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Applied Economics Letters

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A study on intellectual capital and firm performance in biotech companies

Wen-Chung Guo , Shin-Rong Shiah-Hou & Wei-Jer Chien
a b a b b

Department of Economics, National Taipei University, San Shia, Taipei, 23741, Taiwan Department of Finance, Yuan Ze University, Chung-Li, Taoyuan, 32003, Taiwan

Version of record first published: 06 Feb 2012

To cite this article: Wen-Chung Guo, Shin-Rong Shiah-Hou & Wei-Jer Chien (2012): A study on intellectual capital and firm performance in biotech companies, Applied Economics Letters, 19:16, 1603-1608 To link to this article: http://dx.doi.org/10.1080/13504851.2011.646062

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Applied Economics Letters, 2012, 19, 16031608

A study on intellectual capital and firm performance in biotech companies

Wen-Chung Guoa,*, Shin-Rong Shiah-Houb and Wei-Jer Chienb
Department of Economics, National Taipei University, San Shia, Taipei 23741, Taiwan b Department of Finance, Yuan Ze University, Chung-Li, Taoyuan 32003, Taiwan
a

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This article attempts to understand the influence of intellectual capital on the performance of biotech firms. It provides an integrated framework to clarify the inter-relationship between compensation scheme, human capital and financial performance of listed biotech firms. The sample studied includes 279 biotech firms listed in the US market for the period 1994 to 2005. The results show that the association between patents and Research and Development (R&D) expenditure is found to be positive, although the increase in patents did not significantly improve the accounting performance. The quality of human capital, measured by several factors, is expected to play a positive role in technology innovations and financial performance. Keywords: intellectual capital; firm performance; biotech R&D JEL Classification: G14; L65 I. Introduction Intellectual human capital is an essential factor for the success of biotech firms (see e.g. Zucker et al., 1998). The advanced Research and Development (R&D) levels of biotech firms have complicated the incentive system by creating several intangible assets, which are characterized by a high degree of information asymmetry, leading to the well-known agency cost problem (see the classical study of Jensen and Meckling (1976)). This study was motivated by the need for research into the role of information asymmetry and compensation schemes in the success of biotech firms. The objective of this work is, therefore, to provide an integrated framework to understand the inter-relationship between compensation schemes, human capital and financial performance of listed biotech firms.1 Many workers have examined different aspects of compensation schemes. For instance, Jensen and Murphy (1990) found executive stock options as an important input for the production process. Mehran (1995) found a positive association between firm performance and the equity-based component of executive compensation. He also found that firm performance is positively related to the percentage of equity held by managers. Morgan and Poulsen (2001) considered that compensation announcement may signal possible growth in firm performance.2 This study differs from the others in that its emphasis is on the resolution of information asymmetry and

*Corresponding author. E-mail: guowc@ntu.edu.tw 1 Most related articles on the association between performance and intellectual capital focus on either a case study (for instance, Dumay, 2009) or evidence from some unique data (see e.g. Zeghal and Maaloul, 2010). 2 Other studies include Healy (1985), Holthausen et al. (1995) and Yermack (1995).
Applied Economics Letters ISSN 13504851 print/ISSN 14664291 online # 2012 Taylor & Francis http://www.tandfonline.com http://dx.doi.org/10.1080/13504851.2011.646062 1603

