Valuation in the Pharmaceutical Industry

Abstract

Valuation models are used extensively in Finance and Accounting to investigate various empirical questions. Conventional valuation models express firm value as a function of discounted dividends, discounted abnormal earnings, discounted cash flows, or price multiples. One limitation from using these models is that they don't capture unique industry valuation characteristics. However, modeling techniques can be used to modify a conventional model in order to reflect specific business processes. In the first chapter of this thesis I use modeling techniques to develop an industry-specific valuation model for pharmaceutical firms. This allows me to explore how investments in research and development, advertising, and production facilities create value for firms in this industry. In particular, the techniques used in this paper allow me to estimate and explore the economic rents generated by these investments. My valuation model is based on the cash inflows and outflows of a typical pharmaceutical firm. In the second chapter of this thesis I test whether the model is improved by adding a system of accounting accruals. I also compare the performance of my valuation model to a model with summary accounting measures to assess the importance of data disaggregation. The value of advertising investments is likely to have changed in the period investigated in this thesis because on August 8, 1997 the Food and Drug Administration announced that it would relax the rules on direct-to-consumer advertising of prescription drugs. The last chapter of this thesis is an event study of this regulatory change. I investigate the effect of the announcement on share price as well as the firm characteristics associated with the price reactions. Each chapter in this thesis answers a different question with respect to valuation in the pharmaceutical industry. iii