We assess whether a firm's research and development (R&D) expenditures, as well as uncertainty metrics that underlie their ultimate conversion into value, can significantly enhance the relevance of a valuation model based solely on traditional financial reporting variables and improve equity value predictions. We focus on the biotech industry during the 1998-2004 period and classify firms into emerging and mature categories to reflect their commercial maturity. The 1998-2004 period also comprises three distinct market cycles: a bubble (1998-99), a downturn (2000-2), and a rebound (2003-4).
We first show that R&D expenditures are incrementally value-relevant over the baseline financial reporting model (book value and earnings). Also, the value-relevance of R&D expenditures is enhanced significantly by introducing uncertainty metrics as interaction terms. Second, the mapping into value reveals differential roles according to commercial maturity. We find that alliance networks and targeting high profile diseases have greater value-relevance for emerging firms. In contrast, the value of mature biotechs is more sensitive to drug development status and product diversification. Third, the mapping to value also differs across stock market cycles, with a tendency toward a return to fundamentals (financial and nonfinancial) as we move away from the 1998-99 bubble. Fourth, we find that adding R&D expenditures generally improves equity value predictive ability. Adding uncertainty metrics further improves predictions, with differences still prevailing across firms and stock market conditions. Both sets of R&D information make higher contributions to predictive accuracy in the case of mature biotechs, and results reinforce our view of a return to fundamentals, especially for these firms.