The Biotech Industry and Strategic Alliance

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reports in a sample of European biotechnology firms. They examine both the quantity and the quality of voluntary disclosures provided. The sentence is chosen as a recording unit because it is considered a more reliable unit of analysis. A sentence is coded with a score of 0 if it provides no information; with a score of 1 if it provides qualitative information; with a score of 2 if it provides quantitative information. Sentences containing general assumptions (e.g. ‘we strongly believe that . . .’) or information already given are coded as 0 to prevent firms from the possibility of simply adding more sentences to a report to obtain a higher disclosure score while a concise report could have a lower score. This methodology allows building both a total score for a company and various scores for more specific aspects of its disclosure. The results of this study indicate that corporate governance mechanisms and voluntary disclosure can be used strategically to reduce agency conflicts.

In addition to the presence or absence of information, according to the previous studies, content of information will be analyzed systematically through the method of weighting score which will facilitate doing research into non-financial information.

2.4 The Biotech Industry and Strategic Alliance

Regarding uncertainty of the company value, category of industries will affect investor’s evaluation of the company value. The young biotech firms are in an intense competition to discover and patent a new drug because biotech firms are highly dependent on the intellectual property generated through their large R&D expenditures and, as such, are among the most intangible-intensive of businesses.

The value chain of the typical biotech firms stretches some 10–15 years from founding through patenting to successful FDA approval and product sales. Therefore, it has large capital needs over a long period of time. In the early stages of life, the

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firm’s capital needs are met by venture capital and strategic equity investments from pharmaceutical companies. However, capital needs typically become so large that they can only be satisfied through an IPO or mergers and acquisitions by a large pharmaceutical company. Successful biotech firms therefore tend to go public rapidly. Consequently, biotechnology is a very risky but potentially very lucrative equity investment (Hand 2005).

Due to many industrial characteristics in the biotech industry such as the complexity of biotech products, long development time and rapid pace of innovation, there is the large information asymmetry between managers and investors and it is difficult for investors to evaluate the value of the biotech firm. Hence, recently many scholars make a study of the valuation in the biotech industry.

Guo, Lev, and Zhou (2004) consider that in terms of the number of companies, innovative products, and contribution to social welfare, the biotech industry is among the largest and fastest growing sectors of the economy. Because most companies develop only a few products and the entrance of a competitor poses a serious survival threat, the biotech industry is fiercely competitive and disclosure costs are generally high. And they find that biotech firms’ disclosures affect their bid-ask spreads and stock return volatility.

Guo, Lev, and Zhou (2005) think that the unique challenge to the valuation of IPOs lies in the meager information about the firm and its prospects that is publicly available at IPO date. There are generally no established histories of sales, earnings or cash flows for the firms going public and in biotech IPOs the primary assets are intangibles which are notoriously difficult to value. However, it is important to gain a thorough understanding of the valuation of enterprises that are newly introduced into capital markets because the valuation of IPOs is of considerable practical and

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theoretical importance, particularly in dynamic economies. In order to examine the valuation of biotech IPOs, they introduce the number of alliance agreements to be one of potential value driver. Alliance agreements may be value-relevant because they generally involve the contribution of research capabilities or capital by partners.

Furthermore, they often carry a positive signal about the future market potential of the product under development. However, they find a negative association between IPO price and the issuer’s the number of alliances/joint ventures. The argument may be that the IPO firm relinquishes equity in exchange for research and marketing support in the process, and it apparently reflects investors’ assessment that issuers transfer too much value to alliance partners. Although there is a negative relation between alliances variable and IPO prices, alliances variable has a positive and significant coefficient in the long-term regressions. The potential explanation is that the benefits of alliances (higher revenues and earnings) become clear over time and investors revise the early valuation to reflect the contribution of alliances.

Speaking of the benefits of alliances, much prior literature researches into the impact of strategic alliances on the company value in the biotech industry. Pisano (1991) indicates that due to the long product development cycles and the needs for cash in the hundreds of millions of dollars, biotechnology firms tend to be far from generating revenues when they try to go public. And one way that biotech firms have tried to moderate investors’ concern is to ally with major pharmaceutical and health care companies which have prominent marketing and sales expertise as well as financial capital that can support the biotech firms through product development process.

Gulati (1999) considers that strategic alliances may provide opportunities for codevelopment, the sharing of capital, technology or firm-specific assets. And in the

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same year, Stuart, Hoang, and Hybels(1999) indicate that if young firms in the biotech industry tie to major pharmaceutical and health care companies, it can signal a firm’s quality to key external resource holders, which affects IPO performance.

Based on above arguments, Gulati and Higgins (2003) propose that the signal associated with a firm’s strategic alliances may vary with the types of uncertainty that characterize different market situations and the extent to which these alliance partners are most actively engaged in evaluating young firms. During hot markets, a young biotechnology firm’s concerns regarding its ability to sustain the long discovery and development process are not as acute as during cold markets when the availability of funding is much scarcer. Therefore, during cold markets, prominent pharmaceutical/health care firms necessarily attend more closely to the potential of young biotechnology firms since so many firms come knocking on their doors for resources. Consequently, the fact that a major strategic alliance partner chooses a particular firm during an unfavorable market, may send a particularly powerful signal to outsiders, such as investors, that it is a firm worth investing in.

Besides, Jensen (2004) also argues that a firm’s alliance activity provides valuable market signals because alliances are widely observable and reflect the extent to which a firm’s resources and capabilities are in demand by other organizations.

According to previous research, strategy alliances convey a positive signal to investors. Thus, a firm’s strategic alliances may influence its capabilities as well as others’ perceptions of its capabilities. If a new firm lacks resources and suffers from uncertainty about its products and alliances can provide an access to resources it lacks, then a firm’s alliances should provide a significant buffer against the hazards.

This means firms with strategic alliances would be less risky and less uncertainty.

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