Abstract
The biotech industry now accounts for a substantial and growing proportion of total R&D spending on new medicines. However, compared with the pharmaceutical industry, the biotech industry is financially fragile. This article illustrates the financial fragility of the biotech and pharmaceutical industries in the US and the implications of this fragility for the effects that government regulation could have on biotech firms.
Graphical analysis and statistical tests were used to show how the biotech industry differs from the pharmaceutical industry. The two industries’ characteristics were measured and compared, along with various measures of firms’ financial risk and sensitivity to government regulation. Data from firms’ financial statements provided accounting-based measures and firms’ stock returns applied to a multifactor asset pricing model provided financial market measures.
The biotech industry was by far the most research-intensive industry in the US, averaging 38% R&D intensity (ratio of R&D spending to total firm assets) over the past 25 years, compared with an average of 25% for the pharmaceutical industry and 3% for all other industries. Biotech firms exhibited lower and more volatile profits and higher market-related and size-related risk, and they suffered more negative stock returns in response to threatened government price regulation.
Biotech firms’ financial risks increase their costs of capital and make them more sensitive to government regulations that affect their financial prospects. As biotech products grow to represent a larger share of new medicines, general stock market conditions and government regulations could have a greater impact on the level of innovation of new medicines.
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Notes
There are a few cases in which a firm has unusually small assets in a particular year owing to an accounting write-down of the value of its assets. Nevertheless, the firm still spends enough on R&D that the ratio of R&D spending to assets exceeds 1. For those observations, the ratio was set to 1. When those observations were simply dropped from the sample, the pattern over time stayed nearly the same and the averages fell by only a few percentage points.
As with R&D intensity, there are a few cases in which a firm has unusually small assets in a particular year owing to an accounting write-down of the value of its assets. This can produce a net income to assets ratio that exceeds 1 in absolute value. For those observations, the ratio was set to 1 (for positive income) or -1 (for negative income). When those observations were simply dropped from the sample, the pattern over time stayed nearly the same and the averages rose somewhat but kept the same signs.
An average of a long period of factor returns is typically used as a measure of what investors expect to earn as a risk premium for a particular factor; hence we use the 1927–2005 period.
Vernon’s paper tests the capital market imperfections hypothesis using a two-stage least squares instrumental variable estimation procedure for a sample of pharmaceutical and biotech firms.
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Acknowledgements
Some of the work performed in this paper was supported by the Biotechnology Industry Organization. Dr Joseph Golec and Dr John Vernon have consulted for biotech and pharmaceutical companies.
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Golec, J., Vernon, J.A. Financial risk of the Biotech Industry versus the Pharmaceutical Industry. Appl Health Econ Health Policy 7, 155–165 (2009). https://doi.org/10.1007/BF03256149
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DOI: https://doi.org/10.1007/BF03256149