The Complimentary Relation between Financial and Non-Financial Information in Explaining Prices, Equity Returns and the Degree of Investor Sophistication

Abstract

We examine whether financial and non-financial variables are value relevant on a stand alone basis and together in explaining returns, market value of equity and the degree of investor sophistication for a sample of drug development companies. We use patent count, number of collaboration and the probability adjusted portfolio of drugs under development as proxies for non-financial information and earnings as the main proxy for financial information. Although drug companies invest significant amounts in research and development, and these costs are usually expensed as incurred, earnings are value relevant in explaining cumulative abnormal returns around earnings announcement dates, annual returns, and equity prices. These results suggest that prior findings regarding the [lack of] value relevance of financial information cannot be generalized across industries. We also find that non-financial information is value relevant in explaining annual returns, equity prices and the degree of investor sophistication. Furthermore, non-financial variables are still value relevant after controlling for financial variables suggesting that the two types of variables are complimentary.