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long-term financial performance of biotech firms, rather than the success of start-ups. Besides, it discusses the relationship between intellectual human capital, technology innovation and financial performance of biotech firms. More particularly, it attempts to analyse the role of compensation schemes and corporate governance in assessing the influence of human capital on technology innovation and financial performance. Several related streams of literature are briefly reviewed here. The first one is related to stock compensation. Yermack (1995) examined whether the stock options compensated to the Chief Executive Officer (CEO) are affected by the percentage of equity that the CEO holds, retirement of the CEO, agency cost of debt and others. Holthausen et al. (1995) discussed the relationship between manipulation of earnings and adoption of bonus plan. Besides, Tehranian and Waegelein (1985) are the first to research on combined stock price reaction and short-term CEO compensation. The second stream of literature is the human capital in technology firms. Considering the birth of US biotechnology enterprises, human capital is doubtlessly one of the most critical factors. Zucker et al. (1998) concluded that the growth and diffusion of intellectual human capital was the main determinant of the development of biotechnology industry. Specially, star scientists, employees, salary and PhD degree have a great influence on US biotechnology enterprises. Deng et al. (1999) provided a theory that shows how science and technology play the role of predictors of stock performance. Stephan et al. (2004) studied the relationship between initial public offering proceeds, embodied human capital and the reputation of the scientists of the firm. Pukthuanthong (2006) found, in terms of human capital, the difference between biotechnology and nonbiotechnology firms. This analysis is also related to the importance of patents. AliYrkko et al. (2005) found that patenting by a firm is positively correlated with the probability that it will be required by a foreign firm because patenting is associated with industry-specific technological shocks and efficient management. Miyazakia and Aman (2008) suggested that R&D expenditures of a pharmaceutical firm are beneficial to R&D externalities. Borrella (2005) pointed out that patent spurs faster introduction of new drugs. In this research, the authors first examine various factors that may affect accounting performance, such as patent and R&D expense, and then define them for technology innovation. Second, compensation to CEOs or Vice Presidents (VPs) (such as salary, bonus and stock options) and antecedents of CEOs and VPs is considered here as the part of human capital.

W.-C. Guo et al.

Deciding on the percentage of shares to be held by managers and CEOs would be the concept of corporate governance. Besides, the authors use three parameters for their performance here: stock return, Return On Assets (ROA) and Return On Equity (ROE). The main issues proposed to be addressed in this study are as follows: (1) How do technology innovation, human capital and corporate governance affect market and financial performance of the firm? (2) Is there any relationship between the quality of human capital in a firm and its performance? (3) Does market and financial performance of the firm get affected by different kinds of compensation? (4) Does good corporate governance improve companys performance? For assessing the performance of biotechnology companies, the accounting parameters (such as stock return, ROA and ROE) are excluded, and patent citation is treated as an altogether different form of performance technology innovation. This leads to the following question: (5) Is it possible that human capital significantly affects patent citation? Data are described and methodology is discussed in Section II. The empirical results are analysed in Section III, and the conclusions presented in Section IV. II. Methodology and Data Description The research was carried out from 1994 to 2005 on 331 biotechnology firms. First, accounting data of each firm were collected from the biotechnology industry in COMPUSTAT database. Second, details of patent citations were obtained through the United States Patent and Trademark Office (USPTO) website. From this website, one can find all the details of the patents, such as abstract of the patent, inventor name, assignee, application number, current US class and field of search. Third, data in respect of different kinds of compensation paid to the CEOs and VPs were collected from the proxy statements in NexisLexis database. Proxy statement is a report that discloses information about the compensation and corporate governance of a company. Finally, after merging all the data, there were 2035 observations. We examine the five largest patent firms in the biotechnology industry of America. For the period 2002 to 2005, GENENTECH gets the first mark in

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A study on intellectual capital and firm performance

the authors sample. Also, its performance had been as good before 1996. During these two periods, the performance of CHIRON and INCYTE had been slightly worse. But, even when they performed best during 1997 and 2001, GENENTECH still stood at second or third place. We also find that the average number of the patents increased at the beginning of the sample period (1994) and reached the peak in 1999 and then decreased over time because of the entry of new firms into this industry. Also, one can realize that, during the sample period, there had been a proliferation of companies with a record number of patent citations. Further, SDs were relatively huge, and they may well reflect the variations that the biotechnology industry went through. Table 1 shows the descriptive statistics of all the samples counted as company years. In these 2035 samples, one can find that the average stock return was 0.452205, and the average Cash Flow (CF) from operating activities was -401.77 thousands and from ROE -112.09%. The average intrinsic value of the option awarded to CEOs and VPs on the issue day was $26 235. As regards R&D, however, the average R&D expense was 440.884 thousands per year (weighted by total assets) and the average account of new patent each year was 9.868. The chief purpose of this research is to discuss the relationship between human capital, compensation of CEOs and VPs and corporate governance. For this, the authors first tried to choose some proxy variables of corporate performance, including 1-year stock return for market performance, ROA (ROE) for accounting performance, patent citation for R&D performance and SD of return for the variation of performance. We divide the independent variables into several parts, as shown below: human capital variables including salary, cash bonus and stock option for CEO and VP; R&D; and corporate governance variables,

