38 Pages Posted: 20 Dec 2001
Date Written: December 8, 2001
This paper sheds light on how and why the stock market values high technology by examining the pricing of 606 biotechnology firms that were publicly traded at some time during the period 1989:q1-2000:q3. Contrary to the common view that the primary value drivers of biotechnology are "soft" variables such as intellectual human capital, patents, strategic alliances and joint ventures, I show that simple balance sheet, income statement and statement of cash flows data explains some 70% of the variance in biotech firms' equity market values within a log-linear regression framework. Given the size and economic importance of R&D to biotech firms, I also explore in detail the mapping between the biotech firms' R&D expenditures and equity market values. I hypothesize that the elasticity of equity market value with respect to R&D is a function of five factors: where the R&D lies in the biotech value chain of discovery, development and commercialization; the growth rate in R&D spending; the scale of R&D expenditures; the human capital of the firm's employees; and the age of the firm. Using financial statement proxies for these factors, I find that the elasticity of biotech firms' equity market values with respect to R&D is significantly larger the earlier is the R&D expenditure in the value chain, and the greater is the growth rate in R&D spending. The value elasticity of R&D is also reliably decreasing in the scale of R&D expenditures, and the more mature is the firm. However, it appears unrelated to proxies for both the quantity and quality of employee human capital.
Keywords: Equity valuation; biotechnology; financial statement data; R&D
JEL Classification: G12, M21, M41
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