational exuberance framework.
By analysing Kindlebergers views, it was found that that irrational behaviour is a repetitive and almost predictable part of the stock market. Although the agents responsible for causing intense waves of mass speculative psychology resulting in financial imprudence are not discussed, the theory begs important questions concerning how individual rational action could lead to irrational collective behaviour. It was also ascertained that this regular rise and fall patterns of the stock values could be used by companies to adjust their strategies and allocate resources accordingly, thereby reduce the negative effects of weak investment patches and avoid total market crashes. By analyzing Shillers work, it was found that financial economics is blended with aspects of human behaviour to explain the elements of price dynamics. It was understood that his work did not stop with mere analysis of the present but also looked into the future by observing the fact that investors were moving money from stocks and creating a similar bubble in the housing market. His observation on the formation of a similar boom and bust trend in the housing market was spot on, as it eventually happened and led to the current economic recession.
Analysing the dot com boom-bust phenomenon requires linkages of social psychology and the field of economics, alongside understanding the dot coms as a social construction whose speculative bubble led to a boom-bust phenomenon with the reinforcement of the Keynesian model and the speculative theory of economic markets that explain the scientific occurrence of such bubble. The results of the primary data analysis also pointed towards the validity of Keynesian model, as it was found that average opinion indeed was driven by the whims and fancies of the public that are influenced positively by new lucrative trends and negatively influenced by fear mongering by the media hype. The boom-bust phenomenon of the dot com companies in the US in the late 20th century can thus be explained with the use of this irrational exuberance framework.
5.2 Recommendations
With the above conclusion, it is recommended that the following be undertaken
Conduct a thorough examination on how Internet businesses, using an appropriate model or theory, can sustain their growth given their character of lacking dividends, assets, and public trading.
Conduct a research on how the Irrational Exuberance framework may become applicable to firms development and adoption of new market trends.
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