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including PhD degree of CEO and VP, share holding of board of directors and change of CEO. The empirical model used in our study is Y a b1 Patent b2 Size b3 Human capital b4 Corporate governance e 1 where Y is the dependent variable, a and b1, b2, b3 and b4 are the estimated parameters and e is the error term. All symbols of variables are defined and summarized as follows: CF: Cash flow from operating activities weighted by total assets RETURN: 1-year stock return ROA: Return on assets Patents: Number of patent citations every year SD: SD of stock return R&D: R&D expenses weighted by total assets every year Size: Market value of firm CVSB: Salary and bonus for CEO CBdCSB: Bonus divided by salary and bonus for CEO Option: Shares of stock options for CEO and VP Money: The intrinsic value of option CPHD: PhD degree of CEO VPHDp: PhD degree percentage of VPs Hold: Share holding of board of directors Change: Dummy of change CEO in fiscal year We adopt the moving average method of FamaMacBeth to examine how companies perform 3 years after each independent variable acts. The result is robust when the hypothesis can be examined either with the data of all company years or with the average data for each company. Also, all the sample firms were separated into two groups: lots patent citation group and few patent citation group. Following the

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Table 1. Sample descriptive statistics Mean CF RETURN ROA SD PATENT R&D SIZE CVSB OPTION MONEY CPHD VPHD HOLD CHANGE -0.402 0.452 -59.492 0.055 9.868 0.441 4.944 834 729 263 235.6 0.351 0.144 0.437 0.186 0.046 Median -0.226 -0.023 -31.296 0.051 4 0.278 4.888 675 000 95 910 0 0 0 0.120 0 Maximum 0.750 55.429 75 0.216 248 9.411 11.308 13 510 359 9 250 000 103.375 1 4 11.540 5 Minimum -13.710 -0.975 -1753.330 0.014 0 0 -2.604 0 0 0 0 0 0 0 SD 0.824 2.249 123.332 0.023 19.822 0.669 1.678 1 037 465 532 615.3 3.592 0.351 0.799 0.466 0.938 Observations 1578 1289 1577 1337 479 1525 1397 2035 2035 2035 2035 2035 1319 2035

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guidelines in the USPTO website, firms who applied for no patent during the sample period were considered as few patent group, including zero patent citation and no data groups of USPTO, and the others as lots patent group. Thus, different situations can be compared between two groups. III. Empirical Results and Discussion FamaMacBeth method Table 2 presents the regression results by using the FamaMacBeth method. It is observed that both size and CVSB are significantly associated with patent at 1% level. This implies that larger companies have more patents. Salary paid to the CEO may improve the R&D effort. The results also suggest that huge R&D expenses will significantly offset current earnings and then decrease the performance in terms of CF and ROA. Nevertheless, R&D expenses are positively associated with firm returns and volatility. It suggests that the market appreciates R&D activities while R&D increases risk significantly. Moreover, PhD degree of the CEO and VP plays an important role here; it positively and significantly affects ROA and CF from operating activities. The factor loading of shares held by the board of directors also has negative effect here, reflecting agency costs. The influences on market returns are quite different from the one on accounting performance. Comparison of different groups In this section we separate sample firms into two groups according to more patent citation and examine differences between them. Let Group L be the firms with more patents and Group F be the firms with

W.-C. Guo et al.

