sustainability Article R & D Intensity and Dividend Policy: Evidence from South Korea’s Biotech Firms Namryoung Lee 1 and Jaehong Lee 2,* 1 School of Business, Korea Aerospace University, Goyang 10540, Korea 2 College of Business, Sangmyung University, Seoul 03016, Korea * Correspondence: [email protected] Received: 31 July 2019; Accepted: 31 August 2019; Published: 4 September 2019 Abstract: In this paper, we examine the relation between a firm’s research and development (R & D) intensity and dividend payout policy with a focus on biotech firms in a sample of 18,253 firm-year observations in South Korea. We find that biotech firms’ R & D intensity is negatively related to dividend payout. Furthermore, for biotech firms, increased internal cash holding accomplished via a lower dividend policy is positively associated with long-term corporate value. In particular, this study reports that the relation between biotech firms’ cash holding and corporate firm value is significantly positive in firms with high stock dividends. Moreover, it shows that non-biotech firms in the maturity stage of the corporate lifecycle tend to distribute cash dividends, a practice that is relatively uncommon among biotech firms in an R & D steady state. Keywords: R & D intensity; South Korea’s biotech firms; cash holding; dividend policy; firm value 1. Introduction “Today’s business environment, perhaps more than at any other time in modern history, demands a continuous search for new sources of competitive advantage for sustainable growth” [1]. As competition grows, it becomes ever more vital for companies to discover new advantages. One path of discovery is through innovation, which is driven by investment in research and development (R & D). The quality of R & D, e.g., its efficiency and expertise, is essential to the sustainable success of the firm, because a shortening time-to-market timeline has accelerated the need to produce new products [2]. Therefore, management must adeptly assess the financial situation within a firm and determine the appropriate amount of resources to invest in R & D. One decision management must make is whether to fund short-term projects for the purpose of making immediate profits or focus on longer-term projects that may generate a more sustainable success. Management must decide which strategy to employ when investing resources, as the decision partially determines the company’s short-term and long-term value, which has an effect on dividend payments and stock prices [3]. The dividend policy of a firm is a complex financial decision and one of the most highly debated issues in corporate finance literature in both developed and emerging markets. When deciding on a policy, management must consider the amount of earnings that will be reserved and distributed as well as the ways in which the supply shortages that may occur during dividend distribution will be supplemented. Before the financial crisis, the most commonly practiced dividend policy was to distribute low dividends regardless of earnings. However, through the improvement of corporate governance, management transparency and shareholder rights were enhanced. This increased the effect of a firm’s dividend policy on firm value by considering both current earnings and future profitability [4]. Sustainability 2019, 11, 4837; doi:10.3390/su11184837 www.mdpi.com/journal/sustainability Sustainability 2019, 11, 4837 2 of 21 Social interest in dividend policy has increased due to the recent phenomenon of low growth and interest rates. According to Korea Stock Exchange, 755 corporations announced cash dividends from December 2015 to February 2016, 52 more than in the previous year. Total dividends also increased by 3.9 trillion won to a total of 18.0 trillion won. Likewise, there is a continuous increase in the number of cases of domestic firms returning shareholder profits with cash dividends. However, among pharmaceutical and biotech industries, this tendency is reversed. Recently, in the years following a boom in R & D investment in new drugs, these firms seem to be focusing on securing R & D funds for future sustainable growth rather than focusing on dividends. In a 2018 study, the 20 highest R & D-investing firms of all listed pharmaceutical or biotech firms in 2016 were analyzed to find the correlation between cash dividends and R & D investment [5]. Many of those firms either reduced cash dividends or did not distribute them at all. The highest investing firm, Celltrion, invested 39% of its sales, or 264 billion won. Celltrion distributed cash dividends for three years, from 2010 to 2012, but has not distributed them since. Following Celltrion, Hanmi Pharmaceutical, which is second in R & D investment (162.6 billion won), only issued cash dividends once during the 2010s. That was in 2015, when Hanmi Pharmaceutical reached an all-time high in the amount of technology exports. This led experts to determine that domestic pharmaceutical or biotech firms that focus on domestic demands such as developing generics are now