Cost of Capital for Pharmaceutical, Biotechnology, and Medical Device Firms

Abstract

Abstract This article provides new estimates of systematic risk and the cost of equity capital for the pharmaceutical, biotechnology, and medical device sectors. The main analysis employs data for pharmaceutical, biotechnology, and medical device firms with publicly traded stock on US exchanges (including foreign-owned firms) with at least $100 million of market capitalization during the periods 2001–2005 and 2006–2008. Two frameworks are used for estimating firms' risk and the cost of equity capital: the capital asset pricing model (CAPM) and the empirically driven three risk-factor model of Fama and French (the F-F model). The article is organized as follows. The first section briefly reviews prior work and discusses the likely relation between the cost of equity capital and R&D intensity. The next section outlines the CAPM and F-F models and their empirical implementation. The data and samples are discussed in the third section. The fourth section presents beta and cost of equity capital estimates for equally weighted portfolios formed by sector and by sector and firm size. The fifth section presents results concerning the relationship between individual firm betas and R&D intensity, and it is followed by a final concluding section.

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