fewer patents. From Table 3, it can be seen that small firms still tend to have better future returns than large firms and that the recognition of salary and bonus expense will decrease future accounting earnings. It also shows that the options awarded to CEOs and VPs may not significantly improve performance in those firms with more patents and decrease accounting performance in those firms with fewer patents. On the other hand, Group F showed better accounting or market performance when it had managers with PhD degrees. As regards technical innovation, the recognition of R&D expense is a positive signal for future stock return, but it decreases accounting earnings in firms with more patents than those which have fewer innovation efforts. Regarding SD of stock returns, stock prices of large firms with more patents tend to be more stable than small ones. R&D expenses increase the volatility of stock returns of the firms in Group F, and size affects more significantly the firms which have fewer patents. IV. Conclusions The purpose of this work is to discuss the relationship between compensations, human capital, technological innovation and performance of the firms. For accounting earnings, it is found that R&D expense, salary and bonus expense significantly offset the earnings in financial reports and also serve as negative factors in the future. The academic background of managers significantly increases the accounting earnings. As regards firms market performance, R&D expense becomes a significantly positive factor. Salary and bonus paid to CEOs and VPs increase future returns. Patent is an insignificant factor here, no matter in accounting or market returns. This may

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Table 2. Intellectual capital and performance using FamaMacBeth method Variables Constant Patent R&D Size CVSB CBdCSB OPTION Money CPHD VPHDp HOLD CHANGE CF -0.307 (0.033)*** 0.002 (0.002) -0.468 (0.041)*** 0.020 (0.010)** 0.106 (0.039)*** -0.082 (0.109) -0.119 (0.082) -0.002 (0.007) 0.514 (0.088)*** 0.719 (0.136)*** -0.357 (0.143)** -0.286 (0.046)*** RETURN 0.224 (0.073)*** -0.004 (0.004) 0.239 (0.089)*** 0.022 (0.021) -0.035 (0.086) 0.547 (0.237)** -0.258 (0.179) 0.009 (0.014) -0.016 (0.191) 0.522 (0.297)* -0.086 (0.312) -0.040 (0.101) ROA -59.059 (5.247)*** 0.184 (0.283) -63.843 (6.417)*** 5.572 (1.546)*** 11.585 (6.194)* 3.866 (17.156) -14.635 (12.936) -0.453 (1.037) 69.418 (13.831)*** 101.237 (21.467)*** -42.743 (22.582)* -37.776 (7.323)*** SD 0.0299 (0.001)*** 0.000 (0.000) 0.009 (0.002)*** 0.003 (0.000)*** -0.007 (0.002)*** 0.005 (0.005) 0.005 (0.003)* 0.001 (0.000)*** 0.002 (0.004) 0.017 (0.006)*** 0.028 (0.006)*** -0.001 (0.002) Patent 1.042 (0.621)* -0.023 (0.759) 0.564 (0.183)*** 5.049 (0.712)*** -0.661 (2.030) -3.923 (1.528)** 0.011 (0.123) -0.125 (1.637) -3.912 (2.538) -7.129 (2.665)*** -1.145 (0.866)

Notes: CF, Cash Flow; ROA, Return On Assets; R&D, Research and Development. SD values are in parentheses. *, ** and ***Significance at the 10%, 5% and 1% levels, respectively.

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Table 3. Group comparisons R&D Size CVSB CBdCSB OPTION MONEY CPHD VPHDp HOLD CHANGE

Constant

CF-L

CF-F

t-Value RETURN-L

A study on intellectual capital and firm performance

RETURN-F

t-Value ROA-L

ROA-F

t-Value SD-L

SD-F

t-Value

-0.105 (0.092) -0.341 (0.035)*** 3.404a 0.013 (0.113) 0.262 (0.088)*** -2.474b -11.899 (13.948) -67.44 (5.567)*** 5.229a 0.043 (0.003)*** 0.027 (0.002)*** 6.828a 0.049 (0.057) 0.175 (0.071)** -1.966b 0.037 (0.069) 0.010 (0.180) 0.201 1.437 (8.609) 27.808 (11.396)** -2.611a -0.004 (0.002)** -0.007 (0.003)** 1.128 0.252 (0.300) -0.126 (0.114) 1.665c -0.761 (0.367)** 0.779 (0.288)*** -4.669a 54.708 (45.494) -4.114 (18.311) 1.696c -0.016 (0.010) 0.008 (0.005) -3.036a 0.091 (0.120) -0.331 (0.119)*** 3.533a -0.185 (0.147) -0.406 (0.299) 0.941 12.353 (18.276) -45.915 (18.997)** 3.126a 0.004 (0.004) 0.006 (0.005) -0.363

