R&D Project Valuation Considering Changes of Economic Environment: A Case of a Pharmaceutical R&D Project

Abstract

R&D project valuation is important for effective R&D portfolio management through decision making, related to the firm's R&D productivity, sustainable management. In particular, scholars have emphasized the necessities of capturing option value in R&D and developed methods of real option valuation. However, despite suggesting various real option models, there are few studies on simultaneously employing mean-reverting stochastic process and Markov regime switching to describe the evolution of cash flow and to reflect time-varying parameters resulting from changes of economic environment. Therefore, we suggest a mean-reverting binomial lattice model under Markov regime switching and apply it to evaluate clinical development with project cases of the pharmaceutical industry. This study finds that decision making can be different according to the regime condition, thus the suggested model can capture risks caused by the uncertainty of the economic environment, represented by regime switching. Further, this study simulates the model according to rate parameter from 0.00 to 1.00 and risk-free interest rates for regimes 1 and 2 from (r 1 = 4%, r 2 = 2%) to (r 1 = 7%, r 2 = 5%), and confirms the rigidity of the model. Therefore, in practice, the mean-reverting binomial lattice model under Markov regime switching proposed in this study for R&D project valuation contributes to assisting company R&D project managers make effective decision making considering current economic environment and future changes.

Measuring the Efficiency of U.S. Pharmaceutical Companies Based on Open Innovation Types

“…Effective R&D management is thus crucial to a company's ongoing survival because it increases R&D efficiency, innovation, and financial performance. An accurate understanding of R&D projects contributes to a company's strategic decision-making for sustainable management based on empirical analysis and evaluation [60].…”

“…Particularly, pharmaceutical R&D requires risk management because of the large size of R&D expenditures. Therefore, an effective R&D risk management enhances corporate sustainability [60]. Additionally, OI is a positive and flexible substitute for environmental change or risk.…”

To Wait or Not to Wait? Use of the Flexibility to Postpone Investment Decisions in Theory and in Practice

“…Our study focuses on examining the investment decision-making process at the individual level. We join the emerging and promising stream of studies that utilize experimental laboratory designs to closely investigate decision-making behavior in a real options based mechanism [12][13][14][15][16][17]. By doing so, we contribute to the managerial literature regarding micro-foundations of investment decision-making under uncertainty.…”

“…In this journal, the use of real options has been discussed a number of times in connection with economic sustainability. Focus has been on economic evaluation in the context of public private partnerships [12][13][14], technology, research, and development investments [15,16], investment in real-estate [17], and environmental investments [18,19].…”

Ferramentas E Técnicas Para a Avaliação De Projetos De Inovação Radical Ou De Grandes Incertezas: Uma Revisão Integrativa De Literatura

“…O gerenciamento eficaz do portfólio de projetos de pesquisa e desenvolvimento (P&D) é essencial para a produtividade de uma empresa, capacidade de inovação e para promover sua sobrevivência [16]. A abordagem RO para avaliação destes projetos tem a vantagem de lidar com riscos e contribuir com tomadas de decisão estratégicas para o gerenciamento sustentável [16].…”