The valuation of pharmaceutical intangibles

Publication Date11 Jul 2016
AuthorMark Russell
SubjectInformation & knowledge management,Knowledge management
The valuation of
pharmaceutical intangibles
Mark Russell
UQ Business School, The University of Queensland, Brisbane, Australia
Purpose The purpose of this paper is to value the patents of pharmaceutical companies using
discounted cash flows, and compare the value-relevance of these assets against alternative intangible
asset measures such as reported intangible assets and R&D capital.
Design/methodology/approach The study values pharmaceutical intangibles using three
methods: an income method; the sum of unamortised R&D expenditures; the firms reported intangible
assets. Value-relevance tests use ordinary least squares regression and Vuong and Clarke tests.
Findings First, the study finds that the discounted cash-flow valuation of pharmaceutical patents
is value-relevant. Second, the value of pharmaceutical patents explains market value better than
reported intangib le assets but not R&D capital. Howeve r, the valuation of pharmaceutical patents is
more consistent with the risks of R&D than the valuation of R&D capital which assumes recovery of
R&D expenditure.
Originality/value This is the first known study that values patents using an income method and
compares those valuations with reported intangible assets and R&D capital valuation models.
Keywords Intangible assets, Valuations
Paper type Research paper
1. Introduction
The study exploits an opportunity to use discounted cash flows to value the drug
patents of the worlds largest pharmaceutical companies. The study then compares the
value-relevance of our patent valuations to other intangible asset measures such as
company reported intangible assets and R&D capital.
Although the use of intangible assets is increasing, the valuation of intangible assets
is arguably speculative rather than relevant for investment or decision making.
According to accounting standards, internal research and development costs are
expensed as incurred, and only acquired intangible assets are recognised as assets.
This results in the undervaluation of intangible assets. In addition, the heterogeneous
nature of intangibles leads to non-standard and noisy measurement methods of their
value: resource input measures, output measures, management reported measures and
exotic researcher metrics (Wyatt, 2008; Hunter et al., 2012). The failure to recognise
intangible assets puts pressure on valuation analysts to use diverse information
(Damodaran, 2009). As a result, the use of non-standard valuation information outside
the firm reduces the comparability and reliability of the valuations.
The study focuses on intangible assets in the pharmaceutical industry for a number
of reasons. The pharmaceutical industry presents an intangible asset-rich sample of
companies and high-value blockbuster drugs. Second, pharmaceutical companies have
similar product life-cycles, financial structure and operating expenses for the valuation
of intangible assets. Importantly, the largest pharmaceutical companies voluntarily
disclose drug product sales revenues enabling calculation of future cash flows.
There are three motivations for the research. To the best of our knowledge, this
paper is the one of the few to value internally generated intangible assets using an
income method. Many R&D studies test the value-relevance of financial and other
Journal of Intellectual Capital
Vol. 17 No. 3, 2016
pp. 484-506
©Emerald Group Publishing Limited
DOI 10.1108/JIC-10-2015-0090
The current issue and full text archive of this journal is available on Emerald Insight at:
information, or value intangible assets using a large number of different research
designs that illustrate the problem of identifying relevant and verifiable information
(Wyatt, 2008).
Second, the valuation of intangible assets is of substantial importance to
pharmaceutical companies and investors:
The pharmaceutical industry is in the midst of one of the biggest patent cliffs with Pfizers
multi-billion-dollar blockbuster drug Lipitor losing patent protection in the US in late
November 2011 [] other major branded drugs that lost patent protection in the past few
months represent branded sales worth more than $15 billion (Zacks Investment Research,
Industry Outlook, 2012).
Intangible asset information reduces information asymmetry and also benefits banks
and creditors which typically have difficulty in assessing the financial position of
companies with intangible assets (Andriessen, 2004).
Third, the study explores whether drug sales, reported intangibles and R&D
expenses are useful for valuing pharmaceutical companies. The value-relevance of
internally generated pharmaceutical patents provides evidence on the desirability of
valuing intangible assets, either for intangible asset standards, or specifically for health
care companies as a sector. A primary focus of the Financial Accounting Standards
Board and other standard setters is equity investment (Barth et al., 2001).
The key result is that the valuation of pharmaceutical patents by discounted cas h
flows is value-relevant for companies reporting drug product sales that exceed one-
third of total sales revenue. Under those reporting conditions, patent valuation by
discounted cash flows dominates valuation by reported intangible assets in explaining
the market value of the company.
The study contributes to the debate on reporting intangible assets and identifies
conditions when the valuation of intangible assets is useful. The paper provid es
evidence that the presentation of product sales revenue information assists the
valuation of intangible assets and the price discovery of stocks. The study finds that
the discounted cash flow method of valuing intangible assets is more useful in
assessing the financial position of pharmaceutical companies than company reported
intangible assets. The next section reviews the literature and develops the hypotheses.
Section 3 outlines the research method, Section 4 reports the valuation of intangible
assets and descriptive statistics, Section 5 reports the value-relevance results, and
Section 6 concludes the paper.
2. Literature and hypothesis development
The intellectual capital literature has identified and measured many new forms of
intangible assets (Andriessen, 2004). These assets include financial and non-financial
items (Petty and Guthrie, 2000a). The non-financial items have qualities that are difficult to
measure (Catalfo and Wulf, 2016). The intellectual capital literature also indicates several
motives for measuring intellectual capital: internal management, external reporting,
transactional and statutory (Andriessen, 2004; Lagrost et al., 2010). As a result, there are
over 30 methods for measuring and valuing intangible assets (Andriessen, 2004).
This study measures intangible assets with financial data and focuses on one
industry. Few recent studies use traditional quantitative methods such as discou nted
future cash flows to value intangible assets (Lev and Schwartz, 1971; Sada n and
Auerbach, 1974). One reason is that tracing a cash flow stream to a specific intangible
asset is difficult (Lagrost et al., 2010).

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