US Institutional Investors Response to the News Flow of Intangibles Intensive European Stocks: A Study of European BioTech and Pharma Stocks

Abstract

Earlier research on non-US companies has documented that listing an American Depositary Receipt results in an increase in US institutional investor holdings. It is suggested that this result arises because US cross listing, with the related US GAAP financial reporting reconciliation requirements, improves the monitoring of management in the principal agent relationship with US investors. However, for companies in some industries, greater attention to financial reporting is of limited value since market value is highly dependent upon intangibles. Non-financial performance indicators, not covered by US GAAP, are critical for valuation when intangibles make up a significant part of economic firm value. This research restricts attention to the BioTech-Pharma sector and tests to see whether US institutional investors accept enhanced disclosure of key non-financial performance indicators, as a partial substitute for non-adoption of US financial reporting standards. Specifically, tests are conducted to see whether US institutional investors are more or less sensitive to the non-financial disclosures of non-adopters. Results from the econometric analysis provide support for the hypothesis that US institutional investors respond more to the non-financial disclosures of non-adopters suggesting that US institutional investors do see enhanced disclosure of non-financial performance indicators in an intangibles intensive industry as a partial substitute for full compliance with US financial reporting standards.

How Analysts Process Information: Technical and Financial Disclosures in the Microprocessor Industry

“…Most of the evidence documents that forecast accuracy improves with firm-specific experience (Lys and Soo,4 While the microprocessor industry may be distinctive in this respect, it may also have similarities to the biopharmaceuticals industry, as examined by Espinosa et al (2009). 5 Cowen et al, 2006;Dugar and Nathan, 1995;Hong et al, 2000;Lin andMcNichols, 1998.…”

Valuation implications of pharmaceutical companies' R&D regulatory approval notifications

“…5 It is generally accepted that mandatory regulated financial statements are less important in providing an insight into the likelihood of the marketing success of a developmental drug. This is reflected in the relatively lower earnings quality for intangibles-intensive industries, such as the pharmaceutical industry (Espinosa et al, 2009). Game theory predicts that strategically optimising managers will disclose positive news while suppressing negative news about their drug development.…”

“…The argument is that voluntary disclosure is a special case of game theory, where an entity will disclose positive information while suppressing negative information, an outcome of the entity's optimising behaviour (Dye, 2001). Once disclosed, the real-options approach provides a theoretical rationale explaining why key non-financial performance variables are significant value 8 drivers of biotech-pharma companies, and that financial performance indicators are informative when released contemporaneously with non-financial performance indicators, such as drugs-in-progress (Eccles et al, 2001;Ely et al, 2003;Espinosa et al, 2009 It is argued in the literature that each stage represents definable progress for the R&D process, with patenting and pre-clinical trials categorised as basic exploration research, and with human clinical trials and NDA classified as exploitation (DiMasi, 1995;DiMasi, Hansen & Grabowski, 2003;Rothaernel & Deeds, 2004;McNamara and Baden-Fuller, 2007 One estimate is that five out of 5,000 new chemical entities proceed to human clinical trials, with only one likely to be granted approval, with an average total time of 12 years from discovery to market (Dedman et al, 2008). 5 It is generally accepted that mandatory regulated financial statements are less important in providing an insight into the likelihood of the marketing success of a developmental drug.…”

“…Consequently, studies investigating shareholder wealth effects surrounding drug development announcements have an important role in informing a range of stakeholders. In intangiblesintensive industries, non-financial performance indicators provide important signals to investors of firm performance, and can substitute for financial disclosure (Amir & Lev, 1996;Eccles, Herz, Keegan & Phillips, 2001;Ely, Simko & Thomas, 2003;Espinosa, Gietzmann & Raonic, 2009). The aim of this paper is to contribute to the literature by investigating wealth effects surrounding the exploitation stage of the drug development process.…”