Year of Graduation
The Determinants of the Costs of Financial Distress in Pharmaceutical Firms
Strategic Corporate Finance
This study investigates the impact of innovation activity characteristics of pharmaceutical companies on their probabilities and indirect costs of financial distress. R&D investments are considered as an input of innovation activity while the number of new developed drugs – as an output. The study analyzes 149 public pharmaceutical firms during the period 2003-2016. A firm’s probability of default is revealed to be positively associated with the volume of its R&D expenses, and negatively associated with the number of innovative drugs developed by a company. It is consistent with our predictions, since the process of development of a new drug is very risky and has long-delayed return (if any), but if it ends with success the company receives the right to sell the new drug exclusively for several years. Indirect costs of financial distress (in the form of foregone sales) are shown to be positively associated with the volume of R&D expenses. Presumably it is because financially distressed firms with high R&D investments are not able to maintain efficiency of current operating activities due to lack of funding. The number of developed innovative drugs is proven to be an insignificant determinant of indirect financial distress costs.