Faculty & Research
Faculty & Research
When entrepreneurial rhetoric meets strict regulations: Implications for the valuation of health science firms
By Taiyuan Wang, Sumeet Malik and William J. Wales
Entrepreneurial orientation (i.e., the extent to which a business entity embraces product innovation, market entry, and risk-taking) is a crucial yardstick by which investors assess the future prospects of any given company. In particular, assessing EO is an especially important factor when sizing up the long-term viability of health science firms due to the industry’s long product development horizons and stringent regulatory requirements which need to be met to successfully bring new products to market.
Accordingly, the concept of EO rhetoric (i.e., the language used by firms to convey to outsiders how innovative, proactive, and prone to sensible risk-taking they are) is gaining greater attention both in academic and investor circles. Put simply, investors want to know if a company’s EO rhetoric is a fair reflection of the firm’s ability and intention to enable product innovation and market entry, or if it is merely “cheap talk” (i.e., an impression management tactic designed to advance the short-term interests of firm insiders).
A study we conducted involving more than 200 health science firms has found that investors respond more positively to those firms that sustained their EO rhetoric over time, rather than periodically increasing it in occasional bursts. Investors placed higher valuations on heath science firms that kept their EO rhetoric consistently high, and lower valuations whenever they experienced scepticism prompted by only occasional increases in rhetoric, which were often perceived as unreliable “soft-signalling.”
We also found that health science firms could mitigate this investor scepticism by combining their bump in EO rhetoric with hard-information signals that either demonstrated greater entry commitment or higher penalty costs for false signalling. For example, if firms could show that they had irreversibly committed resources to bringing a new product to market (such as seeking FDA approval), they were deemed by investors to be pairing the ramped-up rhetoric with something more real, and hence more reliable. Similarly, offering hard-information signals that could be easily checked and verified over time was also effective in reducing scepticism, as investors recognised that the firm stood to suffer greater reputational losses if they were caught out for deliberate false signalling.
Notably, one key influencer in this equation emerged from our study: corporate social responsibility (CSR). Like acts of entry commitment, demonstrating a higher level of CSR served as a hard-information signal that boosted the credibility of EO rhetoric. We attribute this to investors viewing firms that engage in socially responsible practices to be less likely to give false signals that might compromise their hard-won reputation for trustworthiness.
Together, our findings present both health science firms and investors with a range of important practical implications to consider. First, investors need to carefully review how they interpret EO rhetoric as a potential quality signal when making investment decisions regarding health science firms. Higher credibility (and subsequently higher valuations) should be given to firms that consistently maintain higher EO rhetoric than their peers/competitors over time. A change in EO rhetoric should invite scrutiny and possibly even scepticism, as it may be motivated by a myriad of short-term purposes, such as impression management, hiding negative news, or even the deliberate misleading of competitors.
However, this potential bias should itself be noted by investors, and their reasonable scepticism should be alleviated if the firm couples its change in EO rhetoric with hard-information signals that demonstrate its commitment to production innovation, new market entry, and/or a higher commitment to being a responsible corporate citizen.
In a similar vein, health science firms should proactively work to improve the credibility of their EO rhetoric via the methods outlined above. Consistency is crucial in overcoming investors’ scepticism, and any ramping up of EO rhetoric should ideally be coupled with tangible, demonstrable acts of CSR and entry commitment. False signalling, whether intentional or not, should be avoided at all costs, as it will be penalised by the market.
This article is based on a study entitled “When entrepreneurial rhetoric meets strict regulations: Implications for the valuation of health science firms” published in the Strategic Entrepreneurship Journal here.
Taiyuan Wang is an Associate Professor of Entrepreneurship at CEIBS. For more on his teaching and research interests, please visit his faculty profile here. Sumeet Malik is a postdoctoral researcher at IESE. William J. Wales is the Management Department Chair and Standish Professor at the University at Albany.