-0.370 (0.077)*** -0.513 (0.048)*** 2.233b 0.211 (0.094)** 0.259 (0.122)** -0.443 -63.66 (11.630)*** -64.51 (7.714)*** 0.087 -0.001 (0.003) 0.014 (0.002)*** -6.577a

-0.008 (0.019) 0.026 (0.012)** -2.137b 0.050 (0.023)** 0.011 (0.031) 1.465 -0.247 (2.907) 6.074 (1.937)*** -2.559a 0.001 (0.001)*** 0.004 (0.001)*** -4.083a

-0.011 (0.009) 0.006 (0.010) -1.853c 0.010 (0.011) 0.017 (0.026) -0.319 -1.566 (1.391) 0.570 (1.625) -1.412 0.001 (0.000)*** 0.001 (0.000) 0.958

-0.001 (0.195) 0.641 (0.099)*** -4.157a -0.069 (0.239) 0.007 (0.249) -0.309 9.100 (29.587) 84.148 (15.799)*** -3.164a 0.005 (0.006) 0.004 (0.004) 0.199

0.299 (0.242) 0.844 (0.172)*** -2.589a 0.646 (0.297)** 0.574 (0.434) 0.193 28.971 (36.782) 122.89 (27.560)*** -2.890a 0.001 (0.008) 0.031 (0.008)*** -3.900a

0.956 (0.297)*** 0.177 (0.165) 3.240a 0.464 (0.364) 0.185 (0.418) 1.657c 166.1 (45.117)*** 9.707 (26.505) 4.227a 0.018 (0.010)* 0.029 (0.007)*** 1.318

-0.036 (0.105) -0.356 (0.052)*** 3.872a -0.063 (0.128) -0.045 (0.131) -0.138 -0.473 (15.930) -50.25 (8.300)*** 3.919a 0.002 (0.003) -0.004 (0.002) 1.968b

Notes: SD values are in parentheses. *, ** and ***Significance at the 10%, 5% and 1% levels, respectively. a, b and c Significance at the 1%, 5% and 10% levels, respectively, using t-test for the difference between two samples.

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be because it needs more time to produce its value and increase the earning of companies. On the other hand, R&D expense increases patent citation, and large firms have more capital and ability for technical innovation. Salary and bonus paid to managers are positively related to patent citation. Acknowledgements We thank the National Science Council of Taiwan for the research grant (NSC 94-2416-H-305-013-).

W.-C. Guo et al.

Jensen, M. C. and Meckling, W. M. (1976) Theory of the firm: managerial behavior, agency costs and ownership structure, Journal of Financial Economics, 3, 30560. Jensen, M. C. and Murphy, K. J. (1990) Performance pay and top-management incentives, Journal of Political Economy, 98, 22564. Mehran, H. (1995) Executive compensation structure, ownership, and firm performance, Journal of Financial Economics, 38, 16384. Miyazakia, H. and Aman, H. (2008) The stock markets valuation of R&D externalities, Applied Financial Economics Letters, 4, 36973. Morgan, A. G. and Poulsen, A. B. (2001) Linking pay to performance compensation proposals in the S&P 500, Journal of Financial Economics, 62, 489523. Pukthuanthong, K. (2006) Underwriter learning about unfamiliar firms: evidence from the history of biotech IPOS, Journal of Financial Markets, 9, 366407. Stephan, P., Higgins, M. J. and Thursby, J. (2004) Capitalizing the Human Capital of University Scientists: The Case of Biotechnology IPOs, Georgia State University, Atlanta, GA. Tehranian, H. and Waegelein, J. F. (1985) Market reaction to short-term executive compensation plan adoption, Journal of Accounting and Economics, 7, 13144. Yermack, D. (1995) Do corporations award CEO stock options effectively?, Journal of Financial Economics, 39, 23726. Zeghal, D. and Maaloul, A. (2010) Analysing value added as an indicator of intellectual capital and its consequences on company performance, Journal of Intellectual Capital, 11, 3960. Zucker, L. G., Darby, M. R. and Brewer, M. B. (1998) Intellectual human capital and the birth of US biotechnology enterprises, American Economic Review, 88, 290306.

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