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Measuring life cycles using binomial option pricing: The pharmaceutical industry
Author(s) -
Beneda Nancy
Publication year - 2019
Publication title -
journal of corporate accounting and finance
Language(s) - English
Resource type - Journals
eISSN - 1097-0053
pISSN - 1044-8136
DOI - 10.1002/jcaf.22391
Subject(s) - valuation (finance) , market value , economics , valuation of options , initial public offering , value (mathematics) , investment (military) , binomial options pricing model , financial economics , stock market , business , monetary economics , finance , mathematics , paleontology , statistics , horse , politics , political science , law , biology
This study examines the N computed using an American Binomial Option Pricing Model to address issues in evaluating firms which may be difficult to value such as new pharmaceutical firms. New pharmaceutical products can take up to 12 years to bring a new product to market. This study uses a sample of 15 pharmaceutical initial public offerings (IPOs) brought to market in 2,000. The current study uses a firm's excess market value as a measure of valuable growth opportunities. The study attempts to estimate how much remaining investment in research and development (R&D) is required for potential market success. The study solves for N in an American Binomial Option Pricing Model. The resulting N represents a number which when multiplied by R&D, results in an implied estimated amount of remaining investment in R&D, which the stock market has priced into the value of growth opportunities. The option valuation model uses the firm's excess market value as a call option on the firm's market value, and R&D times N , as the strike price. N is computed for each firm and year observation. The results of the current study suggest that the N , computed in the option‐pricing model, is negatively and highly associated with a firm's future performance and future productivity of investment in R&D.