inclined to invest stockpiled cash in R & D rather than on dividends. In other words, as top firms are spurring R & D for entrance to the global market, they are expanding R & D investment rather than returning cash to shareholders. Management plays an important role in corporate decision making for the benefits of shareholders [6,7]. Its foremost goal is to maximize the value of the firm and increase the market value of its stock [8,9]. In general, managers appear to firmly believe that the market values companies with a stable dividend policy [10]. However, there is evidence that firms that have positive investment opportunities either offer no payout or pay out very little compared to other firms, and that trend is spreading to all firms regardless of investment opportunities [11]. These findings suggest that the ideal dividend policy for firms with positive growth prospects is one in which cash is channeled to corporate insiders by lowering or eliminating the dividend. The biotechnology industry is characterized by particularly high-risk, long-term development and lengthy commercialization periods, in part because it is a rapidly-evolving, high-tech industry that depends on entrepreneurialism and innovation [12]. The innovation of these firms, which is generally believed to be excellent, is measured by the intensity of R & D. That innovation is driven by investment in R & D, which increases both profitability and future growth opportunities of the firm [13]. Due to the increasingly global biotech market, firms must substantially invest in R & D [14]. With this in mind, a biotech company in a small country such as Korea requires a consistent, low-cost source of large amounts of capital in order to be sustainably successful. Relatively little research has been conducted on the unique relationship between intensity of R & D and dividend policy among biotech firms. Regarding this, the study conducted its empirical analysis by using 18,253 firm-year observations (which included 1667 biotech firms for the period from 2000 to 2017 in South Korea) and discovered the following outcomes. First, we found there to be a negative correlation between R & D intensity and dividend payout among biotech firms. Second, internal cash holding is positively correlated to the long-term value of the firm. Furthermore, stock dividends are the only effective tool to satisfy investor demand for dividends while retaining internal funds. This study also found that, while firms outside of the biotech industry often distribute cash dividends when they reach the maturity stage of the corporate lifecycle, that is not the case for biotech firms in an R & D steady state. Due to delayed profitability resulting from large-scale, consistent R & D investment and the long-term lifecycle within the industry, the relatively weak connection between biotech firms with high R & D intensity and dividend payouts are observed at every level of maturity. Finally, we found that firms with high R & D intensity increase firm value through internal funds and a policy of Sustainability 2019, 11, 4837 3 of 21 low dividend payout. Several additional tests were conducted to determine that the findings of this study were still valid by the robust regressions in estimating specifications. This study makes the following contributions. First, our study is one of the first to examine the consequences on the dividends of the biotech firms with high R & D intensity. Prior studies report that R & D drives innovation and has a persistent, positive long-term effect on firm value [15], and they focus primarily on the effect of R & D on firm value. To achieve this, continuously funded R & D investment is crucial. However, the literature does not provide much evidence on the financing sources for aiding R & D activity. By reporting R & D intensity is negatively correlated to dividend payout even if the firms have excess cash holdings, this study contributes to the literature that attempts to link biotech companies with high R & D to financing sources through dividends policy. Second, this study offers an in-depth analysis by considering various types of dividends and industries. Most studies have concentrated only on the cash dividends and general dividend tendency of the firms, implying that firms with high profitability are likely to distribute the earnings in the form of dividends to satisfy shareholders, but the opposite is true for biotech firms. The dividend policies of biotech firms with high growth opportunities and R & D intensity differ in that, since external financing through the capital market can reveal sensitive information about the firm to the competitors, many R & D-intensive biotech firms choose to finance internally via reducing dividends. This paper is structured as follows. In Section2, we review previous literature—mainly related to biotech firms and the effect of R & D intensity of dividend policy—and present our hypotheses. In Section3, we share our research design and dataset, which was used to test our hypotheses.